Subbarao will keep a sharp eye on Chidambaram's budget

RBI Governor D. Subbarao (left) and Finance Minister P. Chidambaram

BT :Anand Adhikari  : February 14, 2013  | 20:17 IST

Falling gross domestic product (GDP) and inflation numbers are clearing the road for a further softening of interest rates in 2013 - if and only if P. Chidambaram plays along. 

Reserve Bank of India (RBI) Governor Duvvuri Subbarao has all along talked about the need for a sustained decline in inflation and a faster and more credible road-map for fiscal consolidation, especially of the fiscal and current account deficits. That was the prerequisite to slash interest rates. 

There is encouraging news on the inflation front. The wholesale price index (WPI) came down sharply to 6.62 per cent in January from 7.18 per cent in December last year. 

Last week the Central Statistical Organisation's advance estimate of a decade low five per cent GDP growth in 2012/13 fuelled talk of the need for an interest rate cut.

But the journey to lower interest rates will not be easy because of an impending general election next year. All eyes will be on Finance Minister P. Chidambaram's 2013/14 budget to see how he plans to rein in the fiscal deficit. And more importantly, how he balances rising expenditure on welfare schemes while reining in the deficit. The current budget is going to be the last full budget of the United Progressive Alliance (UPA) government in its current term. Inevitably, there are expectations of goodies such as food security. Recently, Sachin Pilot, a minister in the UPA government, also hinted that the government could announce another farm-loan waiver scheme. Such proposals will make it hard for Chidambaram to contain the fiscal deficit.

The policy or repo rate, which is the rate at which the central bank lends funds to banks, was last tinkered with in April last year. At the time, the RBI instituted a 50-basis-point cut and followed it up with a 25-basis-point cut in January this year. 

In the past, the RBI addressed the liquidity issue by slashing the cash reserve ratio (CRR), which is the amount of cash banks have to maintain with the central bank. It also infused liquidity through open-market operations, buying bonds from banks. 

If Chidambaram manages to please all while controlling the fiscal deficit, he will make it easier for the RBI to reduce interest rates.