RBI waits for structural reform in Budget

Central bank says govt needs to show commitment to low inflation and fiscal rectitude

The Reserve Bank of India (RBI) held rates steady on Tuesday, as had been widely expected. In addition, it chose not to change the cash-reserve ratio (CRR) of banks or to change the amount of liquidity it provided the market through the liquidity adjustment facility, or LAF. The key policy repo rate was thus kept unchanged, at 6.75 per cent. This was in spite of what it said was a loss of momentum to growth in the third quarter of 2015-16 and tighter liquidity conditions. In essence, the RBI has chosen to wait and watch for the government's actions in the coming months, in particular the fiscal mathematics in the Union Budget that is to be presented about a month from now. In fact, in his traditional post-announcement press conference, RBI Governor Raghuram Rajan specifically referred to the fact that the RBI would wait for the details of the government's plans in the Budget to revive growth and lower inflation, and referred to them as a "package", rather than as disparate steps.

The RBI's estimation of inflation risks remains, in Dr Rajan's words, "balanced". The monetary policy statement pointed out that, excluding petrol and diesel, consumer price inflation has largely remained flat. Crucially, inflation expectations remain elevated, in the RBI's opinion - anchoring expectations has been a crucial part of the RBI's strategy under Dr Rajan. The RBI said, largely, inflation was evolving as it had expected, and would hit five per cent by March 2017. However, it did sound a warning: the implementation of the Pay Commission award, it said, had not been factored into this trajectory. Control of inflation should be a major factor in the government's decision about implementing the Pay Commission award; as this newspaper has argued, it should seriously consider simply delaying the implementation for a year.

The RBI said growth momentum was below what should be expected for the medium term. Many argue that the revival of investment and therefore high growth will depend on lower real interest rates. But the RBI argued that, while its stance was accommodative, a commitment to low inflation and fiscal rectitude on the part of the government was essential to lay the foundations for stable and sustainable growth. This reinforces Governor Rajan's statement recently when he warned against pump-priming the economy to restore growth, saying that abandoning fiscal consolidation would be counter-productive and unsustainable. It is very clear that the ball is now in the government's court. If monetary policy is to become properly growth-supporting, then the government must create space for it. And this, the statement said, would require "structural reforms" in the Budget that "boost growth while controlling spending". The message from Mint Road to North Block is clear: that rates will only drop if the Budget demonstrates a clearer commitment to controlling spending and to deep-rooted structural reform than has been on offer of late. The government must look for creative ways to rein in spending, to enhance infrastructure investment, and to boost deregulation of factor markets in order to ensure that investment takes off. Easy money is not a solution.