Budget impetus for Rajan to cut rates

The second unscheduled cut on March 4 - within two months - in the repo rate at which the RBI lends to commercial banks was not as unexpected as the first in January. Indeed, it could even be called expected after the weekend's historic announcement by Finance Minister Arun Jaitley in his first full budget speech to the Lok Sabha of the government signing the Monetary Policy Framework Agreement with the RBI for controlling inflation.

The agreement will become a law that will provide for a monetary policy committee, Jaitley said. Signed last month, the agreement is to "primarily maintain price stability while keeping in mind the objective of growth." It says the RBI will aim to bring retail inflation below six percent by January 2016 and to around four percent by fiscal 2016-17.

Perhaps RBI Governor Raghuram Rajan was being enigmatic in keeping with his "rockstar" image in deflecting spotters of Wednesday's rate cut off his trail, when he said on March 2 that though central banks everywhere were reducing interest rates to very low levels, the RBI was unable to do so quickly owing to "high inflation".

The consumer price index (CPI)-based inflation rose to 5.11 per cent in January from 4.28 per cent last December.

Indeed, the impression that Rajan's statement Monday was deflecting attention from Wednesday's cut by 25 basis points is strengthened by the text of the RBI release which said that "given low capacity utilisation" and still-weak indicators of production and credit off-take, it is appropriate for RBI to be pre-emptive in its policy action to utilise the available space for monetary accommodation.”

If anything, Jaitley, in his landmark budget, had provided the RBI Governor some reason not to cut interest rates by extending the target deadline for controlling fiscal deficit to 3 per cent, reasoning that insistence on a timetable to contain the deficit would harm growth prospects. The targets for the next three years have been set at 3.9 per cent for 2015-16, 3.5 per cent for 2016-17, and 3.0 per cent for 2017-18.

Rajan, while announcing the rate cut in January, had stated that "the key to further easing are data that confirm continuing disinflationary pressures and sustained high quality fiscal consolidation."

The fiscal deficit exceeded the budget estimate within the first 10 months of the current fiscal (April-January), crossing 107 percent at Rs 5,68,000 crore. It is here that the 2015-16 budget comes as a quasi-revolutionary measure in India's economic history, signalling the shift in budgetary philosophy on subsidies from a rights-based to a reformist one following changes made in their modes of disbursement.

India is now ready to "take off" and "fly", Jaitley said, its engines finding extra thrust from falling oil prices, but he as finance minister was being held in check by low tax buoyancy where the tax to GDP ratio is a measly 10 per cent.

Jaitley has attempted to realize multiple goals like higher growth, increase in investment and wider social safety nets in line with his philosophy about reforms in India being the art of the possible and not about a few "big bang" ideas.

By: Biswajit Choudhury