Walking in sync

The first half of February typically sees a confluence of fiscal and monetary policy announcements. The backdrop for such pronouncements this time was a resilienteconomy amid rising global shocks and uncertainties. With 7.3% gross domestic product (GDP) growth estimated by the National Statistical Office for this fiscal, India’s performance has exceeded expectations. The major bugbear has been inflation, which though localized, has stayed above the 4% target of the Reserve Bank of India (RBI).

Both the budget and monetary policy were well coordinated to address this concern. The interim budget was what an interim budget should be. It avoided populism in an election-bound year and reduced the deficit target to 5.1% of GDP for next fiscal. The overall fiscal impulse was lower, and government expenditure focus was on supporting the investment cycle and creating assets, instead of cash dole-outs. This makes the interim budget non-inflationary.

Although the non-inflationary interim budget smoothens the path for an easy monetary policy, the RBI has not shown any hurry to cut rates or even change stance as theinflation is some distance from the 4% target.

Headline inflation moderated to 5.1% in January as food prices softened a bit, and core inflation slid to 3.5%. But food inflation is still at 8.3%. The monetary policy is focused on preventing generalizing of food inflation, which is always a risk in a strong growth environment.

To be sure, the entire fiscal saw no change in stance or rates. This does not mean the RBI did not tighten monetary conditions. It has done so to improve monetarytransmission and used macroprudential measures (read raising risk weights) to preemptively curb risks from a surge in retail credit growth.

In addition to domestic factors, global developments also influence India’s monetary policy. Although inflation appears to have peaked, the timing and speed of rate cuts are difficult to ascertain as core and headline inflation in the United States (US) and Europe remain above central bank targets. We expect the US Federal Reserve and the European Central Bank to cut rates in June.

The RBI, too, could begin easing the monetary policy by then.

Focus on fiscal consolidation means that when the RBI decides to cut rates, the fiscal policy will not stand in its way.