Budget key for reforms, lowering inflation – Raghuram Rajan

Other major central banks, notably the Bank of Japan and Bank Indonesia have eased monetary policy, and the European Central Bank is expected to ease too, though the US Federal Reserve is expected to raise rates later this year.

“Rajan wants a thrifty budget”, said Tirthankar Patnaik, a Mumbai-based economist at Mizuho Bank.

The central bank governor said it had opted not to move on rates until it could digest economic reforms expected in the government’s budget, due on February 29.

Rajan said: “The Indian economy is now being viewed as a beacon of stability because of the steady disinflation, a modest current account deficit and commitment to fiscal rectitude”. Apart from this, it also sees the large positive terms of trade gain, improving real incomes of households and lower input costs of firms should contribute to strengthening the growth momentum. Rajan said that consolidated fiscal deficit of the Centre and states rose to 7.2 per cent in 2015 from 7 per cent in the previous year.

“The Reserve Bank continues to be accommodative even as it leaves the policy rate unchanged in this review, while awaiting further data on the development of inflation”, Rajan said.

“Announcements in the union budget will certainly decide the roadmap for the reserve bank and how much easing it can talk about”, the senior economist at Dun & Bradstreet said. However the Seventh Pay Commission and One Rank One Pension pose considerable fiscal challenges.

A rate cut is still possible even if the deficit target is above 3.5 percent of GDP as long as the government spends more on investment and less on subsidies, according to Suvodeep Rakshit, an economist at Kotak Securities. Yet as Rajan pointed out on Tuesday, not all is well even after 125 basis points of cuts in the past 13 months: India is expanding below its medium-term potential, and structural reforms are needed to boost growth without increasing spending and stoking inflation.

The headline growth rate looks very creditable, with the RBI projecting 7.4 per cent for the year ending in March, albeit with a downward bias, and 7.6 per cent growth for 2016/17.

Prime Minister Narendra Modi has focused on economic growth since sweeping to power nearly two years ago and India has now posted three straight quarters of growth above seven percent.

The RBI expects the growth to pick up gradually in 2016-17, despite the headwinds. “Going forward, under the assumption of a normal monsoon and the current level of worldwide crude oil prices and exchange rates, inflation is expected to be inertial and be around 5 per cent by the end of fiscal 2016-17″, he said while unveiling the 6th bi-monthly monetary policy of the current fiscal.

To get growth up, Jaitley may have to walk alone. Repo rate that is the interest rate at which the RBI provides liquidity to banks to tide over short-term liquidity mismatches is kept at 6.75 per cent. The reverse repo rate under the Liquidity Adjustment Facility will remain unchanged at 5.75 per cent. Reverse repo rate is the rate at which RBI borrows money from commercial banks within the country. This could mean banks will need more capital, and balance-sheets will look troubled for some more time.