India rates on hold, growth to slow further

July 31, 2012 - 4:36 AM
India Economy

FILE- In this July 24, 2012 file photo, an Indian farmer walks through a dry, cracked paddy field on the outskirts of Jammu, India. India's central bank kept its key interest rate on hold Tuesday, July 31, 2012 because of high inflation and warned that a weak monsoon and intensifying global risks will drive down growth faster than anticipated in Asia's third largest economy. (AP Photo/Channi Anand, File)

MUMBAI, India (AP) — India's central bank kept its key interest rate on hold Tuesday because of high inflation and warned that a weak monsoon and intensifying global risks will drive down growth faster than anticipated in Asia's third largest economy.

The Reserve Bank of India slashed its growth forecast for the fiscal year ending in March 2013 to 6.5 percent from 7.3 percent. It said inflation for the fiscal year will be 7.0 percent, up from its April forecast of 6.5 percent and far higher than the bank's target of 4.0 to 4.5 percent.

"The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path," the bank said in its policy statement. "In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth."

India's economy has slowed for four straight quarters, hitting a nine-year low of 5.3 percent growth in the quarter ended March. In a new blow Tuesday, a power grid failure left 600 million people in northern and eastern India without electricity, the second massive failure this week. Trains halted and hospitals and airports went onto back up power, providing a sweltering reminder of the nation's inability to meet its energy needs as it strives to be an economic power.

Growth has been dragged down by weak investment and waning private consumption. Though the rupee has been hitting lifetime lows, its depreciation has yet to have a positive impact on exports, the bank said. The bank said its earlier growth projection was based on the assumption of normal rainfall — crucial for India's vast and largely unirrigated agricultural sector — and an improvement in industrial output, neither of which materialized. Global growth and trade are also slowing, the bank warned, which will hit India's industrial and services sectors.

The bank said that the inadequate monsoon — rainfall this season is about 20 percent below normal — coupled with a weak rupee, which drives up the domestic price of imported oil, are pushing up inflation, which has been stuck above 7 percent for months.

"The deficient and uneven monsoon performance so far will have an adverse impact on food inflation," the bank said.

Core inflation — the prices of non-food manufactured products — has not fallen in tandem with India's slowing growth. The bank blamed infrastructure bottlenecks in coal, minerals and power supply, all of which lie beyond the reach of monetary policy.

The Reserve Bank of India again warned that India's current account and fiscal deficits "pose significant risks to macroeconomic stability." The deficit in the current account, which is a broad measure of India's investment and trade balance with the rest of the world, rose to 4.2 percent of gross domestic product in the fiscal year ended in March. That was up from 2.7 percent of GDP the year before.

In April and May, food subsidies fell, but fertilizer subsidies were more than twice as high as they were last year, which will make it difficult for the Finance Ministry to make good on its pledge to restrict subsidy spending to 2 percent of GDP unless "immediate action" is taken, the bank said.

"While monetary actions over the past two years may have contributed to the growth slowdown — an unavoidable consequence — several other factors have played a significant role," the bank said. "As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately."

The bank left the key repo rate unchanged at 8.0 percent.

The Confederation of Indian Industry called the decision "a missed opportunity to revive growth momentum."

Faced with slowing growth, central banks around the world have embarked on a rate cutting spree. The Philippines, South Africa, South Korea, China, Brazil, Australia and the European Central Bank have all cut rates recently. The situation in India is more complex because inflation has remained elevated despite slowing growth. That makes it harder for the central bank to lower interest rates, which can further stoke inflation.

"Economic growth is slowing but supply constraints are ensuring price pressures remain," said ING Vysya Bank economist Upasna Bhardwaj. "RBI is correct that more fiscal adjustments need to happen and that would provide more monetary space."

She said there are some policy changes in the pipeline, chiefly a long-anticipated hike in petrol prices, which could help ease the subsidy burden.

"All eyes are on the government," she said. "Only when they take action will RBI act."