Overall, the monetary policy is now set to move toward promoting growth with a shift in its stance, given the low inflation, the large fall in international oil prices – which is likely to be durable in 2015 – weak demand conditions, and Government’s commitment to its fiscal target.

Immediately, as banks readjust lending – and deposit – rates, home and consumer loans should cost less. Many securities and other firms are banking on 50-75 basis points cut during the year, in the post-budget months. Government has promptly hailed the RBI move as one giving a fillip to the economy and noted “a significant shift in stance and direction for policy (monetary) going forward”.

Chief Economic Adviser Mr Arvind Subramanian says the cut would increase spending by private sector, both consumers and firms, and indirectly it should help by improving balance-sheets of private sector and banks. It is consistent with the “strong ongoing disinflationary pressures in the economy” he said.

The element of surprise is in the fact Dr Rajan made his statement outside the bi-monthly policy statements in vogue, the next one not due before February 3. Though he had been indicating a possible easing before the end of first quarter of 2015 (Jan-March), Dr Rajan may have smartly moved ahead of the Budget and earned some kudos for setting the stage for an accommodative monetary policy in store during 2015. He has no doubt set the conditions for continued easing.

During his stewardship of the central bank since September 2013, Dr Rajan had tightened the monetary policy in the context of elevated and persistent inflations. Repo rate had been raised from 7.25 to 8 per cent in three stages in 2013 and maintained at that level since January 2014, no matter corporate and Finance Ministry pressures to cut rate.

In the latest announcement, Dr Rajan said inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015 and are also likely to be below 6 per cent by January 2016. He cited other encouraging developments including consumer confidence and household inflation expectations surveys which along with the low oil prices had provided “headroom” for a shift in monetary policy stance. Those surveys pointed to both near term and longer-term inflation expectations easing to single digits since September 2009.

Dr Rajan said, in its public interactions, the RBI had committed to initiate the process of monetary easing as soon as data indicated that medium term inflationary targets would be met. Keeping this commitment in mind, it has been decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per cent to 7.75 per cent with immediate effect.

The cash reserve ratio (CRR) of scheduled banks would remain unchanged at 4.0 per cent of net demand and time liabilities (NDTL). With the repo cut, the reverse repo rate under the LAF stands adjusted to 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 8.75 per cent with immediate effect.
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According to Dr Rajan, key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained “high quality” fiscal consolidation as well as steps to overcome supply constraints and assure availability of key inputs such as power, land, minerals and infrastructure. The latter would be needed to ensure that potential output rises above the projected pick-up in growth in coming quarters so as to contain inflation.

Mr Arvind Subramanian acknowledges any further cut would depend on aggregate demand on the economy. Along with “other policy actions already taken by the Government” and those under consideration, the repo rate cut represents “one more step towards reviving investment and realizing India’s medium term growth potential”.

Explaining the rationale for the somewhat sudden move by RBI, the Governor said inflationary pressures (CPI) since July 2014, had been easing and, to some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil. Crude prices, barring geo-political shocks, are expected to remain low over the year.

Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, Dr Rajan said, the government has reiterated its commitment to adhering to its fiscal deficit target. Dr Rajan goes by the Finance Minister’s assertions but has also emphasized “quality fiscal reduction” to be judged soon.

This has been an area of doubt and concern until recently in the context of sharp decline in the tax revenue receipts. While the windfall from low oil prices helped Finance Minister Mr Arun Jaitley to cut fuel subsidies and also proclaim a “success’ on inflation front, he has had resort to some drastic cuts in allocated plan expenditure. Major non-tax revenues including disinvestments in public enterprises have to materialize before the end of March.

The fiscal side issues were overshadowed by the flurry of ordinances some purporting to implementation of major reforms relating to insurance, land and minerals, and “Vibrant Summits” fuelling great expectations for the forthcoming Budget and for India to outperform China.

According to the central bank estimates, the dramatic oil price falls would result in a saving of at least 50 billion on annual basis, so long as prices continue to remain at reduced levels seen in the past months or at around 50 dollars a barrel. This would be equivalent to not less than one-third of India’s gross oil imports of about 160 billion (at earlier prices). It works positively for India in easing the current account deficit, besides consumer price inflation, and lower fuel prices should also reduce input costs for business and trigger consumer demand.

So far, so good. But there may be some caveats. If Government decides to make public investment, as urged in the mid-year review – whatever the corporate honchos may or may not invest or rally behind adequately – the fiscal deficit would again become a source of major concern, let alone quality fiscal consolidation. IMF has also cited the need for India to make infrastructure investments to remove bottlenecks especially in transportation and energy. (IPA Service)