Accordingly, the CRR or the portion of deposits banks have to park with the RBI now stands at 4.25 per cent while the repo rate, at which RBI lends to the system, has been retained at 8 per cent.

RBI Governor Subbarao Read full speech

The reverse repo, at which RBI absorbs excess liquidity through borrowings from banks, remains at 7 per cent.

Reacting to the policy, the BSE 30-stock index, Sensex, slid 181.72, or 0.98 per cent, to 18,454.10 at 1138 hrs.

The new rates will be effective November 3, RBI Governor D Subbarao said while unveiling the mid-year monetary policy review.

"Managing inflation and inflationary expectations remains the primary focus of the monetary policy," Subbarao said, stating that the persistently high inflation remains a "key challenge" even though growth has slid.

The CRR cut, the Governor said, is aimed at enhancing liquidity. It will infuse Rs 17,500 crore into the system, complement the Government's reform measures and anchor medium term inflation expectations.

The easing of CRR would release primary liquidity prompting banks to cut interest rates.

The RBI has also revised downwards the GDP growth estimate to 5.8 per cent from the earlier 6.5 per cent, while increased its March-end headline inflation forecast to 7.5 per cent. It is the second time since the beginning of the fiscal that it has revised its estimate on both the aspects.

There was widespread expectation that the Governor may play the ball with the government today especially after North Block announced a fiscal consolidation roadmap against the backdrop of the backdrop of the gush of reform measures announced in the past 45 days.

Subbarao said, however, that once the government efforts bear fruit, the RBI -- which has been consistently criticised for its tight money policy -- will be in a better position to ease interest rates, hinting of a rate cut in the fourth quarter.

"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 higher growth trajectory," Subbarao said.

In the second quarter review, the RBI also introduced a slew of measures on banking regulation, including steeply increasing the provisioning on standard restructured assets to 2.75 per cent from the earlier 2 per cent from immediate effect.

This move will dearly impact the banks, which have been witnessing an unprecedented rise in loan restructuring due to economic stress. Some critics also call it as a ploy by the banks to restructure loans, and not show them as NPAs, in order to protect their bottom-lines.

Significantly, the policy does not mention anything about new bank licences but said initiatives will be taken for having new urban co-operative banks.

The other moves ushered in include a revision in priority sector lending norms, guidelines to banks on restructuring and non-performing assets management, management of unhedged currency exposures of companies and insistence of timely reporting of advances to credit information companies.

RBI also said the existing KYC (now your customer) requirements used for new account openings will be simplified soon, liberalising opening of administrative offices in tier-I centres for domestic banks and having an additional batch of NEFT clearance at 8 AM daily.

India cbank holds rates, cuts cash reserve ratio by 25 bps

(Reuters) India's central bank the Reserve Bank of India (RBI) left interest rates on hold on Tuesday but cut the cash reserve ratio (CRR) for banks, defying pressure from the government to lower rates for the first time since April but also indicating it may soon ease policy further.

While the decision to leave the policy repo rate unchanged at 8.00 percent was in line with forecasts in a recent Reuters poll, 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.

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 Gov. Duvvuri Subbarao wrote in his quarterly policy review.

Headline wholesale price index inflation rose to 7.8 percent 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 percent for the current fiscal year, from 6.5 percent 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 percent, a move it said would inject about 175 billion rupees into the banking system in order to pre-empt potentially tightening liquidity.

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

Stocks Check Sensex/Nifty Reaction

INSTANT VIEW: COMMENTARY

Rahul Goswami, CIO-Fixed Income, ICICI Prudential AMC

“RBI has a tightrope to walk on of managing inflation and growth. With maintaining status quo on Repo rate and reduction in CRR by 25bps, RBI has maintained its stance of tempering inflation and inflationary expectations. As the government’s reform actions translate to moderation of the twin deficits, RBI will get significant headroom to initiate aggressive monetary easing which can come as early as the QI CY 13. Though the current stance may post short term challenges for the bond market, we are confident that the trajectory of long term yields remains southwards. This brings forward an even bigger opportunity for investors who have missed out earlier to enter the fixed income duration segment.”

RUPA REGE NITSURE, CHIEF ECONOMIST, BANK OF BARODA, MUMBAI

There was absolutely no scope for the RBI to reduce the repo rate given that CPI is still close to double digits. The countries which have recently eased monetary policy have much lower rates of inflation, below 3 percent. But given the pressures owing to the festive season and a busy season for industry, the move to reduce the CRR is in the right direction.

I expect a rate cut to happen only in the fourth quarter of the current fiscal year. The improved rabi (winter) crop could reduce the pressure on the food inflation side and generally in the fourth-quarter the supply-side pressure on inflation should also ease and provide some room for the RBI to cut rates.

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.

ANUBHUTI SAHAY, ECONOMIST, STANDARD CHARTERED BANK, MUMBAI

The RBI is still worried about inflation. In a bid to support growth, it has eased liquidity. I think the RBI will now cut rates in the last quarter of the fiscal year by which time there will be more clarity on the government's fiscal consolidation.

Open market operations will still be necessary to support liquidity but they will probably be less and delayed.

SHUBHADA RAO, CHIEF ECONOMIST, YES BANK, MUMBAI

The policy is in line with our revised outlook post yesterday's fiscal consolidation plan. While current inflation is worrisome, going forward, it could provide some comfort. The stance of monetary policy is shifting towards supporting growth and maintaining comfortable liquidity to provide for the credit needs of the economy.

And, as the government measures continue to unfold, we believe the RBI will continue to support growth with a rate cut. We're still expecting 50 bp rate cut during Jan-March, with inflation likely to peak in December.

SHAKTI SATAPATHY, FIXED INCOME STRATEGIST, AK CAPITAL, MUMBAI

Today's policy action is a reiteration of the central bank's agenda on anchoring inflation while putting the growth onus on more fiscal reforms. Though the CRR cut is expected to see a repricing of banker's lending rates, the key remains on the growth in credit disbursal to the productive sectors and managing the inflationary threat arising out of excess liquidity in the system.

The tone of the policy seems to be neutral and would largely be driven by the central government's effort in managing the fiscal risk going forward.

NITESH RANJAN, ECONOMIST, UNION BANK OF INDIA, MUMBAI

RBI is still overweight on inflation risks and thus it continues to use 'liquidity' channel for supporting growth rather than the interest rate channel. Effective government actions and likely moderation in inflation in the final quarter will be key to policy rate cut. In my view, if there is no negative surprise on inflation path, RBI may start repo rate cut by December this year.

SRIVIDHYA RAJESH, FUND MANAGER, SUNDARAM MUTUAL FUND, CHENNAI

There was definitely lot of expectations in the markets for a rate cut, but people will have to wait for some more time. It is disappointing for the markets.

Whatever the government has announced on the reforms front, if they get implemented that will give some comfort to the RBI. They are waiting for that to happen.

KILLOL 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.

LAKSHMI IYER, HEAD OF FIXED INCOME, KOTAK MUTUAL FUND, MUMBAI

Our sense is RBI is acknowledging the growth slowdown. The statement is open-ended and is hinting at a repo rate cut over the next 3-4 months. Interest rates are clearly headed lower, be it via cuts in CRR or repo.

The 10-year yield will consolidate around current levels. We still think that there will be OMOs in Nov/Dec.

DEVEN CHOKSEY, MD & CEO, K R CHOKSEY, MUMBAI

If a CRR cut is not backed by a rate cut it doesn't make sense and this is unlikely to be reviewed before December. By sending more liquidity into the system the RBI is trying to ask banks to take the pressure. The excess liquidity will go towards projects, banks will be pressurised to lend but buyers might not feel confident about spending after borrowing at high rates. You have to allow expenditure to take place in the system so there is infrastructure development which will kick-start the economy.

MARKET REACTION

The 10-year bond yield rose around 4 basis points to 8.16 pecent, while the rupee and stocks weakened after the central bank decision.

Traders said bonds were hit as the cut in the CRR, or the amount of deposits banks must keep with the Reserve Bank of India, could lower the potential of bond purchases via open market operations.

The rupee weakened to 54.03/04 per dollar from around 53.89/90 beforehand.

The BSE index fell 0.3 percent, erasing mild earlier gains.

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.

- India faces a one-in-three chance of a credit rating downgrade over the next 24 months, Standard & Poor's has said, although a series of reform steps launched in September had slightly improved the country's prospects.

Bank shares drop on RBI's restructured loan provisioning norm

Indian lenders, especially state-owned ones, dropped after the central bank increased the amount of provisioning against restructured loans to 2.75 percent from 2 percent, effective immediately, as part of its monetary policy review.

State Bank of India shares fell 2.6 percent as of 0551 GMT, while Bank of India fell 1.6 percent.

Stocks More on ICICI Bank

Company INFO More on State Bank of India

RBI HIGHLIGHTS

* Key lending and borrowing rates left unchanged

* Cash Reserve Ratio cut 0.25 per cent at 4.25 per cent

* CRR cut effective November 3 to inject Rs 17,500 crore into banking system

* GDP estimate lowered to 5.8 per cent, from 6.5 per cent

* March-end inflation target up 7.5 per cent from 7 per cent

* Diesel price correction needed for macro-economic stability

* Fiscal and Current Account Deficit pose risk to growth

* Repo, Reverse Repo, Bank rate retained at 8 per cent, 7 per cent and 9 per cent

* Government policy initiatives to dispel pervasive negative sentiments, improve investment climate

* Monetary policy will stimulate growth, lower inflation

* Mid-Quarter Review of Monetary Policy on December 18

* Third Quarter policy review on January 29.

POLICY MEASURES:

* Keeps repo rate unchanged at 8 percent.

* Reverse repo stays at 7 percent.

* Cash reserve ratio cut by 25 bp to 4.25 percent.

* 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 percent from 6.5 percent earlier.

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

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 percent from 2 per cent, effectively immediately. Draft guidelines will be issued by end-January 2013.