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Inflation roadmap

At the post-Budget press conference on Saturday, a journalist posed a question to Finance Minister Arun Jaitley about the Centre’s decision to increase capital expenditure and whether the Reserve Bank of India would support its move by reducing lending rates. “I think you need to have a little patience to get the answer to your question,” Jaitely said with a wry smile. On Monday the Finance Ministry announced a deal it had signed with the RBI to set an inflation target for India. The main task for the RBI now would be to target 4 per cent consumer inflation by 2017, with a leeway of two per cent either side to account for fluctuations.

The central bank will aim to strike an inflation rate of 6 per cent by January 2016. The rate currently stands at 5.11 per cent, though these figures have been rather volatile in the last few years. In light of the above circumstances, RBI Governor Raghuram Rajan announced a cut in the policy repo rate by 25 basis points to 7.50 per cent from 7.75 on Tuesday, backing a government that is pushing to revive economic growth as inflation cools. This is the second cut in lending rates this year, both of which were announced well outside the RBI’s policy review cycle. “With the release of the agreement on the monetary policy framework, it is appropriate for the Reserve Bank to offer guidance on how it will implement the mandate,” RBI Governor Raghuram Rajan said.

The reasons for the rate cut, though, should be examined in a little detail. Rajan clearly believes that the inflation target for 6 per cent will be easily achieved. The central bank, however, does not believe in the new gross domestic product growth rate of 7.4 per cent that was put out by the Central Statics Office. There is an overwhelming feeling within the bank that the economy is still weak, and as a consequence it will play its part to support growth without igniting inflationary pressures. The latest rate cut, therefore, is another push to banks to lower lending rates, though they have not really reacted. After all a cut in lending rates by 25 basis points is not a massive relief.

The intention, clearly, was to present a positive impact on investor sentiment. There is a belief, mistakenly circulated, that the country’s central bank policy rate is the one decisive factor affecting the country’s credit scenario. The excessive presence of slippages that banks have to face can considerably reduce the effectiveness of policy rate cuts. Financial analysts, however, expect the RBI to cut rates further, since the central government has confined fiscal deficit to 4.1 per cent of the GDP. For months, members of government and industry have been pushing Rajan to reduce lending rates to induce a greater infusion of capital into the economy. Allied with a steep reduction in crude oil prices from more than $100 a barrel at the start of 2014 to under $60 in the past month and falling inflation figures, further cuts should be expected.
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