Rajan Lays Challenge to Modi as India Easing Tied to Budget

By Sandrine Rastello and Unni Krishnan  

Photographer: Kosuke Okahara/Bloomberg

Indian Central Bank Governor Raghuram Rajan.

Related

• RBI Won't Cut Rates This Year, Nomura's Subbaraman Says

India’s central bank chief, pursuing a campaign to strengthen independence, took one of his biggest steps yet in pushing the nation’s government to rein in a fiscal deficit with a signal that lower interest rates depend on budget tightening.
Reserve Bank of India Governor Raghuram Rajan held the main rate at 8 percent yesterday and said he may cut it early in 2015, while not necessarily at the next scheduled policy review Feb. 3. Rebuffing calls for a cut, the decision had analysts speculating whether he’d reduce the rate before or after the government’s annual budget, anticipated in late February.
“Since Rajan became head of the RBI we see the central bank independence increasing, and he’s certainly done a lot to boost that,” said Per Hammarlund, chief emerging-markets strategist at
Skandinaviska Enskilda Banken AB in Stockholm. Among central bankers, “he’s one of the few now definitely in a position where he can speak out more forcefully against the government.”
Rajan’s willingness to reject pressure to lower borrowing costs strengthens his credibility in a campaign to rein in one of Asia’s fastest inflation rates, as Prime Minister Narendra Modi pushes to boost growth. Finance Minister Arun Jaitley called for a rate cut last month, saying it would provide a “good fillip” to the economy as he works to narrow the fiscal deficit to a seven-year low.

‘Confident in Realization’

The central bank will have more confidence that the government is meeting its fiscal targets next year, Rajan told analysts yesterday. “We can be confident in expectation, but then we will be confident in realization when we actually see that happen,” he said.
Policy change depends on “encouraging” fiscal signs and retreating inflationary expectations. The central bank doesn’t “intend to flip flop,” once it moves, he said.
Consumer prices rose 5.52 percent in October from a year earlier, the slowest pace since the index was created in January 2012. The benchmark stock index and rupee have been among the world’s best performers this year.
Deutsche Bank AG, Australia & New Zealand Banking Group Ltd. and Nomura Holdings Inc. said yesterday they predict a first cut after the budget. Goldman Sachs Group Inc. sees a reduction either in February or March, while BNP Paribas SA says the reduction may occur before the budget.

Revenue Shortages

A tax revenue shortage makes it difficult to shrink the fiscal gap to 4.1 percent of gross domestic product in the year through March from 4.5 percent previously, Jaitley said Nov. 21. The government hasn’t begun stake sales accounting for 8 percent of the shortfall and much of the savings are through short-term spending cuts.
The April-October fiscal deficit was about 90 percent of the full-year target, government data show. Failure to meet the goal may cause foreign investors to withdraw and a weaker rupee would fuel inflation, said Christian Maggio, head of emerging markets research at TD Securities in London.
Rajan, 51, vowed to defeat inflation once and for all when he took office 15 months ago. The former International Monetary Fund chief economist raised the repo rate three times and has backed a proposal for inflation targeting.
Cut Carrot?
The Finance Ministry is “looking forward” to the central bank supporting growth, it said in a statement yesterday after the decision.
The 1934 Reserve Bank of India Act says the federal government may direct the central bank on what it considers public interest. The governor has the authority to veto his advisers on rates.
Continued benign price data may prompt Rajan to cut before Feb. 3, Richard Iley, an analyst at BNP Paribas SA, wrote in a report yesterday. A quarter-point cut would be a “carrot” for Jaitley to deliver a tight budget, he said.
Investors are seeking reaffirmation of Jaitley’s pledge to narrow the deficit to 3 percent of GDP by 2017, as well as progress on a goods-and-services tax and raising foreign investment caps. While Modi has scrapped some petroleum handouts, they account for a quarter of India’s subsidy bill.
The more Jaitley succeeds in curbing subsidies, the more room Rajan will have to lower rates, according to Sonal Varma, an economist at Nomura, who predicts a cut in April.
“In any economy, monetary and fiscal policy have to be aligned,” Varma said by phone in Mumbai yesterday. “It’s always an implicit thing. This time they explicitly stated this to anchor the timing of the policy action.”