The Reserve Bank of India (RBI) left the interest rates unchanged for the second time, but cut the Statutory Liquidity Ratio (SLR) by 1 percent and growth forecast to 6.5 percent, reiterating its focus on containing inflation.
The decisions to leave the key rates unchanged was in line with the expectations as inflation is likely to spiral up with the shortage in the monsoon rains is set to impact the agricultural production this year.
The RBI reduced the SLR rate - the amount of deposits banks keep in government bonds - to 23 percent which was unexpected. The cut is expected to ease pressure on liquidity, encouraging the banks to lend more.
"Although the liquidity situation has eased significantly in the recent period, the reduction of SLR is expected to ensure that liquidity pressures do not constrain the flow of credit to the productive sectors of the economy. This will allow banks to shift their portfolio in favor of the private sector," RBI Governor Duvvuri Subbarao wrote in a monetary policy review.
The cut is expected to benefit private and foreign banks that maintain the statutory investment in government securities because most of the Indian public sector banks currently hold up to 30 percent in public bonds.
He said that the rate cuts was not a viable option with the current inflation levels as any such cuts would aggravate the inflation further.
Expressing the rationale behind the decision to keep the repo rate at 8 percent and the CRR at 4.75 percent, the Governor wrote in the First Quarter Review of Monetary Policy 2012-13: "The headline WPI inflation has remained sticky, above 7 percent. Headline inflation has persisted even as growth has moderated and the pricing power of corporate has weakened. Non-food manufactured products inflation has also not declined to the extent warranted by the growth moderation. This reflects severe supply constraints and entrenchment of inflation expectations."
The bank also cut the growth forecast to 6.5 percent from the earlier projection of 7.3 percent, based on the deteriorating global economy and uncertainty in macro economic conditions.