The Reserve Bank of India (RBI) held interest rates and unveiled a suite of liquidity measures today, in its first policy announcement since new prime minister Narendra Modi swept to power last month.
Raghuram Rajan, the RBI governor, said it was "appropriate" to leave policy on hold and let the "disinflationary effects" of earlier rate cuts work their way through the economy.
Annual CPI inflation increased from 8% in February to 8.6% in April, on account of a "sharp" increase in food prices. The central bank had forecast a gradual decline in inflation over the period but seems unperturbed by the recent spike, which Rajan described as "largely seasonal".
Reserve Bank of India holds key rate at 8% despite spike in food prices; takes steps towards creating a ‘more generalised provision of system liquidity’ The RBI aims to bring inflation down to 8% by January 2015 and Rajan stressed that if the economy stays on its present course "further policy tightening will not be warranted".
He even raised the prospect of "faster than expected" disinflation that, should it occur, would "provide headroom for an easing of the policy stance" – the first time he has alluded to the prospect of reversing some of last year's rate hikes.
The RBI also announced new liquidity measures for the second policy statement in a row, most notably a reduction in the statutory liquidity ratio (SLR), which determines the amount of money banks must invest in government securities before offering credit to the wider economy.
The SLR will drop by 50 basis points to 22.5% of banks' net demand and time liabilities on June 14, which Rajan believes "will give banks more freedom to expand credit to the non-government sector".
"However, the Reserve Bank is also cognisant of the significant ongoing financing needs of the government," Rajan said. "Therefore, the SLR is reduced by [50bp] with any further change dependent on the likely path of fiscal consolidation."
The RBI also decided to limit the amount banks can draw down from its export credit refinance (ECR) facility, by cutting the amount of outstanding export credit that will be eligible from 50% to 32%. To prevent a drain on liquidity, the central bank introduced a new special term repo facility.
These changes follow the advice of the Urjit Patel Committee, which recommended the economy "move away from sector-specific refinance towards a more generalised provision of system liquidity without preferential access to any particular sector or entity".
"This should improve access to liquidity from the Reserve Bank for the system as a whole without the procedural formalities relating to documentary evidence, authorisation and verification associated with the ECR," Rajan said.
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