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Economy Jul 30, 2013

Rupee woes: Why RBI is likely to keep rates unchanged today

Mumbai: The Reserve Bank of India (RBI) is likely to leave policy interest rates unchanged later on Tuesday as its priority has switched from reviving an economy growing at its slowest in a decade to supporting a currency that recently plunged to a record low.

The RBI took strong action to defend the embattled rupee two weeks ago by tightening money market liquidity and pushing up short-term interest rates to curb fund flows out of India and make speculating against the currency more costly.

But the strategy has prompted many economists to cut their growth forecasts, despite the government's assurances that the squeeze will be temporary.

Investors will be looking for clues on Tuesday for how long the RBI will maintain its tight grip on cash conditions.

Reuters

Reuters

"The guidance is likely to be hawkish," said Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai.

Outflows of funds from emerging markets on speculation that the U.S. Federal Reserve will soon start winding down its easy money policy and India's own record high current account deficit at 4.8 percent of GDP have made the rupee vulnerable and virtually scotched chances of lower interest rates for now.

Turkey, Brazil and Indonesia have all raised rates to counter capital outflows driven by prospects for tighter monetary policy in the United States.

The RBI last cut its policy repo rate by 25 basis points to 7.25 percent in May. It left the rate on hold at its last review, in June, despite growth that slowed to just 5 percent in the last fiscal year.

Before the rupee's sharp fall began in May, the RBI's next move on rates was widely expected to be a cut.

"If the rupee's weakness persists, the probability of a reversal in monetary policy stance will increase. But for now, the recent measures have given some time for RBI to wait and watch," said Kapur.

The RBI is also expected to keep the cash reserve ratio for banks unchanged at a record-low 4 percent.

Tuesday's monetary policy review will be the last for RBI Governor Duvvuri Subbarao, whose term will end in early September after five turbulent years, unless it is extended.

The Indian currency fell to an all-time low 61.21 to the dollar on July 8, when it was down about 10 percent since the start of the year.

While India has succeeded in stabilising the rupee, which ended on Monday at 59.42, the central bank said in its quarterly macroeconomic review on Monday that its recent measures only provide breathing room and called for the government to put in place reforms to attract longer-term capital flows.

However, New Delhi has struggled to implement steps to attract foreign corporate investment, and with elections due by May, Prime Minister Manmohan Singh's weak coalition government has limited room for pushing through further reforms.

Indian policymakers will be hoping the Fed doesn't spark a fresh surge in flows away from emerging markets when it holds its policy review later this week.

The RBI released a report on the economy on Monday that said its priority was currency stability, giving little comfort to investors hoping for a return to rate cuts anytime soon.

"The report suggests there is no hope of monetary easing for a long time and that interest rates will have to remain high until structural reforms are implemented," said A. Prasanna, economist at ICICI Securities Primary Dealership.

Reuters

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