Reserve Bank cuts repo rate by 25 bps, indicates limited room for more

Reuters: The RBI lowered the repo rate by 25 basis points on Tuesday for the second time this year in a bid to help revive growth in Asia’s third-largest economy, but warned that the scope for further easing is limited.

The rate cut was overshadowed by a political crisis in the governing coalition when a key ally quit, raising fresh doubts about Prime Minister Manmohan Singh’s ability to push through a late burst of reforms and win back investors’ confidence. In its mid-quarter policy review, the Reserve Bank of India lowered its policy repo rate to 7.5% as expected. The reverse repo rate is now at 6.5%.

It also left the cash reserve ratio for banks unchanged at 4%, in line with expectations.

India’s economy is on track to grow at its slowest in a decade at around 5% in the fiscal year ending this month, and had been expected to see modest improvement in the coming year.

A recent up-tick in headline wholesale inflation, rising food price-driven consumer inflation and a record-high current account deficit limit the RBI’s space for monetary easing despite pressure from a Government facing elections in 2014.

“Even as the policy stance emphasises addressing the growth risks, the headroom for further monetary easing remains quite limited,” the RBI said in its statement.

That caution reinforced market expectations that the RBI, which left rates on hold for nine months before cutting them in January, will only lower them by a further 25 or 50 bps in the fiscal year starting in April.

After an initially muted reaction to the widely expected rate cut, the Sensex and the Rupee fell on news that the Dravida Munnetra Kazhagam (DMK) would leave the ruling UPA coalition due to differences over the Government’s stand on alleged war crimes in Sri Lanka.

The withdrawal leaves Singh’s coalition at the mercy of smaller parties which are sceptical of reforms such as landmark land acquisition legislation aimed at boosting investment in infrastructure.