New Delhi, Jan 29: Shedding its 9-month long hawkish monetary policy stance, the Reserve Bank on Tuesday slashed its key interest rates by 0.25 per cent and released Rs. 18,000 crore additional liquidity into the system to perk up growth through reduced cost of borrowing.
RBI Governor D Subbarao in the third quarter monetary policy review surprised the market by cutting short-term lending rate called repo by 0.25 per cent to 7.75% and Cash Reserve Ratio (CRR) by similar margin to 4%, releasing Rs. 18,000 crore primary liquidity into the system.
The RBI cut its key interest rate and CRR by 0.25 per cent on Tuesday as part of its credit policy review. RBI governor, D Subbarao, cited subdued economic activity, weak demand and tight liquidity conditions as some of the reasons for the cut.
Here is the full text of his speech:
"First of all, on behalf of the Reserve Bank, a warm welcome to you all to this Third Quarter Review of Monetary Policy for 2012-13.
2. Earlier this morning, we put out the Policy Review document. Based on an assessment of the current macroeconomic situation, we have decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per cent to 7.75 per cent.
3. Consequent to this, the reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, gets calibrated to 6.75 per cent. Similarly, the marginal standing facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, and also the Bank Rate stand adjusted to 8.75 per cent.
4. These changes have since come into effect immediately after the announcement.
5. We have also decided to reduce the cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.25 per cent to 4.0 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning February 9, 2013.
6. This reduction in the CRR will inject primary liquidity of around Rs. 180 billion into the banking system.
Considerations Behind the Policy Move
7. Today's decision to further ease the monetary policy stance was informed by three considerations.
8. First, both headline wholesale price inflation and its core component, non-food manufactured products inflation, have softened through the third quarter. This provided some relief from the persistence that dominated the first half of the year. Several indicators such as the weaker pricing power of corporates, excess capacity in some sectors, the possibility of international commodity prices stabilising as well as inflation momentum measures suggest that inflationary pressures have peaked. However, further moderation in inflation going into the next fiscal year is likely to be muted as the correction of under-pricing of administered items is still incomplete and food inflation remains elevated. Accordingly, the setting of monetary policy has to remain sensitive to these conflicting pressures and attendant risks.
9. Second, growth has decelerated significantly below trend through the last fiscal year and through this year so far, and overall economic activity remains subdued. On the demand side, investment activity has been way below desired levels and consumption demand too has started to decelerate. External demand has also weakened due to languid global growth. On the supply side, constraints in the availability of key raw materials and intermediates are becoming binding. While the series of policy measures announced by the Government has boosted market sentiment, the investment outlook is still lacklustre, especially in terms of demand for new projects.
10. The third consideration that informed our decision is that liquidity conditions have remained tight. Although the Reserve Bank lowered the cash reserve ratio, CRR, successively in September and October 2012, and carried out open market operations (OMO) injecting systemic liquidity of Rs. 470 billion during December and January to augment liquidity, the average net LAF borrowings at Rs. 910 billion in January have been above the Reserve Bank's comfort level. This tightness could potentially hurt credit flow to productive sectors of the economy. The structural deficit in the system provided a strong case for injecting permanent primary liquidity into the system.
Monetary Policy Stance
11. The policy document also spells out the three broad contours of our monetary policy stance. These are:
first, to provide an appropriate interest rate environment to support growth as inflation risks moderate;
second, to contain inflation and anchor inflation expectations; and
third, to continue to manage liquidity to ensure adequate flow of credit to the productive sectors of the economy.
12. As has become standard practice by now, we have also given the following guidance for the period forward:
13. With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood that going into 2013-14, inflation will remain range-bound around the current levels. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks. This policy guidance will, however, be conditioned by the evolving growth-inflation dynamic and the management of risks from the twin deficits.
14. We expect that today's policy actions, and the guidance that we have given, will result in the following three outcomes:
first, investment will be encouraged, thereby supporting growth; second, medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation; and, finally, there will be an improvement in liquidity conditions to support credit flow.
Global and Domestic Developments
15. Our policy decisions have been based on a detailed assessment of the global and domestic macroeconomic situation. Let me comment first on the global outlook.
16. Since the Reserve Bank's last quarterly Policy Review in October 2012, headwinds holding back the global economy have begun to abate gradually, although sluggish conditions prevail. In the US, activity gathered momentum in the third quarter of 2012 but this is unlikely to have been sustained in the fourth quarter.
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