India cuts key interest rate for 3rd time to try to revive growth but warns scope limited

MUMBAI, India – India’s central bank cut a key interest rate by a quarter percentage point to 7.25 per cent on Friday to try to revive stalled economic growth but warned persistent inflation leaves little room for more aggressive rate cuts in the future.

Bank governor D. Subbarao cited decade-low GDP growth of 4.5 per cent in the October-December quarter last year— about half of the strong 9.2 per cent growth of just two years ago in Asia’s third-largest economy — for the decision.

“Growth slowed much more than anticipated, with both manufacturing and services activity hamstrung by supply bottlenecks and sluggish external demand,” Subbarao said in a statement. Much of India’s IT services sector depends on orders from clients in Europe and the U.S. that are still skittish about spending in an uncertain world economy.

The bank forecast a slow recovery to 5.7 per cent growth for the current fiscal year that ends March 2014, with most of the pickup coming in the later months of the year.

Friday’s action was the third cut this year in the policy repo rate at which commercial banks can borrow from the Reserve Bank of India. The bank hopes that making money cheaper to borrow will encourage more spending and investment.

“Nevertheless, it is important to note that recent monetary policy action, by itself, cannot revive growth,” Subbarao said, adding that the government must step up public investment in infrastructure, clear bottlenecks that are hampering large projects and address twin deficits both in government spending and the current account balance.

He also warned the bank had “little space for further monetary easing” because of inflation, noting that food prices in particular continue to rise at a steep rate.

While wholesale price inflation estimates fell to a three-year low of 6 per cent in February, prices of staples such as wheat and rice were up 20 and 18 per cent over the previous year, threatening an estimated 825 million people in India — more than two-thirds of the population — who live on less than $2 per day and spend most of their money on food and fuel.

The bank also expressed concern about the country’s current account deficit, which hit a record 6.7 per cent of GDP in the quarter ending in December as once-healthy exports stalled and imports surged on high oil and gold prices.

Large current account deficits can weaken a country’s currency and also leave the economy vulnerable to external market downturns. India’s central bank says anything above 2.5 per cent of GDP is unsustainable.