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RBI policy today: Why Raghuram Rajan is unlikely to cut rate until Budget

There isn’t much financial markets are expecting from the sixth bi-monthly monetary policy of the Reserve Bank of India (RBI) set to be announced on Tuesday. Most economists and bond dealers expect the RBI to leave its key rate unchanged with a promise of cutting at a later stage if inflation remains low and government sticks to the fiscal consolidation path.

RBI governor Raghuram Rajan will also likely remind the banking sector to cut their lending rates further. Currently, the repo rate, at which RBI lends overnight funds to banks, stands at 6.75 per cent, down 125 bps since January.

Arun Jaitley (Left) and Raghuram Rajan. PTI

Arun Jaitley (Left) and Raghuram Rajan. PTI

Fiscal concerns

Rajan will wait for cues on fiscal consolidation from the Union Budget set to be unveiled later this month by finance minister Arun Jaitley to decide the future course of rate cuts. This is something Rajan has recently hinted at when he said any deviation from the fiscal consolidation path will hurt stability of the economy.

The government, which is running on a delayed fiscal consolidation path, wants to bring down the country’s fiscal deficit to 3.9 percent in the current fiscal year and further to 3.5 percent in 2016-17 and 3 percent by fiscal year 2018.

For Jaitley, sticking onto this fiscal deficit path will be a gigantic task on account of the tepid progress on the disinvestment front (the government has raised Rs 12,700 crore in the current fiscal as against a target of Rs 70,000 crore) and higher spending on account of 7th Pay Commission in 2016-17 (an additional burden of Rs 1.02 lakh crore on the government’s finances).

To meet the fiscal deficit target, the government is left with not too many options but to aggressively cutting down public expenditure and increasing taxes on individual items. Rajan will be keenly looking for how wisely Jaitley plans his fiscal arithmetic to adhere to the consolidation path.

As Firstpost has highlighted in the past, the government is in a position to keep spending more to speed up the economic revival given that the private sector investments haven’t picked up yet and the banking sector remains stress-ridden. But, what makes things difficult is that it needs to move convincingly on the fiscal deficit roadmap as well.

“Unfortunately, the growth multipliers on government spending at this juncture are likely to be much smaller, so more spending will probably hurt debt dynamics. Put differently, it is worth asking if there really are very high-return investments that we are foregoing by staying on the consolidation path?" Rajan said. In short, the fiscal deficit management much more complicated task for Jaitley to balance growth and fiscal consolidation.

Rajan would closely watch comments from the government in the budget also in the context of 7th pay commission proposals.

Inflation concerns

Secondly, though the RBI has managed to contain the retail inflation within its target so far (6% by January, 2016), the spike in prices in recent months is worrisome. The consumer price index inflation (CPI) inflation has inched up in the recent months to 5.61 percent in December, reversing its trend till August. A visible increase in the food inflation, which has risen to 6.4 percent in December, is a major worry for the policy-makers.

In the fifth bi-monthly monetary policy, the RBI had clearly voiced its concerns on the inflation even while acknowledging that inflation has largely remain under control so far. “While oil prices, barring geopolitical shocks, are expected to remain benign for a few quarters more, the uptick of CPI inflation excluding food and fuel for two months in succession warrants vigilance,” the RBI said.

The RBI has committed to rate easing path provided inflation remains under control. It would want to go for a rate cut only in March or April if inflation sticks to the gliding path and watching the movement of international crude prices.

“The disinflationary impact of low crude prices was more than offset by a sharp jump in food price pressures and was not helped by adverse base effects. Service sector inflation remains sticky and indeed rose to 4 per cent Y-o-Y from 3.1 percent in the September quarter,” Radhika Rao, economist at Singapore-based DBS bank said.

Thirdly, the central bank wants banks to act more on the rate easing front. In the last policy, the RBI had clearly said it isn’t satisfied with the way banks have so far responded to its earlier rate cuts. “Since the rate reduction cycle that commenced in January, less than half of the cumulative policy repo rate reduction of 125 bps has been transmitted by banks. The median base lending rate has declined only by 60 bps,” the RBI had noted.

Of the three triggers, clearly budget is most crucial for the central bank to chart its course on future rate cuts. One can’t rule out an off-policy rate cut if the budget keeps its promises on fiscal consolidation. The ball now is in Jaitley’s court.

(Kishor Kadam contributed to this story)

Updated Date: Feb 02, 2016 09:45 AM

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