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India holds rates steady, ups inflation forecast

Reuters, Mumbai
The Reserve Bank of India (RBI) left interest rates unchanged on Tuesday for the second straight review, showing that bringing down stubbornly high inflation is its top priority even as economic conditions deteriorate.
Underlining its policy dilemma as it faces pressure to reduce rates, the Reserve Bank of India (RBI) cut its economic growth forecast for the fiscal year to March 2013, while at the same time raising its inflation forecast.
The RBI left its policy repo rate at 8 percent and cash reserve ratio for banks at 4.75 percent. The CRR is the share of deposits banks must keep with the RBI.
"In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth," Governor Duwuri Subbarao wrote in the monetary policy review.
The RBTs primary focus remains inflation control, he added. The central bank’s hard line on rates sits in contrast to many other central banks that are easing credit conditions to try to bolster economies feeling the impact of the euro zone debt crisis.
The stance maintains pressure on Prime Minister Manmohan Singh's government to rein-in populist subsidy spending and take other steps to bolster an economy growing at its weakest pace in almost a decade as companies hold back on investment and a creaking infrastructure stunts growth as it adds to business costs and so fuels inflation.
A massive grid failure hit India for the second straight day on Tuesday, cutting power for hundreds of millions of people in the north and east of the country, calling attention to underinvestment in a power sector unable to keep up with demand.
A Reuters poll of 20 economists last week showed all but one expected the RBI to hold rates steady.
Many economists expected the central bank to resume cutting rates only in the second half of the fiscal year.
Weaker-than-normal monsoon rains in India this summer complicate monetary policy. Higher food prices are beyond the reach of monetary policy, but can fuel inflationary expectations and tempt the government to spend more on subsidies.
"Given the inflationary risks and pressures, which I don't see going away, we will continue to see high inflation in the rest of the year," said Abheek Barua, chief economist at HDFC Bank in New Delhi. "In the foreseeable policy horizon, I do not see RBI cutting rates," he said.
Wholesale price inflation remained above 7 percent in June and consumer price inflation was 10 percent. Growth in Asia's third-largest economy slowed to a nine-year low of 5.3 percent in the March quarter.
On Tuesday, the central bank cut its economic growth outlook for the fiscal year that ends in March to 6.5 percent, from the 7.3 percent assumption made in April, putting
its outlook closer to that of many private-sector economists.
It also raised its headline inflation projection for March 2013 to 7 percent from 6.5 percent in its April review, further denting market hopes for policy easing in the near term.
The central bank unexpectedly cut the minimum requirement for banks' government bond holdings to 23 percent of
deposits from 24 percent, a move to free up liquidity. However, some bankers said the cut was unlikely to spur more lending given worries about deteriorating credit quality.
The 10-year benchmark bond yield was up 9 basis points at 8.24 percent from its previous close, after rising to as much as 8.28 percent. The 5-year OIS rate rose 10 bps to 7.10 percent, while the 1 - year rate rose 4 bps to 7.68 percent.
India’s main stock index .BSESN recovered from earlier disappointment over the weakening prospects for near-term rate cuts and was up 0.55 percent in late trade, pulled by strong regional gains.
"The Reserve Bank of India struck a hawkish stance in its monetary policy statement," said Anubhuti Sahay, an economist at Standard Chartered Bank in Mumbai. "Overall it affirms our view that any rate cut from the RBI is unlikely in rest of 2012."
The RBI cut rates by a steeper-than-expected 50 basis points in April but has kept a hawkish stance since, even in the face of widespread expectations in June it would cut rates again.
"Headline inflation has persisted even as demand has moderated and the pricing power of corporates weakened," Subbarao wrote. "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 RBI's hawkish stance makes it an outlier compared with the likes of China, Brazil and South Korea, which have eased monetary policy in recent weeks to bolster their flagging economies.
The central bank has repeatedly called on the government to take steps to revive investment by implementing long-pending reforms, such as allowing foreign direct investment in the supermarket and airline industries, and to cut populist spending