Econintersect: The Reserve Bank of India (RBI) has announced just minutes ago that it is cutting interest rates from 8% to 7.75%. This move had been widely expected and was the first decrease in interest rates in nine months. An additional easing, which was not so widely expected, saw reserve requirements eased. Banks will now be required to hold 4% of their deposits as reserves with the RBI. The previous reserve ratio had been 4.25%. According to the Financial Times this will add $3.4 billion of liquidity to the banking system.
The Financial Times had the following:
The interest rate cut, from 8 per cent to 7.75 per cent, which was anticipated in the financial markets, was the first in nine months. It could mark a turning point for the Indian economy, which has suffered from a sharp fall in growth from more than 8 per cent to below 6 per cent and is now afflicted with high twin deficits in the budget and the current account.
Dr. D. Subbarao, Governor, Reserve Bank of India concluded his statement about the new policy announcement with the following:
Inflation has come off from its peak, but its further downward movement is going to be slow and gradual. On the other hand, economic activity has slowed, trailing well below its potential and opening up a negative output gap. What the economy needs most of all and most urgently is new investment. This will step up currently flagging aggregate demand and also ease the supply constraints so that existing capacity is fully utilised and new capacity is built up. A strong and effective supply response is particularly important for bridging the infrastructure gaps and correcting structural imbalances in other segments of the economy, including key food articles. Critical to this effort are a credible and comprehensive fiscal adjustment by the Government, implementation of structural reforms, hastening the approval process, and improving governance to inspire the trust and confidence of potential investors. The Reserve Bank, on its part, will have to calibrate monetary policy to the evolving growth-inflation dynamic and the management of the twin deficits risks.
Two graphs from the third quarter review released today show why the easing moves have been made.
Both GDP growth and inflation are in down trends, with the decline in GDP appearing more persistent. It appears the RBI is ready to risk, at least for now, the significant possiblity that inflation can move up more quickly than can GDP in order to arrest the decline in GDP. It has fallen from above 8% to about 5.5%.
See also the GEI Opinion article posted tonight by Ajay Shah, one of India's leading economists, with his thoughts written before the announcement. Dr. Shah is quite concerned about the inflation risks ahead.
- Third Quarter Review of Monetary Policy 2012-13 - Statement by Dr. D. Subbarao, Governor, Reserve Bank of India (Press release, Reserve Bank of India, 29 January 2013)
- Third Quarter Review of Monetary Policy 2012-13 (Dr. D. Subbarao, Governor, Reserve Bank of India, 29 January 2013)
- India’s central bank cuts interest rates (Victor Mallet, Financial Times)