Reserve Bank Governor Raghuram Rajan is expected to hold interest rates on Tuesday – his first monetary policy announcement after a change of guard at the centre. Under Dr Rajan, the RBI has raised rates thrice in a bid to fight stubbornly high inflation.
However, a rate cut cannot be ruled out as Dr. Rajan loves to surprise markets. Since taking over in September 2013, the RBI has raised interest rates on two occasions contrary to market expectations.
“The RBI could surprise with a 25 basis point rate cut, which would be a big sentiment positive for the economy,” market analyst Sanjeev Bhasin said.
A surprise rate cut would be seen as a shot in the arm for the Narendra Modi-led government, which has won an overwhelming mandate on a pro-growth plank. India’s economy has been growing at sub-5 per cent for two straight years and many analysts have blamed high interest rates for the sharp slowdown in the economy.
High interest rates make credit more expensive and create a difficult environment to re-ignite growth.
Though the consensus call is of status quo, analysts would be keenly monitoring Dr. Rajan’s accompanying statement for clues to whether the new government’s strong electoral mandate has changed Dr. Rajan’s rate outlook.
Last week, Dr. Rajan met both Prime Minister Modi and Finance Minister Arun Jaitley. Mr. Jaitley is not seen to be as hawkish as Dr. Rajan on inflation, sources say.
One senior finance ministry official told Reuters that Dr. Rajan’s initiative to set an inflation target based on CPI (retail inflation) could create conflict if, as many expect, CPI rises in coming months. Moving to retail inflation would give the central bank a clear price-stability mandate and make fighting inflation its chief objective. Previously, the RBI was charged with promoting growth and financial stability as well as controlling inflation.
“Rajan is … making things difficult for the government by publicly speaking about RBI’s stance on the CPI inflation. He would not find it easy to backtrack even if he wants to adjust with the new government,” the official said.
But if the investment climate improves and government expenses are managed better, Dr. Rajan might get some relief on the inflation front. Investors expect Mr. Modi to bring down inflation by cutting subsidies, improving food distribution and promoting investment in infrastructure.
Dr. Rajan recently softened his tone, noting that inflation targets are for the medium term and are flexible, and that the proposal does not aim to turn the RBI into “inflation nutters”.
However, he was uncharacteristically blunt on the subject of RBI independence in other recent remarks.
“I am happy to talk to the government, I am happy to listen to the government, but ultimately the interest rate that is set is set by me,” he said at an event in St. Gallen, Switzerland.
