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Tuesday, India's central bank left its key interest rates unchanged for a second rate-setting session, but hiked the statutory liquidity ratio and started exiting liquidity support measures, signaling possible policy tightening ahead.
In its second quarter monetary policy review, the Reserve Bank of India led by governor Duvvuri Subbarao, maintained its cash reserve ratio at 5%, the repo rate at 4.75% and reverse repo at 3.25%. The bank rate was retained at 6%.
The statutory liquidity ratio for commercial banks was hiked to 25% from 24%, which would be effective from November 7. The SLR is the minimum share of bank deposits to be held in government bonds, cash and gold among others. The ratio was reduced to 24% in November last year amid the global financial market crisis. The central bank said the increase in the SLR will not impact the liquidity position of the banking system and credit to the private sector.
Economists at ING Bank sees a rate hike from the RBI in the first quarter of 2010. Meanwhile, DBS Group Research expects the central bank to start hiking rates as early as January prompted by further rise in wholesale price inflation above 5% by December. The third quarter review of monetary policy will be undertaken on January 29, 2010.
"The balance of judgment at the current juncture is that it may be appropriate to sequence the 'exit' in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored," the central bank said in a statement. "The 'exit' process can begin with the closure of some special liquidity support measures."
As part of its exit strategy, the RBI decided to discontinue the special refinance facility for scheduled commercial banks, to stop the special term repo facility for scheduled commercial banks for funding to mutual funds, non-banking financial companies and housing finance companies and to end the forex swap facility of banks with immediate effect. The central bank also decided to reduce the limit of export credit refinance facility from 50% to 15%, citing low utilization of these measures.
As policy makers across the world mull exit strategies from easy policy, Subbarao said, "'Exit' is a central issue in our policy matrix too." That said, "reversing of conventional measures is not considered appropriate for now", he said, though "many of the unconventional measures can be reversed immediately".
Further, the central bank maintained its economic growth forecast for the year ending March 31, 2010, at 6% with an upward bias, while hiked inflation outlook, also with an upward bias, to 6.5% from 5%. The bank said the Indian economy, which slowed down in the second half of 2008-09 due to the global financial crisis, has begun to stabilize despite falling exports and poor monsoon. The economy grew 6.1% in the first quarter, during April to June, of 2009-10, following 5.8% growth in the preceding two quarters.
The RBI said there are "definitive indications of the economy reverting to the growth track." Hence, attention has "shifted from managing the crisis to managing the recovery" like elsewhere in the world. Though external demand is shrinking, large fiscal and monetary stimulus measures have boosted domestic consumption, the central bank noted. The prospects of the industrial sector have become more promising, the bank said.
Moreover, the central bank lowered its 2009-10 adjusted non-food credit growth projection to 18% from 20% set in the July monetary policy review. It also reduced money supply growth projection to 17% from 18%.
India, thus became the second country, after Australia, among the group of twenty industrialized nations to start exit from easy monetary policy, implemented to support the economy during the financial crisis. However, a rate hike would make it costlier for India to cover its fiscal deficit now running at 6.8% of GDP. On Wednesday, the Norwegian central bank is expected to hike rates.
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