By Ruma Dubey

Wow! That’s the first thing which one feels on looking at the index and hats off to RBI for springing this surprise rate cut, without waiting for the 7^th April policy date. This is what we call progressive thinking and action where the RBI is matching step-to-step with the Govt’s Budget policy announcements.

Post the Budget, the onus as such was on RBI to give a kick to the economy, by boosting domestic demand through a rate cut. The market had actually resigned itself to a long wait for some positive trigger and this 25 bps rate cut today came like a double bonus much ahead of Diwali!

The Budget left a sense of distaste for the middle class and this rate cut thus comes as the right ingredient, once again pacifying the taste buds with a lovely palate.  RBI waited for the Budget, to see how the Govt treads, whether it shows some fiscal prudence. Probably convinced that RBI took into account the other factors too which went in favor of a rate cut. First and foremost was the inflation, which remains the key decisive factor. At 5.1% for January, it was most certainly much below RBI’s target of 8%.  The low crude oil price which continues to sustain would probably have been an important decision maker. This apart, the Govt in its Budget has indicated that more than spending on subsidies, it will spend more on infra build. The stable rupee has also given that sense of faith that for now, all is well and India could do with a  rate cut push!  Perhaps the most significant influences on near-term inflation will be the strength of aggregate demand relative to available capacity. Two recent developments pertaining to the demand-supply balance are the recently-released GDP estimates and the Union Budget for 2015-16.

The most significant point – the Govt has conveyed to RBI that it wants to work in tandem and not against each other. The first step in that direction was the signing of the inflation targeting memorandum with RBI. This sent out the clear signal – we both have the same objective and are very much on the same page.

This is a very good situation to be in – where RBI and Govt have the same vision and are working together. This rarely happens, at least we did not see this happen during the past few years when Govt was busy doling out largesse with no eye on mounting fiscal deficit and RBI’s warnings. When two of the largest decision makers in the country work together, see the kind of melody it creates!

RBI has stated, “The fiscal impulses in the Union Budget assume importance. There are many important and valuable structural reforms embedded in this Budget, which will help improve supply over the medium term. In the short run, however, the postponement of fiscal consolidation to the 3 per cent target by one year will add to aggregate demand. At a time of accelerating economic recovery, this is, prima facie, a source for concern from the standpoint of aggregate demand management, especially with large borrowings intended for public sector enterprises. Some factors mitigate the concern. The government has emphasized its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers. Also, the government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower.”

Last but not the least, RBI admitted that given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the RBI to be pre-emptive in its policy action to utilise available space for monetary accommodation.

Highlights of RBI’s announcement:

• Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 bps from 7.75% to 7.5% with immediate effect;
• Keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4% of net demand and time liabilities (NDTL);
• Continue to provide liquidity under overnight repos at 0.25% of bank-wise NDTL at the LAF repo rate and liquidity under 7-day and 14-day term repos of up to 0.75% of NDTL of the banking system through auctions;
• Continue with daily variable rate repos and reverse repos to smooth liquidity.
• Reverse repo rate under the LAF stands adjusted to 6.5%
• Marginal standing facility (MSF) rate and the Bank Rate to 8.5% with immediate effect.
• The next bi-monthly policy statement will be issued on April 7, 2015 the still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance.
• RBI will seek to bring the inflation rate to the mid-point of the band of 4 +/- 2% provided for in the agreement, i.e., to 4% by the end of a two year period starting fiscal year 2016-17.
• The guidance on policy action given in the fifth-bi-monthly monetary policy statement of December 2014 is largely unchanged.
• Monetary actions will be conditioned by incoming data, especially on the easing of supply constraints, improved availability of key inputs such as power, land, minerals and infrastructure, continuing progress on high-quality fiscal consolidation, the pass through of past rate cuts into lending rates, the monsoon outturn and developments in the international environment.