MUMBAI, India (AP) — India's central bank said growth will slow to 7 percent this fiscal year, but left interest rates unchanged Tuesday as it struggles to balance a toxic mix of high inflation and a flagging economy.
The bank cut the cash reserve ratio — the percentage of cash commercial banks must keep on hand — by half a percentage point, to 5.5 percent. That should add 320 billion rupees ($6.4 billion) to India's cash-strapped banking system. India's benchmark Sensex stock index rose 1.2 percent.
The bank's new growth projection is a substantial cut from its October forecast of a 7.6 percent increase in economic activity for the year ending March 2012. The downgrade reflects weakening global growth as well as domestic policy paralysis, high inflation and dwindling investment. Last fiscal year, India's economy grew by 8.5 percent.
"The global environment is only partly responsible for the weak industrial performance and sluggish investment activity," the bank said in its policy statement. "Several domestic factors — the unhealthy fiscal situation, high interest rates and policy and administrative uncertainty — are also playing a role."
That toxic cocktail cannot be fought by monetary policy alone.
The Reserve Bank made several stark requests to the government in New Delhi: Get the budget deficit under control. Improve infrastructure and food supply. Take clear steps to restore confidence and boost investment.
"Policy and administrative actions, which induce investment that will help alleviate supply constraints in food and infrastructure, are critical," the bank said.
"In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending," it said.
Despite trimming its growth outlook, the bank left its projection of inflation easing to 7 percent by March unchanged.
A weak rupee has aggravated inflation, which is likely to worsen as the government reduces its fuel and coal subsidies, the bank said.
Inflation, which averaged 9.7 percent from April through October, softened in November and December. But the bank — like many economists — noted that much of the decline was driven by a seasonal fall in vegetable prices.
Fuel inflation remained a high 14.9 percent in December, thanks to high global crude prices and a weak rupee, which drives up the cost of imports.
Nonfood manufacturing inflation also remained an uncomfortably high 7.7 percent in December.
The bank said it would like to see inflation in the range of 4.0 to 4.5 percent.
Between January 2010 and October 2011, the Reserve Bank raised the policy rate 13 times, by 3.75 percentage points, and raised the cash reserve ratio by 1 percentage point.
ING Vysya Bank economist Upasna Bhardwaj said the bank's moves were largely expected — though the market was not pricing in a drop in the cash reserve ratio — and mark a further move toward prioritizing growth over inflation.
"They have highlighted the downside risks to growth, which have increased considerably," she said, but cautioned that inflation remains a problem which the Reserve Bank alone cannot solve.
"On the supply side the bank can't do anything. The government has to do something," she said. "Huge fiscal expenditures are adding to the inflation scenario."