The Reserve Bank of India (RBI) unexpectedly lowered its policy rate for the second time this year, backing a government that is pushing to revive economic growth as inflation cools. Although markets had broadly expected the RBI to reduce rates again after a cut in January, few had expected a move just days after the government unveiled a budget that took a slower path to lowering the fiscal deficit.
The reduction in the RBI's policy repo rate by 25 basis points to 7.5 per cent sent Indian bond prices to 20-month highs. "Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation," RBI Governor Raghuram Rajan said in a statement.
Rajan aired doubts over the credibility of official data after recent changes to methodology showed India's economy grew 7.5 per cent in the last quarter, faster than China. "Nevertheless, the picture of a steadily recovering economy appears right," he said.
The RBI had first lowered interest rates this year on Jan. 15, in a similarly unexpected move that signalled the start of a new easing cycle. Both rate cuts took place outside of the central bank's scheduled policy review meetings.
The benefits of lower official rates have still to pass through to borrowers, however, as commercial banks have been hesitant about lowering their lending rates. Analysts said the latest rate reduction showed the RBI's trust in the 10-month-old government of Prime Minister Narendra Modi to maintain fiscal discipline even though it will take longer to reach its deficit goals.
"The Reserve Bank of India is expressing its confidence on the inflation outlook," said Radhika Rao, economist at DBS. "This also means that despite a higher fiscal deficit, the quality of fiscal consolidation has satisfied central bank expectations."
The budget laid out plans to reduce the fiscal deficit to 3.9 per cent of gross domestic product, in the 2015/16 financial year, and bring it down to 3 per cent by 2017/18 - a year later than an earlier road map had targeted.
Describing the deficit reduction plan as "very prudent", junior finance minister Jayant Sinha said the government was striking a balance between making more gradual reductions in the deficit and investing in infrastructure and key sectors.
"It's that balance that the RBI has appreciated," Sinha said, responding to the interest rate cut.
The boost for the government also comes a week after it endorsed an RBI-led change to monetary policy, formally adopting inflation targeting. India is expected to establish a monetary policy committee, which could give the government more influence over decisions like interest rate moves, but its size and composition remain a matter of heated debate on both sides.
