MUMBAI: India’s central bank has cut its main interest rate by 25 basis points in the third such move this year, but said there was “little space” for further reductions to help the slowing economy.
After meeting in Mumbai, the Reserve Bank of India (RBI) said the benchmark repo rate, at which it lends to commercial banks, would fall to 7.25 percent, as expected by most economists.
After the decision, India’s Finance Minister P. Chidambaram, said that there was “scope for more rate cuts, if inflation came down further.”
India’s headline inflation eased to a three-year-low of 5.96 percent in March, but the consumer price index is at 10.39 percent, led mainly by high food prices.
Explaining the rate cut, the RBI governor Duvvuri Subbarao said “growth had decelerated continuously,” forecasting expansion of 5.7 percent in the new fiscal year — far below the government’s estimate of 6.0-6.5 percent.
But Subbarao warned that there were “significant risks” to inflation in the near-term and said that “monetary policy cannot afford to lower its guard against the possibility of a resurgence of inflation pressures.”
The governor also struck a cautious tone about future rate cuts, saying: “Overall, the balance of risks stemming from our assessment of the growth-inflation dynamics yields little space for further monetary easing.”
The Indian rupee weakened as the central bank disappointed markets with its hawkish tone.
“I feel lucky to have a 25 bps cut after reading the macroeconomic report yesterday,” said Vikas Babu Chittiprolu, a senior foreign exchange dealer with state-run Andhra Bank.
“RBI is clear that it is targeting inflation and will not compromise on inflation in favor of growth. Highlighting of the current account deficit is again a worry,” he added.
Bets on future rate cuts have been significantly reduced post the policy statement, hurting all markets including bonds, equities and the rupee.
Analysts now expect only another 25 basis point rate cuts in this calendar year.
The partially convertible rupee closed at 53.935/945 per dollar, weaker than its close of 53.81/82 on Thursday.
On the week, however, the rupee rose 0.8 percent as sentiment ahead of the policy had been broadly bullish, helped by the cut in withholding tax on debt investments by foreigners.
India recently cut the tax on interest payments to foreigners on government and corporate debt to 5 percent from up to 20 percent for a two-year period starting June, in a bid to draw further inflows to bridge the current account deficit and polish its reformist credentials.
Traders said the policy statement prompted investors to cover their short dollar positions and that rupee is likely to trade with a weaker bias next week.
“There is not much inflows expected. I see the rupee holding in a 53.70 to 54.50 range next week,” Chittiprolu said.
In the offshore non-deliverable forward PNDF, the one-month contract was at 54.07 while the three-month was at 54.60.
In the currency futures market INRFUTURES, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed around 54.08 with a total traded volume of $4.6 billion.
The RBI’s decision to cut rates had been forecast by economists and business leaders, who have been calling for lower borrowing costs to help the economy, which grew at an estimated 5.0 percent in the full year to March.
Indian shares fell as much as 0.91 percent to 19,555.05, reacting to the news that further rate cuts were unlikely in coming months, but recovered marginally to 19,613.10 points, down 0.62 percent.
The cash reserve ratio — the percentage of deposits banks must keep with the central bank — was kept unchanged.
The RBI’s decision to cut rates had been forecast by economists and business leaders, who have been calling for lower borrowing costs to help the economy, which grew at an estimated 5.0 percent in the full year to March.
But they are unsure when the next rate cut could come.
Goldman Sachs chief India economist Tushar Poddar expects the RBI to proceed slowly with future rate cuts. “The forward guidance suggests to us that the RBI is unlikely to cut again in its next policy meeting (of June 17),” he said.
But Nomura economist Sonal Varma said that: “Given the recent fall in commodity prices, upside risks to inflation are likely to remain contained... creating more space for future rate cuts,” in a note to clients.
Industry body Associated Chambers of Commerce and Industry of India (Assocham) criticized the RBI for being “over-cautious” on potential risks to India’s economy.
“While there is a lot the government should do to improve governance, the RBI should not wash its hands off at the cost of economic growth, which is a must for fulfilling aspirations of the people,” Assocham president Rajkumar Dhoot said.
The RBI reiterated that the government should take measures to encourage investment, as policy action was not enough to stimulate the economy.
Subbarao said the biggest risk to India’s economy came from the current account deficit, which widened to a record 6.7 percent of GDP in the December quarter.
The government, led by Prime Minister Manmohan Singh, has been battered by a spate of corruption scandals and is keen to revive economic growth before facing voters in general elections due in 2014.
The World Bank earlier lowered its forecast for growth to 6.1 percent for the new fiscal year which started in April, from the 7.0 percent projected six months ago.
The RBI slashed rates by 25 basis points at its previous two meetings in March and January. Rates had previously been on hold for nine months.
