January 27, 2009 / 6:06 AM / 9 years ago

RBI holds rates, asks banks to pass on easing

A man walks past the entrance of the Reserve Bank of India headquarters in Mumbai January 27, 2009. REUTERS/Arko Datta

MUMBAI (Reuters) - The Reserve Bank of India left its key interest rates steady on Tuesday, saying banks still had to pass on the benefits of previous cuts, but analysts expect another reduction in coming months to shore up the slowing economy.

Asia’s third-largest economy is poised to grow at 7 percent or less in 2008/09, its slowest in six years, the central bank said in its quarterly review, as a global downturn following the financial crisis hurt the economy much more than expected.

“To arrest the moderation in economic growth, it is critical that banks expand the flow of credit to productive sectors of the economy and do so at viable rates,” the central bank said.

It also warned that fiscal measures to rev up growth combined with slowing tax receipts and a raft of spending increases would sharply widen the federal government’s fiscal deficit, which economist said could blunt the impact of monetary easing.

“We need more cuts, we need more fiscal stimulus. But yes, additional fiscal stimulus would mean more government borrowing and will therefore offset the rate cuts somewhat,” said Sonal Varma, analyst at Nomura in Mumbai. “It will crowd out the private investments and may lead to some hardening in yields.”

Since the global financial crisis really hit India hard last September, the Reserve Bank of India (RBI) has cut its short-term lending rate by 350 basis points and slashed reserve requirements to keep credit flowing, while the government has taken a slew of fiscal steps to stimulate the economy.

“The unchanged interest rates are not a surprise. However, the tone of the statement and the factors the RBI highlighted are on the mark,” said Atsi Sheth, chief economist at Reliance Equities.

“It recognises that the transmission of monetary policy to the real economy via the banking system is the key priority over the next six months,” she said, adding she expected rates and cash reserve requirements to be cut by 100 basis points by June.

The central bank said there was now clear evidence of further slowdown as a consequence of global downturn and urged banks to do more in response to its rate cuts.

“In the Reserve Bank’s view, the policy easing done by it in the last few months allows for considerable room for banks to respond more actively to the policy cues,” it said.

STEADY RATES

The central bank left its lending rate steady at 5.5 percent and its reverse repo rate , at which it absorbs surplus cash from the system, unchanged at 4.0 percent.

It had been narrowly tipped to hold interest rates steady in a Reuters poll last week.

It also kept the cash reserve ratio , the amount of funds banks have to keep on deposit with it, at 5.0 percent.

The 10-year bond yield spiked to 5.95 percent after the policy announcement from the previous close of 5.72 percent, but has slipped to 5.84 percent in afternoon trade. The rupee rose to 48.81/82 from the previous close of 49.27/29.

The central bank’s cut in its growth forecast from October’s 7.5-8.0 percent, brought it broadly in line with recent government and market predictions of a marked slowdown from growth of 9 percent or more over the last three fiscal years.

Wholesale price inflation was projected to fall below 3 percent by the end of the fiscal year in March from peaks near 13 percent scaled in August, but the central bank noted consumer price inflation was yet to moderate.

WIDENING DEFICIT

The RBI said the federal government’s fiscal deficit for 2008/09 was set to balloon to at least 5.9 percent of gross domestic product from earlier estimated 2.5 percent, possibly bringing the total federal and state shortfall to 8.5 percent.

The estimates highlighted the limited scope for more stimulus even though cuts in factory gate taxes and import duties and $4 billion extra spending announced in past months paled in comparison with China’s nearly $600 billion package.

The central bank said while circumstances warranted some reversal of the fiscal consolidation of the last several years, it was critically important to resume the process once the immediacy of the crisis had passed.

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