RBI leaves rates steady, stocks slump over 10 %

By Abhishek on 7:16 PM

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MUMBAI (Reuters) – The Reserve Bank of India (RBI) kept interest rates unchanged as expected on Friday so see if a hefty, surprise cut earlier this week shores up the economy in the face of a global slowdown.

Still, the decision disappointed investors who slammed the the BSE Sensex down more than 10 percent to its lowest level in almost three years in the midst of a broader emerging markets' sell off.

At one point, the Sensex and Nifty were down 12 and 14 percent respectively.

"The market was also expecting some liquidity measures, especially for sectors like real estate that have been hit very badly. The market trend is down and in this situation even if the policy is neutral, it will be taken as negative," said Neeraj Dewan, a director at Quantum Securities. Analysts had predicted rates would be left unchanged because of drastic measures by the RBI in the past two weeks to confront a severe downturn in the global economy.

On Monday, it surprised markets by slashing its repo rate by 1 percentage point to 8 percent, the first cut in over four years. It has also slashed the level of reserves banks must hold by 250 basis points in the past two weeks. Central banks globally have scrambled to fend of the financial storm unleashed in the past month following the collapse of Lehman Brothers.

In its quarterly policy review, the Reserve Bank of India cut its 2008/09 economic growth forecast to between 7.5 percent and 8.0 percent, from around 8 percent and noted the difficulty of policy making.

"This is uncharted territory with no standard or conventional solutions," it said. The RBI said it had to strike an "optimal balance" between financial stability, price stability, anchoring inflation expectations and sustaining growth.  "To manage this challenge the RBI has deployed and will continue to deploy both conventional and unconventional tools," it said. The RBI left the reverse repo rate, the rate at which it absorbs excess cash from banks, steady at 6.0 percent. The bank rate remained at 6.0 percent.

"Policy changes that need to be done have been implemented before the quarterly statement," said Han-Sia Yeo, strategist at Bank of America in Singapore. "The change in bias away from inflation is clear. Managing financial stability risk remains a near-term priority, which means the market will remain flush with liquidity."
Finance Minister Palaniappan Chidambaram said the RBI review endorsed the government's assessment of the economy's fundamentals and financial stability, and said calm and confidence were needed to tide over the global crisis.


But investors took a different view, knocking the BSE Sensex down more than 10 percent. The fall accelerated significantly after the rate decision although the market has been swept lower in a global sell off of emerging market assets.

The rupee hit a record low against the dollar in early trading of just over 50 to the dollar before the RBI was suspected of intervening to provide the currency with a prop.

India has been particularly vulnerable to rising risk aversion among foreign investors. They have pulled out more than $12 billion this year from the stock market, which has lost more than half of its value so far in 2008. It rose 47 percent in 2007.

A loss of capital inflows from foreign portfolio investment could add to pressure on the balance of payments because the current account deficit is already running at nearly 2 percent of gross domestic product.
Monday's rate represented a sudden shift for the RBI which had raised the rate in June and July to combat double-digit inflation.

The RBI on Friday said inflation remained a concern and rapid credit growth also needed monitoring. It said it would keep a close vigil on financial markets and enhance liquidity if pressures persisted.

"This could also mean curtailing liquidity if the recent liquidity easing measures are seen to have injected excess liquidity, thereby stoking inflationary pressures," it said. "We cannot afford to let the guard slip on our inflation vigil."

The annual rate of wholesale inflation, India's main measure of price pressures, eased to just over 11 percent in the latest data for early October, down from a peak of 12.91 percent in early August.
Falling oil and commodity prices mean it is expected to moderate further by the end of this year, giving policy makers some room to cater to growth.

Monday's rate cut came after major central banks, including in the United States, Europe and China, cut interest rates in unison to try to restore confidence in the world's shattered financial markets.

In Asia, other central banks have also cut rates, including Taiwan and South Korea.

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