Cut and take

Responding to the downward pressure on growth and an easing of inflation,the Reserve Bank of India has cut interest rates. The monetary policy cut came after the finance minister made concerted efforts to control demand emanating from the higher fiscal deficit. The strong push towards fiscal consolidation was crucial in bringing down the inflation forecast for the coming year. Serious concerns about inflation will still remain. Consumer price inflation continues to be high. But part of this is due to the fuel price hike,which was done to cut the subsidy bill. As RBI governor D. Subbarao remarked recently,in the long run,this will reduce government borrowing to pay for the subsidies. So it reduces demand pressures and the inflation forecast,even though it increases retail price inflation in the immediate context. It is important that there is no rollback of the change in the diesel policy of moving towards market-based prices.

The other concern is about the sustainability of a lower government borrowing programme. If populist policies like the Food Security Bill are pushed through,they will not only push up government expenditure and borrowing,they will also distort Indian agriculture and keep pushing up protein prices and thus consumer price inflation. The RBI has clearly indicated that it is trusting the government to control the fiscal deficit. Only then can monetary policy be eased. If the government does not keep its side of the bargain,India will have easy monetary and fiscal policies,a sure recipe for a fiscal and external crisis. If the government comes up with a large supplementary budget and it becomes obvious that it has no intention of keeping its promise on fiscal consolidation,the RBI can be expected to raise interest rates again.

While there has been unhappiness at the RBIs tight monetary policy in the last few months,especially among industry,which has had to pay high interest rates,and households that have had to pay high EMIs,the RBI has played an important role in pushing the government towards fiscal consolidation. Fiscal discipline was partly brought on by Indias external problems and the large current account deficit and fear of a rating downgrade,but equally importantly,by a stubborn RBI that refused to cut rates unless the government did its bit in trying to control inflation. Now the ball is in the court of the government. Surely,the RBI will carefully monitor pressures on demand,the fiscal deficit and the governments intent before the next monetary policy announcement.