MUMBAI The Reserve Bank of India (RBI) left interest rates on hold on Tuesday but cut the cash reserve ratio for banks, defying pressure from the government to lower rates for the first time since April but also indicating it may ease policy in early 2013.
Leaving the policy repo rate unchanged at 8.00 percent was in line with forecasts in a Reuters poll. But rate cut expectations had grown after India's finance minister on Monday outlined a plan to cut the country's hefty fiscal deficit, which is a concern of the central bank.
Finance Minister P. Chidambaram appeared disappointed with the central bank's decision, as were investors, who pushed bond yields and swap rates higher. Indian stocks fell for the worst performance in Asia on the day.
Unusually, RBI Governor Duvvuri Subbarao gave fairly explicit policy guidance, saying the central bank might ease policy in January to March, the final quarter of the fiscal year, when it expects inflationary pressure to ease. That implied it will not cut rates at its next review on December 18.
"There's a positive that RBI has said there's a likelihood of easing in the Jan-March quarter. Looks like the RBI wants inflation to peak out before cutting rates, so we shouldn't expect anything in December," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
The central bank said it expects inflation -- which hit a 10-month high of 7.8 percent in September -- to rise before easing in the final quarter of the fiscal year.
"While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13," Subbarao wrote.
RBI VS GOVERNMENT
Investors, companies and the government have clamoured for a cut in interest rates to boost flagging growth. Interest rates have been on hold since April even as many other central banks cut rates, and remain some of the highest anywhere.
"Growth is as much a challenge as inflation," Chidambaram told reporters after the rate announcement.
"If government has to walk alone to face the challenge of growth, well, we'll walk alone," he said.
Since taking office three months ago, Chidambaram has made several moves to revive investment, clear economic bottlenecks and repair government finances. While he has sought support from the RBI in the form of policy easing, the hawkish Subbarao has said New Delhi needs to do even more.
"Government is doing its best to send a clear message that we are on the path to fiscal consolidation. And it is my hope that everyone will read and understand government's commitment to fiscal consolidation," Chidambaram said.
While the RBI is not statutorily independent, it operates with a high degree of autonomy and Subbarao has resisted calls in the past from New Delhi to ease policy.
"The government is an important stakeholder in the Reserve Bank's policy. So we understand that the finance minister has a position, he represents the government, and we have respect for what the finance minister says," Subbarao told a media briefing.
Credit Suisse Economist Robert Prior-Wandesforde said he had expected the RBI to "give the government a bigger pat on the back at this meeting," and had forecast 25 basis point cuts in both the repo rate and CRR.
"We wouldn't be surprised if the government felt that the central bank had not fulfilled its side of what could have been considered an implicit bargain at least," he wrote.
GROWTH DOWN, INFLATION UP
While Subbarao has kept rates on hold, he has been cutting CRR in order to inject more liquidity into the banking system and pressure banks to pass along earlier rate cuts to borrowers.
Chidambaram's plan to nearly halve the fiscal deficit in just over four years gave few specifics, but his announcement at a hastily called news conference on Monday was seen by financial markets as adding pressure on the RBI to cut rates.
Last month , New Delhi raised the price of subsidised diesel and eased rules on foreign investment in several industries.
"Recent policy announcements by the government, which have positively impacted sentiment, need to be translated into effective action to convert sentiment into concrete investment decisions," Subbarao said in the policy review.
Economic Affairs Secretary Arvind Mayaram said the government and central bank needed to work together.
"I hope they will consider next time ... before January, there is a need for rate cut," he said.
The RBI cut its GDP growth forecast for Asia's third-largest economy this fiscal year to 5.8 percent from 6.5 percent previously. It increased its projection for inflation in March to 7.5 percent from 7 percent earlier.
The RBI lowered the cash reserve ratio, the amount of deposits that banks must keep with the central bank, by 25 basis points to 4.25 percent, its lowest since 1976, which would inject 175 billion rupees into the banking system in order to pre-empt a potential tightening of liquidity.
In the Reuters poll, economists had been divided on whether or not the RBI would cut CRR.
Bond market investors were disappointed that the CRR cut suggested the central bank would delay expected bond purchases.
India's 10-year bond yield closed 5 basis higher at 8.18 percent and the one-year overnight indexed swap rate ended 12 basis points higher at 7.70 percent.
Sensex ended down 1.1 percent, making India the day's worst-performing market in Asia.
(Additional reporting by Neha Dasgupta and Swati Bhat in MUMBAI and Arup Roychoudhury in NEW DELHI; Editing by Neil Fullick)
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