Weak rupee, high inflation force RBI to hold rates

The Reserve Bank on Monday kept the key interest rates unchanged citing elevated food inflation, rupee depreciation and uncertainty over foreign fund inflows.

The repo rate at which the RBI lends to the system has been retained at 7.25 per cent, while the cash reserve ratio will continue to be 4 per cent.

"The monetary policy stance has been informed by the evolving growth-inflation dynamics, the balance of risks as well as recent developments in the external sector," RBI Governor D Subbarao said in the mid-quarter policy review.

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He specifically cited the decision of the US Fed to trim the growth stimuli in a phased manner and articulated concern over risks coming "on account of uncertainty over policies of systemic central banks."

The May 22 announcement has led to fund outflows from emerging markets, including India, and hence, depreciation in the rupee, which is already facing trouble over the high current account deficit, touching an alarming 6.7 per cent in the December quarter.

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To reduce the CAD to a sustainable level; the near term challenge is to finance it through stable flows," the statement said.

The Rupee has declined by 5.8 per cent since January 1 and touched a record low of 58.96 to a dollar last week. It was trading at 57.84 during the morning trade.

In its guidance, the RBI, particularly, flagged risks on inflation, saying "it is only a durable receding of inflation that will open up the space for monetary policy to continue to address risks to growth."

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The status quo maintained by RBI has dashed hopes of interest rates cut which was widely expected by the market.

The Central Bank had reduced key policy rate (repo rate) by 0.75 per cent during the last three monetary policy announcements.

Following policy announcement, 30-share BSE Sensex fell by 83 points to 19,095.

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Though the headline inflation has come down, the RBI also sounded concerned over the persistently high food inflation, which has been hovering in the region close to ten per cent.

"Inflation has moderated as projected. However, upside pressures on the way forward from the pass-through of rupee depreciation, recent increases in administered prices and persisting imbalances, especially relating to food, pose risks of second-round effects," it said.

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"Future monetary policy stance will be determined by how growth and inflation trajectories and the balance of payments situation will evolve in the months ahead," it added.

RBI Governor noted that since the May 3 Annual Policy statement, global economic activity has slowed and risks remain elevated, most recently on account of uncertainty over policies of globally important central banks.

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As recent experience has shown, shifts in global market sentiment can trigger sudden stop and reversal of capital from a broad swath of emerging economies, swiftly amplifying risks to the outlook. India is not an exception, it said.

On the domestic front, it said, macroeconomic conditions remain weak, hamstrung by infrastructure bottlenecks, supply constraints, lacklustre domestic demand and subdued investment sentiment.