RBI Governor Raghuram Rajan on Tuesday left the key policy rate unchanged but indicated an accommodative stance saying with "inflation moving closer to the target" there would be more room for rate cut to support growth.
The repo or short term lending rate remains unchanged at 6.75 percent and the reverse repo rate at 7.75 percent.
In the event, RBI governor has, in no uncertain terms, put the onus of further rate cuts on Arun Jaitley.
Here are the highlights:
Inflation keeps to trajectory: There is not much concern as inflation has evolved closely along the trajectory set by the RBI. "With unfavourable base effects on the ebb and benign prices of fruits and vegetables and crude oil, the January 2016 target of 6 per cent should be met," it said. It assumes that a normal monsoon, benign crude prices and exchange rate will result in an inflation of 5 percent by the end of 2016-17.
But 7th pay commission may push up inflation: The central bank sees the Pay Commission recommendation, which sought to increase the salary of government employees by 23.5 percent increase in salary, allowances and pensions from 1 April, will likely "impart upward momentum to this trajectory for a period of one to two years".
According to Jay Shankar, chief economist, Religare, the central bank will keep a close watch of what big states are doing with their own state pay commissions. He notes that Punjab, Uttar Pradesh, West Bengal, Kerala and Tamil Nadu are all election bound. With Himachal Pradesh already announcing the setting up of their respective Pay Commissions, other states are likely follow, he says. Religare sees the Pay Commission implementation by the Centre and state governments leading to a $50 billion fiscal stimulus over the next two years.
The inflation projections by the central bank have not taken the pay commission impact into account, it has said. So there could be changes in the projection going forward.
Growth may pick up in Q4: The RBI has noted that domestic economic activity lost momentum in the third quarter of 2015-16, due to slackening agricultural and industrial growth. The reason for this is weak investment demand and deceleration of capital goods production that negatively impacted the industrial activity in the first two months of the quarter.
However, the central bank expects "a modest expansion of activity" in fourth quarter. It sees GVA growth for 2015-16 at its earlier projected 7.4 percent, but "with a downside bias". In 2016-17, it sees the growth at 7.6 percent.
On stalled projects: Stalled projects have been a major issue for the economy. The central bank says these projects continue to remain high. What is making things worse is a decline in new investment intentions, which it attributes to low capacity utilisation.
The message to Arun Jaitley: Finance minister Arun Jaitley may feel like he has been trapped between a rock and a hard place. The RBI has indicated that it will keep a close watch on the government's expenditure.
In order to maintain the current growth momentum, the disinflation should continue steadily, current account deficit should remain modest and fiscal rectitude should also be maintained. For this, the key is carrying out structural reforms while controlling spending.
"Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5 percent by the end of 2016-17," the RBI has said.
In essence, Arun Jaitely will need to do a tough balancing act when he presents the budget as there is an urgent need to increase quality spending in the absence of private investment. Raghuram Rajan has clearly lobbed the ball into Jaitley's court.