India keeps rates steady on concern of inflation

India Dispatch: Despite the Indian government's recent flurry of economic reforms sparking hopes for a rate cut, the country's central bank has chosen to keep interest rates on hold.

A vegetable market in Ahmedabad. The monsoons have not brought enough rain and food inflation could rise as a consequence. Ajit Solanki / AP Photo

MUMBAI // Despite the Indian government's recent flurry of economic reforms sparking hopes for a rate cut, the country's central bank has chosen to keep interest rates on hold.

The Reserve Bank of India (RBI) is grappling with the problem of balancing slowing economic growth and high inflation. In situations of high inflation, interest rates are normally increased to bring inflation under control. Raising borrowing costs, however, was not an option for the central bank given the slowdown in the country's economy.

The policy repo rate was kept on hold at 8 per cent, in line with consensus forecasts, as the central bank yesterday said it remained focused on fighting inflation.

But economic reforms announced last week raised hopes of a cut to help boost growth.

"In its forward guidance, the RBI basically said that its hands are tied at the moment due to lingering inflation risks and the persistence of the twin deficits [fiscal and current account deficits], leaving little room to ease monetary policy," said Leif Eskesen, HSBC's chief economist for India and Asean (Association of South East Asian nations). The central bank lowered the cash reserve ratio by 25 basis points in an effort to inject more liquidity, estimated at about 170 billion rupees (Dh11.56bn), into the system.

"The decision to keep the monetary policy rate unchanged was spot-on and the prudent thing to do," said Mr Eskesen. "Inflation risks are still lingering. The monsoons remain deficient despite more rain in recent weeks and food inflation is expected to rise as a consequence. The adjustment in fuel prices will also add to inflation and possibly lift inflation expectation."

The government last week reduced fuel subsidies as it hiked diesel prices by 5 rupees per litre.

The wholesale price inflation rate eased to a 32-month low in July of 6.87 per cent, only to increase to 7.55 per cent last month on higher food and energy prices.

Economic growth slowed to 5.5 per cent in the first quarter of the financial year. While that might seem an enviable rate in other parts of the world, the consensus in India has been the country needs a persistent growth rate in the region of 8 per cent for the benefits of an expanding economy to spread to the lower-income segments of its population.

The government reforms included measures to open up the retail and aviation sectors to more foreign investment.

"While acknowledging the recent positive initiatives by the government, RBI believes that inflation momentum remains fairly strong," said Dhananjay Sinha, the co-head of institutional research at Emkay Global Financial Services.