RBI leaves rates unchanged

Future policy dependent on rupee.

By R. Chandrasekaran

CHENNAI: The Reserve Bank of India has left key interest rates unchanged, citing both internal and external challenges ahead. The fate of the future policy will depend on the growth and inflation trajectories, besides the current account deficit position in the coming months. However, much will depend on how well the Indian currency behaves until the next month, when the central bank could revisit the rates.

The RBI cited increased risks of food inflation, a sharp fall of the rupee and an uncertainty over the inflows from foreign funds for deciding to the rates untouched. While some are disappointed with the central bank’s decision not to reduce interest rates, it was of no surprise as the risks perceptions are well known.

As if to support the RBI’s concerns, an announcement came on Monday that trade deficit has widened to $20.1 billion in May from $17.8 billion in the preceding month, presumably on higher imports of gold, which was available at a cheaper rate than earlier.

Import of gold and silver recorded close to 90 percent increase to $8.5 billion in May over the last year. While the dollar value of these commodities increased from $7.5 billion in April, in terms of percentage, April recorded 138 percent growth suggesting that May upside was slower.

Overall imports grew 7 percent to $44.65 billion, while exports slipped 1.1 percent to $24.51 billion indicating first yearly drop in five months time. In comparison, April recorded 10.9 percent growth in imports to $41.95 billion whereas exports managed to post 1.6 percent gain.

While the government and the RBI have taken measures to curb import of gold, the fall in exports will remain a big concern. Sops announced by the government for exporters are expected to lift exports performance in the coming months\. However, the weakening rupee could lift oil import bill to upset the government’s calculations. Therefore, a strong export performance and inflow of foreign funds alone could save the deteriorating current account deficit or the balance of payment position.

The consumer price index for May also slowed moderately only, whereas Index of Industrial Production (IIP) came in below than expected for April. Going forward, the weakening rupee could increase the wholesale price index (WPI) to hurt any chances of interest rate relief.

The RBI, thoroughly cornered when dealing with the monetary policy, pointed out the risks ahead while dealing with external factors. Shifts in world market sentiment could trigger unexpected reversal of capital from emerging markets thereby impacting the outlook unfavorably and India is no exception to this, it said.

The domestic scenario, too, does not offer much scope, with economic conditions continue to be weak — hurt by infrastructure bottlenecks, subdued domestic demand, supply constraints, and poor investment sentiment.

Given the ground realities, the RBI stated that, “Future monetary policy stance will be determined by how growth and inflation trajectories and the balance of payments situation will evolve in the months ahead.”

Interestingly, in a recent survey on business confidence in the fourth quarter by the Federation of Indian Chambers of Commerce and Industry,  nearly 74 percent of the respondents had said that if the interest rates are not reduced, it will have serious impact on their investment proposals. FICCI president Naina Lal Kidwai said at the time, “As the monetary transmission mechanism has been weak, RBI will need to focus on the outcome of lower lending rates by banks.”