RBI holds key rates; eases banks' liquidity ratio by 50 bps

The Reserve Bank of India (RBI) has decided to keep its key policy rates unchanged, belying expectations of another 25 basis point reduction in the repo rate after the 0.25 per cent reduction in the key rate announced on 15 January.

RBI Governor Raghuram RajanIn its sixth bi-monthly monetary policy review today, RBI decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.75 per cent and keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL).

The reverse repo rate under the LAF will also remain unchanged at 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 8.75 per cent.

The central bank, however, announced a reduction in the statutory liquidity ratio (SLR) of scheduled commercial banks by 50 basis points to 21.50 per cent of their net demand and time liabilities (NDTL) from 22.0 per cent beginning 7 February 2015.

RBI also decided to replace the export credit refinance (ECR) facility with the provision of system level liquidity with effect from 7 February 2015.

While business and industry have been clamouring for a reduction in lending rates citing the resurgence of growth under the new GDP formula, RBI said the decision to keep rates unchanged has been taken on the basis of an assessment of the current and evolving macroeconomic situation.

However, the argument that high interest rates are holding up business expansion  and economic growth does not hold good since the high growth of 6.9 per cent, estimated anew for the financial year 2013-14 has been achieved under higher interest rate regime.

RBI said it would continue to provide liquidity under overnight repos of 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 7-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system through auctions, and continue with daily variable rate term repo and reverse repo auctions to smooth liquidity.

A slight softening of cereal prices and a sharp seasonal fall in vegetable prices have moderated the trajectory of headline inflation, despite persistent firmness in the prices of protein-rich items such as milk, meat and pulses. RBI noted that retail inflation, measured by year-on-year changes in the consumer price index (CPI), edged up in December on the expected reversal of favourable base effects that had tempered upside pressures since June.

However, CPI registered a monthly decline for the first time since February 2014. Benign expectations were also mirrored in surveys of professional forecasters and industry conducted periodically by the Reserve Bank.

While there has been some stability on the price front, RBI noted that seasonal increases in vegetable prices, which typically set in around March, have to be monitored carefully.

The announcement of massive quantitative easing by the European Central Bank (ECB) in late January has reinvigorated financial risk taking, boosting stock markets across the world, even though many market participants have read the softness in crude prices and the ECB's announcement as signifying a weaker global economic outlook.

RBI noted that bond yields in advanced economies (AEs) have fallen to historic lows on the growing belief that the US Fed will stay off the market longer than previously thought. Financial markets, however, remain vulnerable to uncertainty surrounding monetary policy normalisation in AEs as well as possibly weaker growth in China and oil exporting EMEs.