Rajan Holds India Rate to Boost Slumping Rupee Before Budget

  • Rate left at 6.75% as predicted by most economists surveyed
  • The central bank "continues to be accommodative," Rajan said
Raghuram Rajan

Raghuram Rajan.

Photographer: Simon Dawson/Bloomberg

India’s central bank left interest rates unchanged for a second straight meeting as it awaits details of the government’s budget later this month, providing support for a currency battered by China-led market turmoil.

Governor Raghuram Rajan kept the benchmark repurchase rate at 6.75 percent, the Reserve Bank of India said in a statement in Mumbai on Tuesday. The move was predicted by 42 of 44 economists in a Bloomberg survey, with two seeing a quarter-point cut.

“The Reserve Bank continues to be accommodative even as it leaves the policy rate unchanged in this review, while awaiting further data on the development of inflation,” Rajan said. Structural reforms in the budget “that boost growth while controlling spending will create more space for monetary policy to support growth” and ensure inflation hits the target of 5 percent in March 2017, he said.

Rajan is caught between a stock selloff that’s pushing the rupee toward a record low and an economy that’s showing mixed signs of strength. While falling oil prices give him space to join Indonesia and Japan in easing further, lower rates may jeopardize his inflation target if the government reneges on its pledge to narrow the budget deficit.

The benchmark stock index fluctuated after the decision, sovereign bonds reversed gains and the rupee declined. The yield on the note due 2025 rose to 7.83 percent as of 11:51 a.m. in Mumbai from 7.79 percent on Monday.

“The probability of a rate change in April may have gone down a little bit because the inflation forecast is still 5 percent,” said Indranil Pan, chief economist with IDFC Ltd. “To a certain extent, the cut will depend on the budget and on global currency movements and its implications for domestic inflation.”

Key points from the statement:

  • While inflation is expected to be around 5 percent by end-March 2017, planned pay increases for government employees “will impart upward momentum to this trajectory for a period of one to two years.” The RBI will adjust the inflation forecast when clarity emerges on the timing of implementation.
  • Growth “is expected to strengthen gradually, notwithstanding significant headwinds.” Gross-value added growth for the 12 months ending March 2016 is kept unchanged at 7.4 percent with a downside bias, and is projected at 7.6 percent for the following 12 months.
  • “The current momentum of growth is reasonable, though below what should be expected over the medium term. Underlying growth drivers need to be rekindled to place the economy durably on a higher growth trajectory.”
  • “The Indian economy is currently being viewed as a beacon of stability because of the steady disinflation, a modest current account deficit and commitment to fiscal rectitude. This needs to be maintained so that the foundations of stable and sustainable growth are strengthened.”
  • Money market rates “remained close to the policy rate with a marginal downside bias” after the central bank injected liquidity in December and January.
  • The RBI separately announced steps to encourage the creation of start-ups. It proposed measures that would allow start-ups to tap foreign venture capital investment and said it is considering allowing these companies to issue innovative instruments such as convertible notes to attract foreign direct investment.

Budget Focus

Prime Minister Narendra Modi’s government is due to present its budget on Feb. 29. Rajan warned last week that deviating from the fiscal consolidation path could increase the government’s borrowing costs, both through a higher volume of bonds and a potential loss of credibility.

The Finance Ministry said last month it would stick with its fiscal deficit target of 3.5 percent of gross domestic product for the year starting April 1. Even so, Standard Chartered Plc and Citigroup Inc. predict the government will raise the target to at least 3.7 percent to pay for mandatory salary increases without cutting infrastructure spending.

The government won’t cut spending on development activities, Finance Minister Arun Jaitley said in New Delhi after Rajan’s decision. Private investment is still weak, he said.

A larger shortfall risks stoking inflation, hindering Rajan’s efforts to slow consumer-price gains toward his 5 percent target from 5.6 percent in December. Most economists surveyed by Bloomberg last month foresaw just one 25-basis point cut for all of 2016, while swap traders are pricing in the possibility of a 50-point reduction.

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