'Limited room for RBI to ease policy rates'

The Reserve Bank of India is likely to keep the key interest rate on hold until the end of this year and is likely to go for some 'easing' in the first quarter of 2013, a Morgan Stanley research report has said.

In the mid-year monetary policy review on Tuesday, RBI, left the key interest rate unchanged but reduced cash reserve ratio by 0.25 per cent to infuse additional liquidity of up to Rs 17,500 crore (Rs 175 billion) into the system.

RBI kept the repo rate and reverse repo rate unchanged at 8 per cent and 7 per cent respectively.

"Given the central bank's guidance for monetary policy stance, we believe that policy rates would be on hold until end of 2012, with easing to start in 1Q 2013," Morgan Stanley said.

RBI's policy stance emphasised that even as the focus has been shifted to address growth risks, the objective of containing inflation remains important.

Inflation as measured by all indices has remained elevated and Wholesale Price Index-based inflation has remained above the RBI's comfort zone of 5 to 5.5 per cent for past 34 months now.

Going ahead, Morgan Stanley said, WPI inflation is likely to edge up to 8-8.3 per cent in the quarter ending December before moderating to around 7.5 per cent in the quarter ending March 2013

and thus RBI will have limited room for easing of its monetary policy stance.

"We believe that even as inflation starts to ease from Q1, 2013, it may remain above RBI's comfort zone for longer.

Hence, we expect policy easing to be limited to about 50 - 75 bps in 2013," the report added.

As the macro stability indicators for the Indian economy remain 'challenging', monetary policy easing is a less effective tool to revive growth in the current cycle, it said.

"We believe that policy reforms that help to correct the bad growth mix issue will be key to reviving growth," Morgan Stanley said.

Accordingly, policy reforms including the government's effort to revive investment, to cut fiscal deficit via control of expenditure, and to manage rural wage growth down to reasonable levels, would help in reviving growth parameters, the report added.

Meanwhile, the RBI has also revised downwards the GDP growth estimate to 5.8 per cent from the earlier 6.5 per cent, while increasing its March-end headline inflation forecast to 7.5 per cent.

It is the second time since the beginning of the fiscal that it has revised its estimate on both the aspects.