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HindustanTimes Wed,01 Oct 2014

Growth worries versus price pangs

Gaurav Choudhury, Hindustan Times   October 30, 2012
First Published: 22:31 IST(30/10/2012) | Last Updated: 12:04 IST(12/11/2012)

RBI on Tuesday kept interest rates unchanged despite mounting pressure from domestic industry to slash lending costs. HT explains the linkages between interest rates, prices and growth.

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What has the Reserve Bank of India (RBI) announced in its quarterly monetary policy review?
Caught between rising prices and sliding growth, the RBI on Tuesday maintained a status-quo on key rates, but has cut the cash reserve ratio by 0.25 percentage points to 4.25%.

What is cash reserve ratio (CRR)?
CRR is the proportion of deposits that banks have to park with the central bank.

What does a CRR cut aim to achieve?
A CRR cut allows banks to unlock funds for lending. According to the estimates, the 0.25 percentage point cut in CRR will allow banks an additional Rs. 17,500 crore to lend.

What is repo rate?
It is the rate at which the RBI lends to banks.

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How does repo rate influence interest rates that banks charge from customers?
A lower repo reduces banks' borrowing costs, allowing them to cut interest rates for home, auto and corporate borrowers.

Does a reduction in CRR reduce borrowing rates for customers?
Maybe, in a very indirect way. With more cash in hand to lend following the cut in CRR, banks may not need to woo customers by offering higher interest rates to shore up their deposit base. Some banks may even consider lowering the interest they pay to customers on their fixed and savings deposits to cut costs. Lower costs, in turn, could prompt them to reduce their final lending rates.

What are policy rates?
The policy rate acts as the guide for final lending rates that banks charge from borrowers. In tight liquidity situations, the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts the policy rate.

What prompted the RBI to maintain a status quo on interest rates?
High prices essentially shrink household incomes, as middle-class Indians have to spend much more for the same amount of goods. Food prices shock have spread into what economists call "core inflation", or prices of non-food and non-fuel commodities. India's retail prices are already high and costlier fuel will knock up prices. This has dissuaded the RBI to slash interest rates to suppress prices.

What's the latest on the price front?
Latest price data showed that retail inflation measured by the consumer price index (CPI) stood at 9.73% in September, marginally down from 10.03% in August. Wholesale price index (WPI)-based inflation was 7.81% in September, up from 7.55% in August. Experts expect prices to rise further.

Why are experts saying that prices will rise further?
It is because the government, in a move fraught with political risks, raised diesel prices by R5 per litre in September - the steepest ever hike - and capped sale of cheaper cooking gas to six cylinders per year for each family. High diesel prices will raise the cost of transporting products, which will further fan inflation.

What has the RBI said about prices?
The RBI has projected that wholesale price-based inflation will be 7.5% in March 2013 end, up from 7% forecast earlier. This is based upon the view that greater demand will knock up prices. Additionally, a possible global financial instability will weaken the rupee, shaving off its recent gains and make imports costlier. Besides, higher urban and rural wages is also fanning inflation.

Has there been recent sign of recovery?
Hopes of an economic recovery have sprung anew with India's factory output growing by 2.7% in August, up from a contraction of -0.2% in July. With the busy season kicking in, analysts said these could well be the little green shoots of recovery to push growth across the broader economy.

What has the RBI said about growth?
The RBI has forecast that India's GDP will grow at 5.8% in 2012-13, down from 6.5% it had projected in July. The RBI is of the view that although industrial output picked up marginally in August and the services sector has shown a modest improvement in September, the outlook remains uncertain.


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