RBI's surprise rate cut: Here's why the central bank decided to back the govt

The Reserve Bank of India cut its policy rate by 25 basis points to 7.5 percent second time in about a month’s time, giving a significant push to the growth agenda set by the government. Here is all you need to know about why the central took the unexpected step: 1) Faster-than-expected disinflation: Prices of vegetables declined and, hearteningly, inflation excluding food and fuel moderated in a broad-based manner to a new low. Thus, disinflation is evolving along the path set out by the Reserve Bank in January 2014 and, in fact, at a faster pace than earlier envisaged. [caption id=“attachment_2134917” align=“alignleft” width=“380”]  PTI image[/caption] 2) GDP estimates not really supported: The picture the CSO’s GDP estimate presents of a robust economy, with growth having picked up significantly over the last three years, is at odds with still-low direct measures of growth of production, credit, imports and capacity utilisation as well as with anecdotal evidence on the state of the economic cycle. 3) Stamp of approval on govt’s fiscal efforts: There are many important and valuable structural reforms embedded in this Budget, which will help improve supply over the medium term. 4) Concerns over fiscal deficit: The delaying of fiscal consolidation by one year will add to aggregate demand. At a time of accelerating economic recovery, this is prima facie a source for concern from the standpoint of aggregate demand management, especially with large borrowings intended for public sector enterprises. 5) Happy that mess created by UPA will be cleaned up: The government has emphasized its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. 6) Thumbs up to Modi’s co-operative federalism: The government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower.