RBI unlikely to budge yet on rates

A spate of long-delayed reforms unleashed by India to shore up government finances is unlikely to be rewarded by an immediate interest rate cut, with the Reserve Bank of India expected to hold rates steady on Monday as it wages a protracted battle with inflation.

In an unexpected 24-hour frenzy, New Delhi opened its supermarkets and airlines to foreign investment, raised the price of subsidised diesel and announced planned share sales in four state companies as it looks to jump-start flagging growth.

The measures aim to rein in a ballooning fiscal deficit and avoid a credit rating downgrade to junk.

"As an immediate impact, business and consumer sentiment will improve, the stock market will improve," said Samiran Chakraborty, an economist at Standard Chartered Bank.

"But I don't think the RBI will cut rates after these measures because the impact of these steps on the supply side will only be in the medium term."

The RBI has held borrowing costs steady since a deeper-than-expected 50 basis point cut in April, and has repeatedly called on the government to do its part by improving its fiscal position.

Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, said his government has already done enough in the last couple of days but it is for RBI to feel the need to create more fiscal space. However, inflation remains above the comfort range, he added, not willing to second guess what the central bank may do at its policy review today.

Thursday's diesel price hike had initially prompted market participants to speculate that the RBI may lower interest rates on Monday, but a spike in August inflation data on Friday from July's near three-year low put a damper on such expectations.

India's wholesale price index rose a higher-than-expected 7.55 per cent in August from a year earlier, mainly driven by higher food prices.

Earlier, Godrej group chairman Adi Godrej told NDTV: “I'm in favor of reduction of rates, CRR.”

The diesel price rise will aggravate short term inflation.

But, along with the measures unveiled on Friday to liberalise ownership of supermarkets and other industries, it shows the government is serious about fiscal consolidation and encouraging investment and may make RBI Governor Duvvuri Subbarao more inclined to ease monetary policy sooner rather than later.

"It is time the RBI got rid of its obsession with the inflation numbers while completely ignoring grave situation thrown in by constantly decelerating industrial growth," ASSOCHAM President Rajkumar Dhoot said in a statement on the eve of the central bank reviewing its credit policy.  

It is merely not enough to pass the blame on government and suggesting that the central bank has run out of the monetary tools in the wake of a large fiscal deficit and the rising current account deficit, the industry chamber said.  

The government kicked into gear late last week after a wave of corruption scandals had weakened it and led to months of little substantive policy action, souring investor sentiment and putting at risk India's investment-grade credit rating.

Analysts have cut their economic growth forecast for the current fiscal year - some to as low as 5.1 per cent - amid stalling industrial and manufacturing activity and concerns about the current account and fiscal deficits and lack of reforms. By comparison, the prime minister's economic advisory panel's trimmed-down forecast of 6.7 per cent looks optimistic.

Bankers are also divided on their view on the steps RBI could take today. While SBI chairman Pratip Chaudhuri does not see the repo rate coming down but expects a 1 per cent cut in the CRR, Union Bank head D Sarkar and OBC chief SL Bansal hope the RBI will ease repo rates by 0.25 per cent.

"...the RBI is not going to be in the mood to cut and we expect it will remain on hold on Monday. The hikes in fuel prices will be welcomed by the RBI, but since the steps will only contain and not prevent fiscal slippage they will not be sufficient to trigger an easing cycle," Leif Eskesen, chief economist for India and ASEAN at HSBC, said on Friday.  

In a Reuters snap poll of 18 economists on Friday, all but two expected the RBI to leave its policy repo rate unchanged at 8 per cent, in line with a poll conducted earlier this month.

The snap poll was taken before Friday's reform announcements.

The median estimate for the repo rate at the end of 2012 was 7.75 per cent, unchanged from the previous poll.

Meanwhile, the US Federal Reserve's aggressive stimulus plan last week complicates the RBI's task, as the injection of liquidity delivered by the Fed's measures may push up global commodity prices and add to inflationary pressures in India.

With inputs from PTI, Thomson Reuters 2012