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CORRECTED-ANALYSIS-India's central bank stuck in damage control mode
March 14, 2012 / 7:18 AM / in 6 years

CORRECTED-ANALYSIS-India's central bank stuck in damage control mode

(Corrects reference in quote in paragraph 6 to government, not
    By Suvashree Dey Choudhury	
    MUMBAI, March 14 (Reuters) - Over the past two years,
India's central bank was raising rates in a futile effort to
contain stubborn inflation, as the government fumbled on fixing
decrepit infrastructure and other supply bottlenecks in the
    Now, it has switched to pumping huge amounts of cash into
the banking system to cool another government-led crisis, a
funding crunch caused by heavy public borrowing to finance
popular subsidies on fuel and other goods.	
    For the Reserve Bank of India, 2012 is shaping up as another
year of damage control for a populist government's excesses
rather than pursuit of its own priorities of boosting investment
and containing inflation.	
    This could leave the economy trapped in an unhealthy
confluence of high inflation and slowing growth, with little the
RBI could do -- other than easing bank funding -- to encourage
investment or to direct cheaper money to the most stressed parts
of India's supply chain.	
    "It is a mistake to look at the RBI always as a vacuum
cleaner for the mess the government makes," said Rajeev Malik,
senior economist at CLSA Singapore. "The government needs to be
more accountable. 	
    "I agree that politically (the government) doesn't have the
teeth to bite. But there is so much dirt being shoved under the
carpet that it is coming out the other side."	
    Fresh from a debacle in state elections, the ruling
Congress-led coalition is likely to fill its budget for the next
12 months, to be unveiled on Friday, with more sops and
unbridled spending on populist measures such as free food and
cheap fuel, doing little to address India's deeper economic
    Even if the Congress party were to grapple with tough
reforms to shore up tattered government finances and improve
crumbling infrastructure -- with 40 percent of the country's
food production perishing before it reaches consumers -- it
would be unlikely to get support from its recalcitrant coalition
partners, let alone the opposition.	
    The central bank has been forced to step into this policy
vacuum, announcing in quick succession two large reductions in
mandatory reserve levels for banks.	
    The latest, last week's surprise 0.75 percentage point cut
in the cash reserve ratio, was meant to ease a cash crunch in
the banking system that progressively worsened over the past
year as inflows into the country dried up and inflation eroded
    To RBI-watchers, the central bank appeared to have made a
secondary goal -- ensuring the banking system is liquid and able
to lend -- a priority over price stability, albeit reluctantly
given worries about high oil prices.    	
     "I think the RBI will have to go with a dovish stance now,"
said Sanjay Mathur, head of research and strategy at Royal Bank
of Scotland.	
    "There will be huge pressure on the RBI to cut rates as it
is easier for the RBI to cut rates than for the government to
reduce borrowing." 	
    Policy rates were raised 13 times since March 2010 to bring
down double-digit inflation. That sharp rise in the cost of
borrowing has taken a heavy toll on economic growth. 	
    On average, economists estimate growth in the fiscal year
ending in March 2013 will be 7 percent, a far cry from the 9
percent pace of expansion that policymakers in Asia's
third-largest economy had taken for granted just a year ago.	
    It might make sense, economists said, for the RBI to admit
to the futility of its battle against inflation -- which is
largely due to supply bottlenecks and high oil and commodity
prices, and has anyway stabilised in recent months around 7
percent, albeit still well above its comfort zone of 4-5 percent
-- and try instead to push up the pace of growth.	
    "The RBI's actions on the CRR (cash reserve ratio) and bond
purchases don't suggest that inflation is a top priority," said
Hitendra Dave, global markets head at HSBC India.	
    "They have taken cognizance of the fact that inflation is
headed in the direction they want but growth can create a two-
to three-year problem."	
    Three of 20 economists polled by Reuters expect a cut to the
repo rate, India's main policy rate and now at 8.5 percent, when
the RBI reviews policy on Thursday. 	
    "Given the growth outlook and inflation outlook for the year
ahead, the repo rate at 8.5 percent would be too restrictive,"
said A. Prasanna, economist at ICICI Securities Primary
Dealership and one of those forecasting a rate cut. 	
    "While global oil prices pose some upside risk to the
inflation outlook, I expect the RBI to view the recent rise as
driven by temporary supply-side factors," Prasanna said.	
    The cut in the cash reserve ratio should ease banks'
struggle with a shortage of cash in the system, where the
average daily deficit has run as high as 2 trillion rupees ($40
    But the central bank faces an uphill battle to boost growth.	
    There's plenty of evidence that RBI Governor Duvvuri
Subbarao's prolonged fight against inflationary  pressures,
which were beyond the control of demand-side monetary measures,
did more damage than good to the economy.	
    One side-effect was to lock in high funding costs for most
banks, which tried to attract deposits with high fixed rates and
may now be reluctant to pass on any immediate rate cuts to
    Lower rates may also merely make it easier for a spendthrift
government to borrow more, further crowding out the sort of
investment the faltering economy badly needs.	
    What's more, the multitude of woes afflicting the economy,
from poor infrastructure to policy uncertainty, have dampened
businesses' appetite for loans.	
    The incremental credit-deposit ratio, which reflects fresh
demand for loans in proportion to deposits, slumped to 76.6
percent in the period from April 2011 to this February, compared
with 95.5 percent in the same period last year.	
 (Editing by Vidya Ranganathan and Edmund Klamann)

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