India Central Bank Resists Rate Cut Pressure as Inflation Spikes

(Bloomberg) --

India's central bank defied expectations for an interest rate cut, preferring to keep its arsenal dry in case growth in Asia's third-largest economy struggles to recover strongly in coming months.

The decision not to cut in the face of spiking consumer prices is likely to burnish the Reserve Bank of India's inflation-fighting credentials, three years after it adopted a 4% medium-term target. The six-member Monetary Policy Committee headed by Governor Shaktikanta Das decided to wait and see how the five rate cuts already delivered this year pan out before it does more.

Read more: India's Central Bank Just Did Something Crazy: Daniel Moss

The MPC unanimously voted to keep the repurchase rate at 5.15%, confounding both economists and markets. None of the 43 economists surveyed by Bloomberg predicted the move, with Das telling reporters after the rate decision that the pause was temporary.

“The RBI is keeping some of its powder dry for later,” said Teresa John an economist with Nirmal Bang Institutional Equities Pvt. in Mumbai. “We believe space for rate cuts -- 40 to 50 basis points -- is likely to open up in the first half of the next fiscal year as growth is unlikely to be significantly above 6%.”

The surprise move was prompted by a spike in inflation in October above the central bank's 4% medium-term target, and follows less than a week after data showed growth slowing to a six-year low. The RBI, has lowered rates by a total 135 basis points. with cuts in each of its policy meetings this year until now, though banks haven't passed on all of that easing to borrowers.

“There is space available for further monetary policy action,” Das told reporters. “There is a need to maximize the impact of rate reductions,” he said adding that such actions could not be “mechanical.”

Sovereign bonds and stocks declined, with the yield on the benchmark 10-year bonds rising 13 basis points to 6.60%. The rupee rose 0.1% to 71.4250 per dollar.​

While central banks around the world have been loosening monetary policy to offset a growth slowdown, the RBI seemed more worried that food prices are likely to remain sticky.

“The RBI did indicate that it recognizes there is policy space to cut further, but policy makers appear to be keen to build inflation credibility amid higher prints,” Rahul Bajoria and Ashish Agrawal, analysts at Barclays Bank Plc. wrote in a note. “Despite cutting growth projections sharply, it has left the door open for future cuts as long as inflation comes down in line with its projections.”

The RBI cut its full-year growth forecast for the fiscal year through March to 5% from 6.1%, while adding the inflation print in October was “much higher than expected.” The central bank raised its inflation forecast for the second-half of the fiscal year to 4.7%-5.1% from 3.5%-3.7% seen previously.

Transmission Woes

A crisis among shadow lenders and a build-up of bad loans at banks have curbed lending in the economy. The spread between the central bank's key policy rate and the weighted average lending rate on outstanding loans from commercial banks is the highest in data going back to February 2012.

Das said the central bank was aware of vulnerability among the top 50 shadow banks it was monitoring closely. It was trying to encourage banks to lend more to the crisis-ridden shadow banking sector, which has been a huge driver of domestic consumption by way of consumer loans in recent years.

As such he indicated that monetary policy alone could not get the economy out of the slowdown and the government too needed to deploy counter-cyclical measures to boost activity.

Prime Minister Narendra Modi's government has announced a slew of measures, including $20 billion in tax breaks to companies. It's also merged weak state-run banks with stronger ones in a bid to spur lending, eased foreign investment rules and set up a special real-estate fund to salvage stalled residential projects.

What Bloomberg's Economists Say

The Reserve Bank of India's shock hold on interest rates suggests rising inflation is a bigger concern than slumping growth. If so, this raises the prospect of another hold at its February review. The failure to ease -- the consensus forecast was for a 25 basis point cut, while we expected a deeper reduction -- will delay a recovery in the economy.

-- Abhishek Gupta, India economist

Click here to read the full report

Despite these measures a recovery looks uncertain. While Das said there were “green shoots,“ most high frequency indicators show that a rebound is some way off.

The RBI's decision “defies the expectation of the market and also the body language of the central bank over the last six months or so when they seemed amenable toward out-of-the-box thinking and being very proactive in terms of supporting growth,” said Taimur Baig, chief economist at DBS Bank in Singapore.

--With assistance from Tomoko Sato, Kartik Goyal and Ragini Saxena.

To contact the reporter on this story: Anirban Nag in Mumbai at anag8@bloomberg.net

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Karthikeyan Sundaram, Jeanette Rodrigues

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