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As the Reserve Bank of India (RBI) prepares for its bi-monthly monetary policy update here on Tuesday, uncertainty remains over Governor Raghuram Rajan cutting interest rates, despite requests to do so from stakeholders -- right from the government to corporates.
Rajan has twice cut the repo rate, at which RBI lends to commercial banks, over two unscheduled monetary policy reviews in January and March, bringing it down to the current 7.50%.
On the other hand, the scheduled reviews in February and April passed without any changes. He kept interest rates on hold at 7.5% in April, saying he was waiting for banks to pass on the previous rate cuts - and dismissed bankers' claims that the cost of funds remained too high.
Rajan also said the government's "fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative". Announcing the rate cut in January, he had said that "the key to further easing are data that confirm continuing disinflationary pressures and sustained high-quality fiscal consolidation".
Finance Minister Arun Jaitley had in his first full budget in February extended the target deadline for controlling fiscal deficit to three%, reasoning that insistence on a timetable to contain this would harm growth prospects. The targets for the next three years have been set at 3.9% for 2015-16, 3.5% for 2016-17 and 3.0% for 2017-18.
With the background of unexpected rate cuts this year, the inflation numbers are providing more room for the central bank governor to ease monetary policy and making the clamour for him to do so louder.
The annual rate of wholesale price inflation (WPI) decelerated further to its lowest in six months at (-)2.65% in April from (-)2.33% in the previous month. The annual rate of inflation based on WPI was 5.5% in April 2014. The country's retail inflation based on the consumer prices index (CPI) was also on the downswing in April by 40 basis points to 4.87%.
The key elements to consider in this situation are the predilections of the governor himself, and the way the government has sought to make changes this year to the very domain of the RBI.
Here, it is instructive to hear RBI Deputy Governor Urjit Patel on the thinking of Rajan, who in 2005 had predicted the financial meltdown three years later that is still affecting global economy and feels stronger in his belief that global markets now are at the risk of a crash due to the competitive loose monetary policies being adopted by developed economies.
"We are in the midst of the age of competitive depreciation and of a beggar-my-neighbour philosophy. It brings to mind an old African saying that when elephants fight the grass suffers," Patel said at the press conference to announce the February policy review, on the trend of accommodative monetary policies being adopted by developed economies.
"While the ECB (European Central Bank) and the Bank of Japan are printing money and devaluing their currencies on one hand, the US economy is reviving on the other. Anyone in the middle is getting crushed," he said.
Rajan has been warning that emerging markets are especially vulnerable to big shifts in capital flows triggered by the unprecedented monetary accommodation in rich countries.
Jaitley, in his February budget, had announced the fait accompli of a monetary policy committee pact earlier with the RBI that will reduce the governor's power to act alone. The monetary policy committee and an official inflation target for the RBI are going to come about through the biggest post-Independence overhaul of the RBI Act of 1934.
However, in what was the biggest backtrack by the government earlier this month, Jaitley withdrew from the Finance Bill the clauses pertaining to setting up of a public debt management agency (PDMA) and the amendments to the RBI Act that would have taken away its powers to regulate government securities.
The United Forum of Reserve Bank Officers Employees had earlier written to MPs and chief ministers of various states that the changes, if implemented, would cripple the functions of the central bank. It said the proposed changes would curtail the authority of the RBI and render it totally ineffective in discharging its responsibilities on monetary policy, financial stability and targeting inflation.
(Biswajit Choudhury can be reached at biswajit.c@ians.in)
