India's central maintained its main policy rates, as expected, but cut its growth forecast and appealed to politicians to take immediate steps to slash the current account deficit and it was "ready to use all available instruments and measures at its command to respond proactively and swiftly to any key adverse development."
The Reserve Bank of India (RBI), which has taken a string of measures in recent months to curb the fall in the rupee, maintained its repo rate at 7.25 percent - it has been cut by 75 basis points this year in the face of declining growth - along with the reverse repo rate at 6.25 percent and the cash reserve ratio (CRR), which was cut by 25 basis points in January.
The forecast for Gross Domestic Product growth in the current 2013/14 fiscal year, which began April 1, was cut to 5.5 percent from 5.7 percent due to "tepid" global growth and the main risk to the outlook stems from global financial markets and a sudden stop or reversal of capital flows.
The International Monetary Fund (IMF) has forecasts Indian economic growth of 5.6 percent in 2013/14, up from 3.2 percent in 2012/13 but still well below the 6.3 percent rate in 2011/12.
"India, with its large CAD (current account deficit) and dependence on external flows for financing it, will remain vulnerable to the confidence and sentiment in the global financial markets," RBI said.
India has a history of current account deficits and for the last three years the deficit has exceeded 2.5 percent of GDP - seen as a sustainable level by the central bank - hitting 4.8 percent of GDP in the 2012/13 fiscal year that ended March 31.
The RBI said the deficit posed a "formidable structural risk factor" that has brought the external payments situation under increased stress and "eroded the economy's resilience to shocks."
India's currency, the rupee, has been declining over the last two years and is down 27 percent since its slide began in late July 2011 when it was trading at 44 to the U.S. dollar compared with 59.5 today.
The rupee stabilized in late 2012 and at the beginning of this year, but the downdraft from the shift in investors' view of global risks in May triggered a sharp bout of weakness that took it below the psychologically important level of 60 rupees to the dollar on July 8.
From May 1 through July 8, the rupee lost close to 11 percent but since then it has bounced back following the RBI's measures to tighten liquidity, which include raising short-term lending rates.
The RBI said its measures, which would rolled back "in a calibrated manner as stability is restored to the foreign exchange market" had provided politicians with a window of opportunity and "emphasized that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels."
The RBI said it was currently "caught in a classic 'impossible trinity' trilemma whereby we are having to forfeit some monetary policy discrection to address external sector concerns."
The trilemma refers to an concept in international economics that says it is impossible to have a fixed exchange rate, free capital movement and an independent monetary policy at the same time.
Under normal circumstances, the RBI would have been able to continue last year's policy of easing to further stimulate growth as softening food inflation from this year's robust monsoon would have given it room to act. But the downward pressure on the currency is limiting the bank's options.
India's main inflation gauge of wholesale prices rose slightly to 4.86 percent in June from 4.7 percent and the bank said the stronger than expected monsoon had not yet softened food prices and some vegetable prices had been hit by weather-driven supply disruptions.
"The sharp depreciation of the rupee since mid-May is expected to pass through in the months ahead to domestic fuel inflation as well as to non-food manufactured products inflation through its import content," the RBI said, adding the timing of this and a revision to administered prices was a source of uncertainty for the inflation outlook.
The RBI's objective is to maintain WPI inflation at 5.0 percent by March 2014 while its medium-term objective is to keep the rate at 3.0 percent.
The RBI's policy stance today was largely expected following the release yesterday of its review of economic and monetary developments in the first quarter of the current 2013/14 fiscal year, in which it said that its priority is to restore stability in the currency market and the macro-financial risks warranted a cautious monetary policy stance.