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Why Jaitley Wants Rate Cut And Rajan Asks For Reforms

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The Narendra Modi-led National Democratic Alliance (NDA) government's impatience with the Reserve Bank of India (RBI) over its failure to effect quicker and deeper lending rate cuts is understandable. At present, the bulk of the global economy is passing through turbulent times, and China, which has served as the world's growth engine, is slowing down, India's performance offers a welcome contrast. With oil prices once again plunging, the NDA government is of the view that the fiscal headroom provided by lower energy import costs and falling inflation offers a window of opportunity to further stimulate growth.
 
Pitching for an interest rate cut to boost growth, Union Finance Minister Arun Jaitley has asserted that common sense says the interest rates should come down. RBI Governor Raghuram Rajan, who has so far resisted pressure from the government as well as the industry on easing monetary policy, is due to announce the next bi-monthly policy on September 29. Experts are of the view that the possibility of achieving a gross domestic product (GDP) growth of 8 per cent this fiscal, a rate cut could just be the icing on the cake for investors, both domestic and foreign.
 
"If oil is selling at half the normal price, commodity prices are low, and we have stocks and stocks of food grain, then inflation is the least of our worries," Jaitley told Britain's The Financial Times. Growth, he said, was running at 7-7.5 per cent, a strong performance given adverse international conditions in which investors have scampered from emerging markets. Still, he said, if India's interest rates were lowered, the economy could grow still faster.
 
With uncertainty getting over with regard to the US Fed rate, the central bank may yield to the pressure of easing rates. Quite a few columnists and media commentators read the Fed's decision to hold rates as clearing the ground for RBI to announce a rate cut. Given the current economic scenario, analysts are not ruling out the possibility of a 25 basis point repo rate cut by the central bank, particularly after a disappointing first quarter GDP data. 
 
Rajan has been under pressure to cut the rates further, with the government and industry leaders repeatedly stressing on the need to lower the cost of capital to give a boost to the economy, especially in the wake of retail inflation hitting record low levels and wholesale inflation actually being in the negative zone for 10 months in a row. Earlier this month at a meeting with Prime Minister Narendra Modi, industry captains renewed their call for another rate cut in the backdrop of a slowing economy and falling inflation. 
 
Industry association Assocham has said there was room for monetary easing to the tune of 75-125 basis points over the next seven months. The association pointed out that between January and July this year, the Wholesale Price Index (WPI) and Consumer Price Index (CPI) inflation fell 793 and 298 basis points, respectively, over the same period in 2014.
 
Rajan's cautionary admonition, that achieving sustainable and inclusive growth is not possible merely through quick fixes like rate cuts and giveaways, takes a longer and more holistic view of the reforms debate. During the course of the CK Prahlad memorial lecture last week, the RBI boss counselled patience while cautioning policymakers against overemphasising the importance of rate cuts and other forms of stimuli.
 
Citing Brazil's experience, Rajan said, "Brazil tried to grow too fast. The 7.6 per cent growth came on the back of substantial stimulus after the global financial crisis. In an attempt to keep growth high, the central bank was pressed to reduce interest rates, fuelling a credit spree that overburdened customers are now struggling to repay." Brazil, which was hailed as one of the most promising emerging markets not too long ago, has been downgraded to junk rating by international credit assessor Standard and Poor's.
 
Rajan also cited India's own example.
 
"Growth has to be obtained in the right way. It is possible to grow too fast with substantial stimulus, as we did in 2010 and 2011, only to pay the price in higher inflation, higher deficits and lower growth in 2013 and 2014," the governor said.

Rajan also advocated the necessity of strong institutional structures, to support high growth. He also put the ball in the government's court, saying reforms (not rates) held the key to India's sustainable growth. 
 
Rajan said monetary policy can help strengthen the current economic recovery, but he added India will ultimately "expand sustainable growth potential only by continuing to implement reforms the government and regulators have announced. In a nutshell, the focus should be on improving the business environment as a way to drive growth rather than extending stimulus and rate cuts.


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