RBI says: Hum sabke saath hain

The Union Budget 2015-16 was packaged as a "sabke saath, sabka laabh" Budget - a Budget that would benefit everyone in some way - and yet be fiscally prudent. A part of its success depends on the support of the Reserve Bank of India. The central bank was widely expected to cut rates, but mostly in April when a monetary policy review was due.

But, the central bank sprung a surprise. In an unexpected move, the central bank cut its policy repo rate - the rate at which it lends to commercial banks - by 25 basis points to seven point per cent early Wednesday.

The cut in repo rate is significant for everyone - it signals that loans will become cheaper in the next few months. For all of us who borrow to pay buy homes, vehicles and for emergency needs. For companies that need to borrow for fresh investment as well as working capital. And, for the government - the largest borrower and therefore the biggest beneficiary.

So why did Raghuram Rajan cut rates within two months of the last rate cut on January 15? Why did he not wait till April when a monetary policy review is due?

He provides the answers in his statements announcing the easing of monetary stance.

One, he says was the still weak state of certain sectors of the economy. "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."

Second reason was that the recent agreement of monetary policy framework that the central bank signed with the central government on inflation targeting. The agreement makes it incumbent on the RBI to give guidance on how it would go about its mandate.

Three, inflation in January 2015 at five point one per cent was well within the RBI's target of eight per cent for January 2015 and was falling faster than anticipated by the central bank. Core inflation - that is inflation excluding food and fuel which are by nature volatile - had moderated. Also, global commodity prices were benign although crude oil had firmed up in recent months.

Four, the government has promised to clean up legacy issues that misrepresented the rot in government finances. It has suggested that subsidies will be better targeted through direct transfer to beneficiaries and thus reduce leakages. The RBI believes such measures should lead to better than projected fiscal consolidation.

In addition, the Centre has accepted the 14th finance commission recommendation to transfer larger share of central tax revenues to states, while continuing to fund some of the central programmes. That will help narrow state Budget deficits and the general fiscal deficit.

Five, higher interest rates also attract foreign funds into the country and thus put pressure on the rupee to appreciate. A stronger rupee is good for imports but it makes exports less competitive. A balance was needed there too, as exports were not growing and cheap imports can make prices fall in the domestic economy faster than what is good for the economy.

And finally, public investment needs to be stepped up to accelerate growth in the economy. With the government as the largest borrower and interest payments eating up as much as 37 per cent of the Centre's revenues, any easing of monetary policy lowers cost of funds for government and reduces fiscal stress.

The RBI and the government seem intent on keeping inflation low and accelerate growth. Inflation is expected to stay soft in the first half of fiscal year 2015-16, but it may firm up to below six per cent in the second half of the year. As for growth, the Budget has estimates eight to eight point five per cent growth, and large part of it will be investment led.