New govt's fiscal policy to affect RBI's monetary stance

If the new government takes concrete steps, it would provide room for RBI to cut rates in the future, say experts

With a new government at the Centre only a few weeks away, the Reserve Bank of India (RBI) might wait for the new dispensation’s fiscal policy to take its policy actions, feel experts. Although Consumer Price Index (CPI)-based inflation is on the rise in March, RBI might hold rates till June.

According to experts, if the new government takes concrete steps, it would provide room for RBI to cut rates in the future, though not in near term.

“While inflation remains a concern, so does growth. It is important to balance the two. RBI’s policy reaction will depend on the new government and the burden of inflation management that they are willing to take on. For example, if there are concrete steps to consolidate the fiscal deficit and ease the supply side issues, that gives RBI room to hold rates. But if that does not happen, it may force RBI to raise rates,” said Brijen Puri, executive director and head of markets, JPMorgan.

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The CPI-linked inflation rose to 8.3 per cent in March from a 25-month low of eight per cent in the previous month, as food inflation rose due to a faster increase in prices of vegetables, fruit, milk and milk products.

Mohan Shenoi, president - group treasury and global markets, Kotak Mahindra Bank, said: “The monetary policy has to be synchronised with the fiscal policy. So, if there is something new in the fiscal policy of the new government, then monetary policy will have to be syncronised with that. It depends on what kind of fiscal policy the new government pursues. It is unlikely that there can be any dramatic change in monetary policy unless there is a major change in fiscal policy.”

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In the first bi-monthly monetary policy of the RBI earlier this month, the central bank had communicated to the market to look through transient effects, including the base effect, not only monthly CPI data. This is because a section of the market starts drawing conclusions on RBI’s policy decisions when such data are released every month.

In line with the Urjit Patel Committee’s report, the central bank has projected eight per cent CPI-based inflation by January 2015 and six per cent by January 2016, while growth in gross domestic product (GDP) for 2014-15 is seen at five-six per cent, albeit with downside risks to the central estimate of 5.5 per cent.