With US Fed hike done, Rajan to eye budget to chart course on rate cuts

So, finally, the US Federal Reserve has hiked its key interest rate by a quarter point to a range of 0.25 percent to 0.5 percent, after year-long speculations in global markets that it would do so in every next meeting.

When the Fed finally hiked its rates, the biggest relief for the world markets, especially, emerging markets like India, is the clear message from the US Federal Reserve chair Janet Yellen that the future rate hikes will be “gradual”. This assurance takes away the shock element from future hikes.

 With US Fed hike done, Rajan to eye budget to chart course on rate cuts

RBI governor Raghuram Rajan - PTI

Yellen’s calming words reflected in the Asian markets, which reacted positively to the development. On Thursday, the BSE Sensesx earlier rose 165 points before giving up its gains amid volatility. Probably, markets drew comfort from the fact that the rate hike has finally happened followed with a dovish note, as the world’s largest economy is slowly regaining strength from the days of 2008 global financial crisis that followed the collapse of Lehman brothers on 15 September 2008.

Back in India, this clears one of the three big sources of uncertainties for the Indian central bank governor, Raghuram Rajan — the other two being the course of retail inflation and the fiscal path finance minister Arun Jaitley set to unveil in the union budget towards February end.

Of these, the inflation is a relatively lesser concern for the Reserve Bank of India (RBI) now. The consumer price index inflation (CPI), despite showing signs of spikes in the recent months, is well under control of the January, 2016 target of the apex bank (around 5.8 per cent).

In this context, the next big trigger for the central bank will be the budget before it decides on the future rate moves. The RBI has so far cut its key lending rate by 125 basis points so far this year as inflation concerns have begun easing in the economy. In the previous monetary policy documents, Rajan had clearly said that the central bank’s future course of action will be after getting clarity on both domestic and external factors (mainly US Fed action.)

On the fiscal front, the RBI’s concerns will be whether the government manages to stick to the fiscal roadmap. As Firstpost noted before, it’s almost certain that the government will miss the 3.5 percent fiscal deficit target by 2016-17 if the proposal for 24 percent rise in wages of government employees is implemented in its entirety, coupled with a likely decline in corporate taxes ahead. About a 72 percent of the Rs 1.02 lakh crore wage burden will be on a the central government.

On account of the higher wage bill, based on the last budget roadmap, in fiscal year 2017 the fiscal deficit amount would stand at Rs 6,29,299 crore or 4 percent of GDP. That’s already crossed the red line — the 3.5 percent target the government has targeted for that period. The deficit can only be even higher.

According to a calculation by rating agency Care, to attain the 3.5 percent deficit ratio, the government needs to generate approximately Rs 80,000 crore additional money in revenues. The other option -- hiking the corporate tax rates -- wouldn’t be possible since Jaitley has already committed a phased reduction in corporate taxes to 25 percent from 30 percent in the last union budget.

Also, a lot will depend on how quick the government moves on the disinvestment front. That leaves the possibility of higher service tax rates or increase in individual segments. A picture on how Jaitley works out the fiscal math will be clear only in the full year budget. The central bank would want to wait till then before deciding its future rate course.

The bottomline is this: how well Jaitley works out his fiscal math in next budget will be critical for Rajan to unfold further rate cuts. Over to Jaitley now.

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Updated Date: Dec 17, 2015 15:03:19 IST