While the decision to leave the policy repo rate unchanged at 8.00 percent was in line with forecasts, expectations for a rate cut had grown after India's finance minister on Monday outlined a plan to trim the country's hefty fiscal deficit.

RBI Governor Subbarao's full speech

As inflation eases further, there will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to mitigate the growth risks and take the economy to a sustained higher growth trajectory, RBI Governor D Subbarao wrote in his quarterly policy review.

Headline wholesale price index inflation rose to 7.8 per cent in September, a 10-month peak, and the RBI said it expects inflation to rise before easing in the final quarter of the fiscal year, which ends in March.

While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13, Subbarao wrote.

The market had been positioned for a rate cut, said A Prasanna, economist at ICICI Securities Primary Dealership.

There's a positive that RBI has said there's a likelihood of easing in the Jan-March quarter. Looks like RBI wants inflation to peak out before cutting rates so we shouldn't expect anything in December. We expect a 50 basis points cut during Jan-March, he said.

India's 10-year bond yield rose around 4 basis points, while the rupee and stocks weakened.

Investors, companies and the government have been clamouring for a cut to interest rates that have been on hold since April and remain some of the highest among major economies.

A rate cut in the face of jump in September WPI, sharp upward revision to historical numbers and recent rebound in the proxy core inflation measure, might have put the bank's inflation-fighting credibility at risk, said Radhika Rao, an economist at Forecast Pte in Singapore.

While economic growth in India has been slowing, inflation has not, and the central bank has been calling on the government to follow through quickly on recent steps to cut its deficit and encourage investment, and to take further such measures.

Recent policy announcements by the government, which have positively impacted sentiment, need to be translated into effective action to convert sentiment into concrete investment decisions, Subbarao wrote.

Finance Minister P Chidambaram on Monday outlined a plan to nearly halve the deficit in just over four years. While he gave few specifics, his announcement at a hastily called news conference was seen as adding pressure on the RBI to cut rates.

New Delhi has unveiled a spate of reforms to bolster investment and rein in its fiscal deficit, including raising the price of subsidised diesel and lifting caps on foreign investment in several industries.

The RBI cut its GDP growth forecast for Asia's third-largest economy to 5.8 per cent for the current fiscal year, from 6.5 per cent previously, and increased its projection for headline inflation in March to 7.5 percent, from 7 percent earlier.

The central bank lowered the cash reserve ratio, the amount of deposits that banks must keep with the central bank, by 25 basis points to 4.25 per cent, a move it said would inject about 175 billion rupees into the banking system in order to preempt potentially tightening liquidity.

In a poll earlier this month, economists had been nearly evenly split on whether or not the RBI would lower CRR.

COMMENTARY

* RADHIKA RAO, ECONOMIST, FORECAST PTE, SINGAPORE

RBI stood by its tough anti-inflation rhetoric by opting not to lower the key policy rate though preferred to trim the CRR as a step to lower funding costs and possible compromise. A rate cut in the face of jump in September WPI, sharp upward revision to historical numbers and recent rebound in the proxy core inflation measure, might have put the bank's inflation-fighting credibility at risk.

Notably there appears to be some sort of policy guidance, as RBI expects inflation to ease in Q4 2013, priming the markets to lower expectations of an imminent rate cut. We maintain our call for 50 bps more cuts by end-FY13.

HIGHLIGHTS

POLICY MEASURES:

* Keeps repo rate unchanged at 8 per cent.

* Reverse repo stays at 7 per cent.

* Cash reserve ratio cut by 25 bp to 4.25 per cent.

* Cut in cash reserve ratio would inject 175 billion rupees of primary liquidity into the banking system.

POLICY STANCE:

* There is reasonable likelihood of further policy easing in the January-March quarter.

* Managing inflation and inflation expectations must remain the primary focus of monetary policy.

* The reduction in the CRR is intended to pre-empt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable to support growth.

FORECASTS

* Baseline GDP growth forecast for 2012/13 cut to 5.8 per cent from 6.5 per cent earlier.

* Baseline wholesale price index inflation projection for March 2013 raised to 7.5 per cent, from 7.0 per cent.

INFLATION STANCE

* Underlying inflationary pressures reflected in non-food manufactured products inflation has remained stubbornly above comfort levels.

* It is critical that even as the monetary policy stance shifts further towards addressing growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised.

* Anticipates the projected inflation trajectory which indicates a rise in inflation before easing in the last quarter.

* Persistent increase in rural and urban wages, unaccompanied by commensurate productivity increases, is also a source of inflationary pressures.

* Maintain an interest rate environment to contain inflation and anchor inflation expectations.

* An appreciating rupee will also help to contain inflationary pressures by bringing down the rupee cost of imports, especially of commodities.

GROWTH, ECONOMY

* The large twin deficits, i.e., the current account deficit and the fiscal deficit continue to pose significant risks to both growth and macroeconomic stability.

* In a situation of volatile capital flows, the deficit could exacerbate downward pressures on the rupee.

* A persistently large fiscal deficit reduces the space for a revival in private spending, particularly investment spending, without quickly re-kindling inflationary pressures.

* Liquidity pressures pose risks to credit availability for productive purposes and could affect overall investment and growth prospects adversely

* Manage liquidity to ensure adequate flow of credit to the productive sectors of the economy.

LOAN PROVISIONING NORMS

* Increases the provisioning for restructured standard accounts to 2.75 per cent from 2 per cent, effectively immediately. Draft guidelines will be issued by end-January 2013.

* KILOL PANDYA, HEAD OF FIXED INCOME, DAIWA MUTUAL FUND, MUMBAI

I was expecting a 50 basis points cut in the CRR. The policy is in line with what the RBI has been saying. While it has raised the inflation projection and cut growth estimates, it has held out hope for a rate cut in the next calendar year. I expect the 10-year yield to hold in the 8-8.25 percent range.

* JAGANNADHAM THUNUGUNTLA, STRATEGIST, SMC GLOBAL SECURITIES, NEW DELHI

For the central bank, inflation is the main anchoring point and that has been the case all along. I don't think they will do much in the next couple of quarters as inflation is not going to come down any time soon.

Now they are coming closer to the reality in terms of the GDP growth.

* DARIUSZ KOWALCZYK, SENIOR ECONOMIST & STRATEGIST, CREDIT AGRICOLE CIB, HONG KONG

Such outcome is in line with consensus, but there was a strong minority expecting a rate cut, so its lack should move markets: hit the INR (growth will take longer to rebound with high rates) and trigger paying flows on the INR OIS curve (it could steepen as gains in long end should be larger given that short end should be somewhat anchored via improvement of liquidity after CRR cut).

* A. PRASANNA, ECONOMIST, ICICI SECURITIES, PRIMARY DEALERSHIP LTD, MUMBAI

Market was positioned for a rate cut, but a cut in CRR delays the beginning of open market operations (OMOs). There's a positive that RBI has said there's a likelihood of easing in the Jan-March quarter. Looks like RBI wants inflation to peak out before cutting rates so we shouldn't expect anything in December. We expect a 50 basis points cut during Jan-March.

BACKGROUND

- Prime Minister Manmohan Singh gave his cabinet an overdue facelift on Sunday, bringing in younger ministers in a bid to breathe new life into his aged, scandal-tainted government ahead of state and federal elections.

- India's fiscal deficit needed to be brought under control, a deputy governor of the Reserve Bank of India said on Oct. 16, days after the finance minister called on the central bank to take calibrated risks to support the struggling economy.

- The government will move to cut its fiscal deficit to 3 percent of GDP by March 2017, the finance minister said on Monday, as the government tackles its ballooning expenditure to prevent the country's credit rating being downgraded to junk.

- A series of measures taken by Finance Minister P. Chidambaram will not fix the sluggish economy in the near term, and the window of opportunity for implementing game-changing reforms such as slashing government spending on fuel, food and fertiliser subsidies will narrow as campaigning for a 2014 election gets under way.

- India is shaking up the way it gets billions of welfare dollars to the poor with a plan that could one day reshape the economy and tackle graft keeping millions in poverty, but in one small town a pilot of the new system is proving unpopular.

- Rising fuel prices boosted Indian inflation in September to 7.8 percent, its highest level since November, undermining the government's case for a central bank interest rate cut this month to boost the sluggish economy.

- Annual exports fell for the fifth consecutive month and imports rose in September, pushing the trade deficit to its widest in 11 months as Asia's third largest economy struggles to balance its finances.