RBI delivers, can lame duck govt?

The Reserve Bank of India (RBI) on Friday surprised the markets by slashing the cash reserve ratio (CRR) — or the portion of deposits that banks have to compulsorily keep with the banking regulator as a safety measure — by 75 basis points to 4.75% from 5.5%. (A 100 basis points make a percentage point, or, in layman terms, 1%)
The RBI preferred t

o call it a liquidity measure, essentially to facilitate the more than Rs20,000 crore of advance tax that companies will have to pay by March 15, taking it out of their bank accounts.
The CRR cut releases Rs48,000 crore back to banks.
But since the cut too is effective after March15, underscoring the RBI’s confidence that the move won’t stoke inflation. That’s a big change from its stance of the past two years, when it resorted to more than a dozen policy rate hikes and CRR hikes to control inflation.
While the RBI has done all it can for now, can the Union government reciprocate by cutting expenditure in the Union Budget next Friday, and allow the central bank to cut interest rates too, especially since the debacle at the hustings in Uttar Pradesh and other states?
Experts say the UPA has little elbow room to deliver.
“The options are very limited due to the huge fiscal deficit. While this limits the possibility of populist measures, on the other hand, the government can’t come out with bold and drastic steps because of the strong opposition from other parties,” said N Sethuraman Iyer, CIO at Daiwa Asset Management India.
The best that the central government can do is produce a fiscal deficit number that is believable and is based on credible assumptions, said Abheek Barua, chief economist, HDFC Bank.
“But the only change would be a more toned down approach towards controversial elements in the budget speech such as foreign direct investment (FDI) in retail,” Barua said.
If the government keeps spending on populist schemes, which essentially is putting more money in the hands of people — it increases inflation in the economy, which, in turn, limits the RBI’s ability to bring down interest rates.
Fiscal consolidation, therefore, is an imperative in the Budget this time. Barua pointed out that a large part of the recent liquidity squeeze was due to the recent foreign exchange intervention by the RBI to control the rupee’s fall.
“This move will help counter that and provide further space for future intervention,” Barua said.
The rupee falls when demand for dollars increases. To arrest the fall, RBI sells dollars and buys rupees, which sucks out the local currency from the banking system, crimping inter-bank liquidity.
The central bank has thus cut CRR twice in the past three months by 125 bps, showing a more relaxed monetary policy as against its aggressive anti-inflationary stance earlier this financial year. This shows that RBI is somewhat comfortable with the way the inflationary trajectory has panned out so far, the street believes.
Apart from the Budget, what can happen next when the RBI meets to review monetary policy on March 15?
“I don’t expect the RBI to make any changes in policy rates,” said Sonal Varma, economist at Nomura Securities.
“Till banks cut lending rates, the benefit will not be felt on the ground,” said Venugopal Dhoot, chairman of Videocon Industries.
That’s unlikely to happen till the April review of the policy, is the refrain on the street.