Sorry, no gifts: Why the RBI held back on rate cut, again

The Reserve Bank of India (RBI) has chosen to keep its powder dry in the face of strong inflationary pressure persisting in the economy.

In its mid-quarter monetary policy review on Monday, RBI kept interest rates unchanged, but injected liquidity of around Rs 17,000 crore into the system through a reduction in cash reserve ratio (CRR) that banks are mandated to maintain.

CRR was cut by half-a-percentage point to 4.50 per cent.

RBI's policy statement showed it to be pleased with the recent policy measures of the Union government and even hinted that it wants to bring down rates to help revive economic growth.

"As policy actions to stimulate growth materialize, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management," the central bank said in its policy statement.

It didn't trigger a cut in interest rates, however, as it felt last week's measures to raise the price of diesel and ration subsidised cooking gas were overdue, and strong upward pressure on price level in the economy persist.

Two developments continue to keep RBI anxious, it seems.

The decision of European Central Bank and US Federal Reserve to unleash more liquidity into global economy in order to bolster their economies has negative implications for India. RBI points out these measures will push up the prices of commodities.

It's really crude price that RBI is worried about as earlier bouts of liquidity have shown up in crude prices firming up. If crude price keeps increasing from its current level of about $114 a barrel, it would immediately widen the potential subsidy the government owes state-owned oil marketing companies.



In the domestic economy, August's headline inflation number of 7.6 per cent came as a shock as it was higher than market expectations. Moreover, the internals of inflation data showed that core inflation - inflation after stripping it of food and fuel items - has begun to increase again.

The primary aim of RBI's tight monetary policy since early 2010 has been to rein in core inflation by compressing demand in the economy.

These two factors appear to have forced RBI to adopt a cautious stand despite a flurry of policy actions last week by the central government.

The liquidity that has been injected into the system should cheer banks, still. The weekend would have seen liquidity drained out of the banking system as companies pay the second installment of advance tax for 2012-13. In addition, the approach of festival season usually sees a higher demand for cash.

For the moment, RBI's stance remains unchanged: fighting inflation is Priority No. 1. It is unlikely to be hasty in reversing painful steps of the last two years until signals on inflation turn positive.