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RBI monetary policy: Focus shifts to January review now

It is clear that there will be a softening of interest rates only from January, going by RBI's guidance in October. The central bank says headline inflation has been below the RBI's projected levels in the last two months.

twitter-logoAnand Adhikari | December 18, 2012 | Updated 18:55 IST

Anand Adhikari
History appears to be repeating itself in the dance between the Reserve Bank of India (RBI) and the finance ministry.

A day before the mid-term policy review in October, Finance Minister P. Chidambaram came out with a fiscal consolidation plan, which made a compelling case for a repo rate cut by RBI Governor Duvvuri Subbarao.

RUN-UP TO THE REVIEW:Another CRR cut in the offing?

It addressed Subbarao's concerns about reining in the fiscal deficit. The five-year fiscal consolidation roadmap targeted reducing the fiscal deficit to 3 per cent by 2016/17 from 5.9 per cent in 2011/12.

But the RBI Governor wasn't convinced as it looked a mere promise - in the past such promises had always been broken.

In 2011/12, the fiscal deficit target was 4.6 per cent but the government ended the year with a much higher deficit of 5.9 per cent.

So, Subbarao stayed away from reducing the repo rate. However, he lowered the cash reserve ratio (CRR) - the level of deposits banks have to compulsorily maintain with the RBI - to infuse more liquidity into the system and spur growth.

In addition, the RBI has also been undertaking open market operations (OMOs) actively to release liquidity into the system by buying government securities from banks.

A similar story played out before the mid-quarter monetary review this morning (Tuesday, December 18).

On Monday, the finance ministry came out with another set of numbers, signalling that it wanted the RBI Governor to walk with the government in supporting growth.

The ministry revised its GDP growth projections for 2012/13 down to 5.7-5.9 per cent, much below its earlier estimate of 7.6 per cent. It also said inflation would moderate to around 6.8-7 per cent by March 2013.

Clearly, these numbers were the perfect setting for a reduction in policy rates, especially the repo rate, in view of growth bottoming out and inflation moderating.

ROOM FOR WORRY?Industrial output up, but keep your hopes down

But once again, the RBI governor did not bite. The RBI has kept the CRR unchanged at 4.25 per cent and also refrained from tinkering with the repo rate, which stands at 8 per cent.

It is clear that there will be a softening of interest rates only from January, going by the RBI's guidance in October this year. The central bank says that headline inflation has been below the RBI's projected levels in the last two months.

It notes that while inflation may edge higher over the next two months, emerging patterns reinforce the likelihood of steady moderation in inflation going into 2013/14.

ECONOMY WORRIES:Challenging times ahead for deficit-driven economy

From that point, if inflation pressure eases, the RBI has said that monetary policy may shift focus and respond to the threats to growth.

This is good news for the economy.

In its policy statement today, the bank said that it is "closely monitoring the evolving growth-inflation dynamic and will update the formal numerical assessment of its growth and inflation projections for 2012/13 as part of the third quarter review in January 2013".

All eyes are now on the quarterly review in January. If there is a softening of interest rates, it will come as a big relief for both corporate entities and retail borrowers.

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