The Reserve Bank of India (RBI) kept its policy rate on hold at 6.75 per cent on Tuesday, as widely expected, opting to wait until after the government's annual budget statement at the end of February to decide on whether to cut interest rates further.
Having cut the policy repo rate by 125 basis points in 2015, RBI Governor Raghuram Rajan warned on Friday against straying from the path of fiscal consolidation or relaxing the fight against inflation.
Rajan, in his statement on Tuesday, said the central bank would stay "accommodative" but would look forward to the government's budget on Feb. 29, saying it needed to be one that supports growth and controls spending.
How the government implements a planned 24 per cent pay hike in salaries and pensions for some 10 million current and former government employees will also be key in determining the path of inflation, he noted.
"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 in his statement.
"Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth."
Rajan also reiterated the central bank would ensure it is injecting sufficient liquidity into the banking system including conducting more open market operation bond purchases.
Lack Of Cash
Banks have blamed the lack of cash in the financial system for their inability to match the RBI rate cuts last year, with most banks having lowered lending rates by only about 60 bps.
The 10-year bond yield rose around 5 basis points to 7.83 per cent from levels before the decision, but the rupee and the NSE share index were broadly range-bound.
If the fiscal deficit is kept within reason, then inflation trends over coming months could also favour hopes for lower interest rates.
The RBI will have to keep watch over developments in global markets that began this year in a jumpy state.
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.
Oil prices near 13-year lows and seasonally subdued food price should help bring inflation down to the RBI's target of 5 per cent by March 2017, after it hit a 15-month high of 5.61 per cent in December.
Only 37 out 39 economists polled by Reuters had expected the RBI to leave the policy repo rate unchanged for now.
But more than half of them saw scope for at least a 25 bps rate cut by the end of June thanks to the reduced inflationary pressures, with some saying the reduction could come as early as March, before the next scheduled policy review in April.
Eyes On Budget
"If the government's budget looks to boost growth through reforms and keeping spending under check, we expect an inter-meeting cut post the budget - 25 basis points, may be even 50 bps," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors in Mumbai.
There is growing impatience with Prime Minister Narendra Modi's government to deliver stronger growth, as vaunted economic reforms keep getting delayed.
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. But private sector investment remains weak, and India needs sustained growth of around 8 per cent to generate jobs for its growing workforce.
Prospects for the rabi harvest are improving slowly, Rajan said, adding that the near-term outlook for industrial activity may be constrained by adverse base effects in the fourth quarter of the current fiscal and still weak exports, although the pick-up in corporate profitability on the back of declining input costs may provide an offset.
Some categories of services are likely to gain momentum on expectations of higher activity in coming months, though the aggregate state of activity remains muted, he said.
Expressing concern, Rajan said, stalled projects continue to remain high, and there is a decline in new investment intentions, perhaps on the back of low capacity utilization.
"While revenue growth in manufacturing has been modest, the fall in costs, partly because of a decline in commodity prices, and partly because of improvements in manufacturing efficiency, have resulted in relatively stronger profitability," he said.
Analysts expect India's budget to slightly raise fiscal deficit targets to free up money for investment in infrastructure projects, while keeping subsidies and other spending under control.
(Agencies)
