Last few days are witnessing the government and the RBI exchanging pleasantries. First, the government has made a budget announcement for ratifying the RBI’s dream project of inflation targeting. Now, in return the central bank has cut the short term interest rate by 25 basis points. Unscheduled meeting of the RBI has decided to cut the repo rate to 7.5 per cent.
The RBI has strategically hint that fiscal deficit is a factor for introducing the rate cut, though many economists have warned the 3.9 per cent fiscal deficit target as an unrealistic one. “The true quantum of fiscal consolidation may be higher than in the headline numbers.” Dr Raghuram Rajan has made a surprising observation about the fiscal scenario.
The hint is that the present rate cut was immediately caused by the government’s move to ratify inflation targeting. On the other hand, the economic rationale doesn’t support a rate cut now though it should have occurred quite earlier.
For the government, the interest rate cut will give joy; and being an unexpected one it may give more joy. It was pressing the RBI to introduce rate cut in the context of clear disinflationary trends. The RBI’s rate cut when adding to the one made couple of months back, may tempt bankers to reduce their lending rates as well.
Ever since the formation, the new government was trying to bring back momentum in the economy. The image of a business friendly administration has kept the Modi government to go for some extra measures like making a pre-announcement of the future corporate income tax reduction.
A certain additive to the efforts for energizing the economy is the interest rate cut signal to be made by the RBI.
The RBI has cited the ongoing disinflation as other propelling factor for interest rate cut. Similarly, its inflation expectation survey also estimated declining prices for the month of April.