Last March, a few days after Finance Minister Arun Jaitley presented his first full budget, and also later in 2015, one of the narratives that played out was the potential conflict between the government and the RBI, triggered by the proposals to shift regulation of the domestic government bond market and debt management away from the central bank, and form a monetary policy committee or MPC. Cut to Budget 2016. One of the most striking things is the perceptible convergence of views of the RBI and the government — reflected best in the decision to stick to the path of fiscal consolidation and not indulge in adventurism. In the run-up to the budget, RBI Governor Raghuram Rajan had cautioned the government not to deviate from the roadmap for fiscal consolidation and warned about the potential loss of credibility. The government has been mindful about this, acknowledging the negative fallout of higher government borrowing on private investments, and has restricted its borrowings in 2016-17 to Rs 4.2 lakh crore. The markets have welcomed this. Since Friday (before the budget was presented), the Sensex has climbed 1,089 points or 4.7 per cent in anticipation of interest rate cuts by the RBI. Ten-year government bond yields have fallen from 7.9 to 7.6 per cent. This, coupled with an agreement on the composition of the MPC, and the RBI’s decision to ease rules on capital requirements for banks, clearly shows that India’s central bank and government are acting in concert — a huge positive both from the point of view of investors and the market, and also from an institutional and policy-credibility perspective.
Speculation has now been rife about a rate cut. Last September, Rajan surprised the market with a 50-basis point cut in interest rates. Since then, there have been few signs of a pick-up in global growth; exports have contracted for the 14th consecutive month while domestic capacity utilisation is still relatively low. Headline inflation has also been under control. It is possible that the RBI may like to weigh the prospects of the monsoon this year and also the fact that despite cutting rates by 125 basis points last year, banks have been diffident when it comes to passing on the benefits to borrowers, citing the need to set aside capital for the bad loans on their books.
With growth estimates for FY17 at 7 per cent or a little higher, and to stoke demand in the domestic market, there could be a persuasive case for a deeper cut than the baby-step approach of 25-basis point rate reductions. That could be the trigger for the much-needed private investments and a rebound in growth.