While keeping key rates unchanged, the RBI said India is currently caught in a classic ‘impossible trinity’ trilemma whereby it has to forfeit some monetary policy discretion to address external sector concerns
 

The Reserve Bank of India (RBI), in its first quarter credit policy review has kept repo, reverse repo, cash reserve ratio (CRR) and bank rate unchanged. The central bank said India is currently caught in a classic ‘impossible trinity’ trilemma whereby it has to forfeit some monetary policy discretion to address external sector concerns.

"The recent liquidity tightening measures by the Reserve Bank are aimed at checking undue volatility in the foreign exchange market and will be rolled back in a calibrated manner as stability is restored to the foreign exchange market, enabling monetary policy to revert to supporting growth with continuing vigil on inflation.  It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels," the central bank said in a statement.

With no change in key policy rates, the repo rate (the rate at which the RBI lends money to banks) remains at 7.25%. Similarly reverse repo rate (the rate at which the RBI borrows from banks), CRR, and bank rate remains at 6.25%, 4.00% and 10.25%, respectively.

Repo Rate.......................7.25%

Reverse Repo Rate..........6.25%

CRR.................................4.00%

Bank Rate......................10.25%

The central bank said its monetary policy stance over the last two years has predominantly been shaped by the growth-inflation dynamic even as external sector concerns have had a growing influence on policy calibration over the last one year. “The current situation – moderating wholesale price inflation, prospects of softening of food inflation consequent on a robust monsoon and decelerating growth – would have provided a reasonable case for continuing on the easing stance. However, 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 RBI said.

The trilemma refers to the difficulty of simultaneously having free capital movement, a stable exchange rate and an independent monetary policy.

DK Aggarwal, chairman and managing director of SMC Investments and Advisors, said, "By announcing the measures twice this month to curb deceleration in rupee, it has become quite evident that RBI is not going to cut rate and that only happened in today policy review meeting. The past cuts also did not get transmitted meaningfully in the banking system because of rise in delinquency rates and overall deficit in the banking system. And now with the shift in policy stance we expect RBI to cut rates with a lag of three to six months."

"Looking at the other side of the coin, let us suppose even if RBI cut rates, then also banks would not reduce rates as now there would be shortage of funds of more than 1% of net demand and time liabilities. The recovery is yet to gather momentum and as a result of which more pain in terms of rise in non-performing assets (NPAs), fall in government revenues from the levels at which they are budgeted, may happen," Mr Aggarwal added.

RBI also lowered the gross domestic product (GDP) forecast to 5.5% from 5.7% and headline inflation to 5.1% from 6% for the fiscal year ending March 2014 and said that monetary policy stance would again shift towards supporting growth when normalcy returns in foreign exchange market.

Industry body, Confederation of Indian Industry (CII) feels that the moderation of growth outlook by the RBI is a matter of great concern and this enforces its view that actions on multiple fronts are required to help the economy revive.

"We have shared with the Government our concerns about the high Current Account Deficit and these concerns call for financing measures, but more importantly, we need to ensure that we are able to establish a very competitive manufacturing sector. Our exports need to increase exponentially and with a strong manufacturing sector we should be able to obviate the need for many imports, which could be very well manufactured within the country" said Kris Gopalakrishnan, president, CII.

Through 2012-13, the Reserve Bank persevered with efforts to address growth risks with a 100 basis points (bps) reduction in the repo rate, supported by policies to ease credit and liquidity conditions through a 75 bps reduction in the CRR, 100 bps reduction in the statutory liquidity ratio (SLR) and open market operation (OMO) purchases of about Rs1.5 trillion.

During May this year, the central bank continued with its easing stance with a reduction in the policy repo rate by a further 25 bps to support growth in the face of gradual moderation of headline inflation. With upside risks to inflation still significant in the near term, however, the Reserve Bank indicated that it saw little space for further policy easing and warned that risks because of the CAD could warrant a swift reversal of the policy stance. In its mid-quarter review of June, the Reserve Bank paused its policy easing. This policy stance was informed by the need to wait for a durable receding of inflation and to be prepared for the impact of growing uncertainty in global financial conditions.