Opinion: No Diwali bonanza for borrowers as Subbarao leaves rates untouched

Reserve Bank of India (RBI) Governor D. Subbarao has refused to give in to pressure from the government to lower interest rates. On Tuesday morning, delivering RBI's half-yearly review of monetary policy, Subbarao said the apex bank had decided to keep the repo rate unchanged at 8 per cent.

However, it has reduced the cash reserve ratio (CRR) by 25 basis points to 4.25 per cent. This move will infuse some liquidity in the market, releasing Rs 17,500 crore into the system.

Markets responded negatively to the news, with the Bombay Stock Exchange's Sensex tumbling 195 points soon after.

Subbarao cited rising inflation and the widening current account deficit and fiscal deficits for leaving interest rates untouched.

The RBI governor does not have much room to cut rates as inflation has remained high for some time now. Inflation projections for 2012/13 have already been revised upwards, from 7.3 per cent to 7.7 per cent.

Inflation, as measured by the wholesale price index (WPI), rose to 7.81 per cent in September 2012 from 7.55 per cent a month earlier. There was some respite in food inflation, which was at 7.86 per cent in September, against 9.14 per cent in August. However, inflation in manufactured goods has emerged as a new danger.

RBI is of the view that unless the macro-risks from inflation, fiscal and current account deficits recede, there is no room for a rate cut. The apex bank has drastically lowered its growth projection from 6.5 per cent earlier to 5.7 per cent in 2012/13. It has reasoned that the high fiscal deficit has impacted the macroeconomic climate and contributed to the investment downturn.

While Finance Minister P. Chidambaram has stated that the fiscal deficit would be contained at 5.3 per cent in 2012/13, the central government's deficit indicators have actually widened in the first five months of 2012/13.

Experts say that a fiscal roadmap, without any concrete moves on the ground, is not sufficient to take a call on interest rates. According to the RBI, the Centre's gross fiscal defcit ratio in 2012/13 is unlikely to see a significant improvement from the previous year. In fact, the RBI has suggested that there is a need to for further reforms, in addition to the measures taken since mid-September 2012.

While gross domestic product (GDP) growth is consistently falling, RBI has said in the past that it should not be blamed for keeping the interest rate high. The crucial domestic factor impinging on growth was policy uncertainties and lack of reforms, it said.

The RBI's move to cut the CRR by 25 basis points is consistent with its policy stance since the beginning of 2012 to create sufficient liquidity in the system. So far, it has lowered the CRR by 175 basis points (including today's move), the statutory liquidity ratio (SLR) by 100 basis points, the repo rate by 50 basis points and infused over Rs 1.7 trillion of liquidity through open-market purchases.

The only good news is from the domestic currency front. The rupee has been appreciating against the dollar after the measures taken by the RBI to check speculation and volatility early this year. This has reduced the danger of inflation seeping in through costly imports, especially of crude oil.

However, the RBI has said that the exchange rate is not a foolproof tool to address the "challenges of structural inflation that we face today".

Ultimately, fiscal policy needs to work towards "expediting supply side responses and keeping private consumption demand under reasonable control", says RBI.