RBI keeps liquidity tight to save rupee from external shocks

The Reserve Bank of India (RBI) has kept its tight money policy unchanged in order to address the risks to economic growth and macroeconomic stability from external shocks, especially with the US Federal Reserve continuing with its lose dollar policy.

Accordingly, the RBI has kept the repo rate under the liquidity adjustment facility (LAF) unchanged at 7.25 per cent. The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands at 6.25 per cent.

The marginal standing facility (MSF) rate has been kept unchanged at 300 basis points above the repo rate at 10.25 per cent.

The Bank Rate stands at 10.25 per cent.

RBI also kept the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of their net demand and time liabilities (NDTL).

However, RBI said it would manage liquidity conditions in such a way to ensure adequate credit flow to the productive sectors of the economy while guarding against re-emergence of inflation pressures.

While the current situation of moderating wholesale price inflation would have provided RBI an opportunity to ease its monetary policy stance, the growing external sector concerns have had an increasing influence on its policy calibration over the last one year.

''India is currently caught in a classic 'impossible trinity' trilemma whereby we are having to forfeit some monetary policy discretion to address external sector concerns,'' the central bank noted.

RBI said the recent liquidity tightening measures aimed at checking undue volatility in the foreign exchange market will be rolled back in a calibrated manner as stability is restored to the foreign exchange market.

While the current policy will support exchange rate stability, RBI noted that only structural measures aimed reducing current account deficit to sustainable levels would help stabilise the rupee.

The easing of risks to global recovery has, however, not helped emerging economies to grow faster, due mainly to the turmoil in financial markets.

In fact, there has been a reversal with growth slowing in emerging economies amidst an improvement, albeit slow, in US economic growth.

This is coupled with a rapid appreciation of the US dollar consequent to an increase in real interest rates in the US.

Commodity prices have generally softened, except in the case of crude, which remains stable still. Although the inflation outlook in advanced economies is still benign, upside risks remain in several emerging and developing economies, RBI noted.

Overall, global economic activity remains subdued with still elevated downside risks.

In the US also, recovery in domestic demand is slow and export activity slow. In the UK, recovery is gradually gathering momentum on the back of consumer spending. The euro area continues to be in recession with high unemployment. Japan's economy is returning to positive growth with improved industrial production and retail sales.

Among the BRICS countries, although retail sales in China have maintained the impetus of recent months, the manufacturing purchasing managers' index (PMI) and industrial production declined in June. Growth has clearly lost momentum in Brazil, Russia and South Africa.

Keeping in view the domestic demand-supply balance, the outlook for global commodity prices, and a good monsoon, RB said it expected domestic inflation to be around 5 per cent by March 2014.