India Cuts Interest Rates to Support Investment

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Jan. 30 – In a move that hopes to kick-start India’s flagging economy, the Reserve Bank of India (RBI) has lowered the nation’s interest rates from 8 percent to 7.75 percent. This marked the first time since April of last year that rates have been reduced, and only the second time in the past four years.

“It is critical now to arrest the loss of growth momentum, without endangering external stability,” the RBI said in a statement.

The inflation projection for March was reduced from 7.5 percent to 6.8 percent, granting the necessary space for a slight cut to interest rates. However, while inflation has stabilized to a three-year low, the RBI has warned that the possibility of further rate cuts this year is low.

“There is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-14. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” said the Governor of the RBI, Duvvuri Subbarao.

In a surprise move, the RBI also cut the cash reserve ratio by 0.25 percentage points to a near 40-year low of 4 percent. The cash reserve ratio refers to the percentage of deposits that all banks must keep with the central bank. Reducing this percentage effectively allows an additional 180 billion rupees to be introduced into the banking system.

The RBI will now be looking to the government’s action, especially their federal budget, later next month to determine a course of action for the future. If inflationary pressures further decrease as new measures are introduced that provide strong stimulus to the economy, further interest rate cuts may be on the horizon.

Recently, India’s Finance Minister Palaniappan Chidambaram has been travelling abroad to boost the confidence of international investors. First in Hong Kong and Singapore, and now in Europe, Minister Chidambaram has been resolute in stating that the Indian government is determined to implement reforms that are aimed at encouraging growth and further investment.

“There is enormous interest in India. There is enormous goodwill for India, that India must get back to the high growth path and they want us to recapture what we achieved between 2004 and 2009. I am very positive and I am very hopeful,” Minister Chidambaram stated.

The RBI is ultimately focused on encouraging growth. After the central bank reduced India’s GDP expectation for the current year to 5.5 percent, and with the inflationary danger of further reducing interest rates, Governor Subbarao hopes that greater investment into India will save the day.

“What the economy needs most of all and most urgently is new investment,” Governor Subbarao commented. “This will step up currently flagging aggregate demand and also ease the supply constraints, so that existing capacity is fully utilized and new capacity is built up.”

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