RBI pushes government to act on fiscal consolidation promises

The governor of the Reserve Bank of India (RBI), Duvvuri Subbarao, said today (October 30) that the Indian government must take concrete action if it wants to meet recent deficit reduction pledges.

The central bank chief said a recovery of Indian growth depended crucially on the government following through with its pledges announced on October 29, when finance minister Palaniappan Chidambaram said the government would target a deficit of 5.3% this year, falling to 3% by 2017, but revealed little in the way of concrete policy measures.

"A revival in investment activity, which is key to stimulating growth, depends particularly on the recent policy announcements by the government being translated into effective actions," Subbarao said, after unveiling the central bank's latest monetary policy decisions.

The RBI decided to hold headline interest rates at 8%, keeping pressure on the cost of the government's debt positions. But Subbarao said that with headline inflation averaging 7.5% during the first half of the year, there was not scope for a rate cut. "It is critical that even as the monetary policy stance shifts further towards addressing growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised," he said.

The governor hinted, however, that some easing of the rate might follow in the coming months. "As inflation eases further, there will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to mitigate the growth risks and take the economy to a sustained higher growth trajectory," Subbarao said.

A research note published by HSBC said the rate hold had been the prudent course of action, but suggested a cut was still likely in future. "We believe the RBI could signal a modest 25bp cut in the key repo rate to 7.75% in Q4 2012 or early Q1 2013 in anticipation of further government action on the fiscal front," HSBC said.

The RBI did cut its cash reserve requirement by 25 basis points to 4.25%, hoping to inject around 175 billion rupees of liquidity into the market, partly in response to expectations of an uptick in cash demand around Diwali. If liquidity was allowed to fall, this would have "adverse implications" for the flow of credit, Subbarao said.

India has been struggling with slowing economic growth and persistent inflation in recent months. Subbarao said continued uncertainty in the global economy, poor production figures and a slowdown in consumption had all contributed to a downward revision of growth forecasts. "On the basis of the above considerations, the baseline projection of GDP growth for 2012–13 is revised downwards from 6.5% to 5.8%," he said.