RBI Repo Rate Cut: ‘Rate cut Raghu’ provides ‘Advantage Jaitley’

Barely a day after RBI Governor suggested in a public forum that quick rate cuts might be difficult to hand out, despite inflationary pressures coming down and no signs of a growth uptake given the dismal January core sector data, he surprised the stock markets with a 25 basis point cut in repo rate to 7.50% from 7.75%.

The Repo Rate is the rate at which the central bank lends to commercial banks in the event of a shortfall of funds. As most experts suggest the Repo Rate cut will create greater liquidity in the market, clearing the investment log-jam to a certain extent for crucial sectors such as infrastructure that the government gave top-billing to as far as driving growth was concerned.

This reduction, coming in almost a month before the slated monetary policy action on April 7, suggests that Rajan is clearly towing the Government’s outlook on growth and fiscal consolidation. In the statement released by the central bank, mentioning the measures announced by Finance Minister Arun Jaitley in his budget speech on February 28, Rajan says, “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. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers.’

He also goes onto commend the government on three other factors, all of which he says have led to the decision for the rate cut, the second one since January 2015. Rajan says, “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. Furthermore, supported by lower international energy prices, there is a welcome intent to shift from spending on subsidies to spending on infrastructure, and to better target and further reduce subsidies through direct transfers. Finally, the central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. This makes explicit what was implicit before – that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way. In sum, then, the government intends to compensate for the delay in fiscal consolidation with a commitment to an improvement in the quality of adjustment.”

The other very important factor has been a strong Rupee. While an excessively strong currency is undesirable, Rajan says that, a strong currency does hold disinflationary impulses.

However, what could prove to be a further impetus and advantage for the Narendra Modi Government is that Rajan maintains that going forward, ‘softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6 per cent in the second half. The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative. Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation.’ This bides well with the economy, given that most industry experts and analysts believe that to be able to take the economy out of its current rut, a further reduction by almost 50 basis points is required, especially to get investments flowing into stagnant infrastructure projects, which will be the key to jumpstarting India’s economic revival

The central bank also said that going forward the RBI will seek to bring the inflation rate to 4% by the end of a two year period starting fiscal year 2016-17.