Jun 17, 2013 11:28 AM EDT

India Leaves Rates Unchanged, Warns of Inflation Risks as Rupee Sags

The Reserve Bank of India kept interest rates unchanged on Monday as expected after cutting them in each of its previous three policy reviews, warning of upward risks to inflation as its currency is among the hardest hit amid a global emerging markets sell-off.

The Indian rupee touched an all-time low of 58.98 to the dollar last week as investors worried about India's record-high current account deficit and were unimpressed by government efforts to boost investment.

The RBI said food prices and the falling currency pose inflationary risks, and also called for vigilance over global economic uncertainty, citing the risks of a reversal of capital flows like the one that has roiled emerging markets in recent weeks.

Last week, Indonesia responded to outflows and market volatility by unexpectedly raising interest rates - the first Asian central bank to do so since 2011 - in a bid to support its currency, while Brazil said it would scrap a tax on foreign exchange derivatives as the real weakened.

Other major developing countries with large foreign financing needs such as South Africa and Poland are also seen at risk.

"The RBI was slightly hawkish but with the rupee under pressure to weaken, the tone was appropriate," said Suresh Kumar Ramanathan, head of regional interest rates and FX strategy at CIMB in Kuala Lumpur.

India's current account deficit hit 5.4 percent of GDP in the April-December period, exacerbating pressure on the rupee.

"As long the rupee is under pressure, RBI will hesitate to ease anytime soon," Ramanathan said.

The Indian central bank left its policy repo rate unchanged at 7.25 percent and kept the cash reserve ratio (CRR), or the share of deposits banks must keep with the central bank, steady at 4.00 percent, despite some signs of moderating inflation in recent months.

"It is only a durable receding of inflation that will open up the space for monetary policy to continue to address risks to growth," the RBI said in a statement.

Indian markets were little affected by the policy decision. The 10-year bond yield briefly fell, while stocks .BSESN extended losses to trade down 0.4 percent. The rupee was trading largely unchanged from pre-statement levels, at around 57.80/81 per dollar, but still down more than 4 percent for the year to date.

Still, economists said there remains room for moderate policy easing in coming months.

"What the RBI is looking at is not just a couple of months of improving inflation but something that is much more lasting," said Rajeev Malik, senior economist at CLSA in Singapore, who expected a rate cut in the July policy review but none thereafter in the near term.


A Reuters poll released on Thursday showed 28 of 38 analysts expected the RBI to hold the repo rate steady and 30 of 34 saw the CRR unchanged.

The RBI left rates on hold despite headline wholesale price index inflation that fell to 4.7 percent in May, within its comfort zone, and further signs of economic weakness.

The economy expanded by just 5 percent in the fiscal year that ended in March, its weakest in a decade.

India's May trade deficit widened to $20.1 billion from $17.8 billion a month ago, a trade ministry official said on Monday, amid high imports of cheaper gold, increasing pressure on the current account balance.

Imports rose about 7 percent from a year earlier, while exports fell 1.1 percent, the first annual fall in five months.

While noting that inflation had eased, the central bank warned of looming price pressures.

"Upside pressures on the way forward from the pass-through of rupee depreciation, recent increases in administered prices and persisting imbalances, especially relating to food, pose risks of second-round effects," the RBI said.

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