By Rajesh Kumar Singh and Suvashree Choudhury
MUMBAI (Reuters) - When the Reserve Bank of India (RBI) cut interest rates by much more than expected this week, government officials hailed it as a victory after months of imploring Governor Raghuram Rajan for strong action. Now it is New Delhi that will need to deliver.
Rajan cut the key repo rate by 50 basis points to a 4-1/2 year low of 6.75 percent on Tuesday. He expects that show of faith to be rewarded by government efforts to manage food inflation and keep fiscal spending under control, said officials familiar with discussions at the Reserve Bank of India and the finance ministry.
Fixing structural constraints that push up inflation could be critical in determining whether the RBI considers easing policy further, these officials said, given government officials are already pushing for even more rate cuts.
"The next crucial element is what the government does on the quality of spending, whether there will be large capital spending, whether food inflation will remain anchored and fiscal deficit goals will be attained," said one of the officials.
"The governor will watch all these developments very closely for the next six months."
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While manufacturers have welcomed the rate cut, they say much more needs to be done - making it easier to buy land, a more simple tax structure and flexible labour laws, are needed to speed up corporate investments.
"Rate cut is good, but it alone is not a sufficient condition for companies to start investing," said M.S. Unnikrishnan, managing director of Thermax Ltd, an engineering company.
"For it (the rate cut) to have a material impact on the ground, other factors need to turn conducive."
IMPROVING THE RELATIONSHIP
The ruling Bharatiya Janata Party (BJP) has proposed legislation on land acquisition and tax and labour reform, seen as critical to revive an economy that grew 7 percent in the April-June quarter, well below the government's target of 8 to 8.5 percent for the year ending in March 2016.
But many of these measures have been blocked in the upper house of parliament by the opposition.
Still, the rate cut seems to have ushered better ties between the RBI and the government, improving a relationship that has been rocky at times.
Although the RBI is not statutorily independent from the government, Rajan, like previous RBI Governors, has long valued his independence.
And to the great frustration of government officials, the central banker had cut interest rates only slowly this year despite a steep fall in inflation, with 3 rate cuts totalling 75 basis points. That had made him unpopular among some quarters in New Delhi.
This time, the officials said, the RBI was persuaded by the government's call to help bolster faltering domestic growth in light of the weak global economy and because consumer inflation had eased in August to a record low.
But they said the RBI was equally swayed, and heartened, by government efforts to manage food supply and its pledge to keep a tight lid on spending.
That gave the RBI more confidence about New Delhi's assurances that more measures would be taken to douse food prices, building on earlier efforts such as managing the state's stockpile of grains and allowing more imports of onions and pulses, all crucial barometers of food inflation.
The government efforts also convinced the RBI that New Delhi could keep to its fiscal deficit targets, now targeted at 3.9 percent of gross domestic product for the year ending in March and 3.5 percent the next year.
"We presented our views and facts and they finally accepted it," said a senior government official. "The case for a steep cut was very strong."
(Additional reporting by Sumeet Chatterjee; Editing by Rafael Nam and Raju Gopalakrishnan)