Rajan lobs the ball into Centre court

The Reserve Bank of India (RBI) logo is displayed on a gate at the central bank's headquarters in Mumbai, India, on Tuesday, April 1, 2013. India’s central bank left its key interest rate unchanged as consumer-price inflation eased to a two-year low and the rupee strengthened, increasing scope to support growth ahead of national elections starting this month. Photographer: Vivek Prakash/Bloomberg

The Reserve Bank’s monetary policy announcement on Tuesday has significant two-fold implications for the Modi Government.

The BJP in the run up to the Lok Sabha had demanded lowering of interest rates. Corporate India has for quite some time now been demanding that the cost of loans be made affordable so that they can start investing.

The RBI didn’t announce a rate cut on Tuesday. In his policy announcement, Reserve Bank Governor Raghuram said there would be headroom for an easing of the policy stance if disinflation is faster than currently anticipated. What are the chances this will happen? The Governor seemed to suggest that the answer lies with the Modi Government. This is so as he said besides, the softening effect of the pass through of rupee appreciation on local prices, the other factor that could balance the risks to inflation is strong government policy action on food supply and fiscal consolidation.

The inflation trend itself, he said, excluding food and fuel, retail inflation has been edging down. Even the retail the recent rise in inflation led by a sharp spike in prices of fruits, vegetables, pulses and milk, he said, is largely a seasonal phenomenon. So the key is really in the government’s hands. And, its response to the policy announcement confirmed the Governor’s message had been received on Raisina Hill: “We would like to address the problem of inflation through supply side measures particularly in relation to food inflation,” Union Finance Minister Arun Jaitley said in his statement on the monetary policy.

Flow of bank credit

To free up the flow of bank credit to the non-government sector, the Governor reduced the statutory liquidity ratio (SLR) for banks by half a percentage point to 22.5 per cent. SLR is the minimum percentage of its deposits a bank must maintain in the form of gold, cash or other approved securities. So the SLR limits banks’ lendíng to private borrowers. At 28 per cent, SLR held by banks at present is excess of the current stipulation of 23 per cent. Chances are Tuesday’s SLR cut will not result in banks drastically increasing their lending to the private sector.

The Governor himself noted in the policy announcement liquidity conditions “improved significantly” in April and May. So then, the cost and not the availability of funds is the problem in the lending markets. Since the SLR cut opens up the possibility of a big reduction of government debt holdings by banks, it can raise the cost the government’s borrowings. As he prepares the Modi Government’s first budget Mr. Jaitley will have to factor in this possibility. The lower SLR will take effect from the fortnight starting June 14. The Modi Government will present its first budget about two to three weeks after that. “Fiscal consolidation is a priority for the government,” Mr. Jaitley said in his statement on the policy announcement.

So, for now the Modi Government is on its own in its pro-growth agenda.