India unlikely to cut interest rate on Tuesday

Mumbai: Threat of a slumping rupee and an ill-disciplined budget will probably prevent Indian central bank governor Raghuram Rajan from cutting interest rates on Tuesday.
The rupee’s 2.3 per cent loss this year, the most in Asia after South Korea’s won, risks worsening inflation if Prime Minister Narendra Modi cuts stimulus spending rather than subsidies to narrow Asia’s widest budget deficit this month. Thirty-six of 38 economists in a survey predict the Reserve Bank of India (RBI) will leave the benchmark repurchase rate at 6.75 per cent, while two see a cut to 6.5 per cent.
"Primarily, the RBI will be waiting for the budget and its focus will be both on the quantity and the quality of fiscal consolidation," said Sonal Varma, an economist at Nomura Holdings in Mumbai. "If you have an easy fiscal policy, then the room for an easy monetary policy closes up."
Twenty-six of 27 economists in a separate survey also predict that Rajan will keep banks’ cash reserve ratio at 4 per cent on Tuesday, compared to a call for a 50-basis point cut from Goldman Sachs economist Tushar Poddar.
The rupee’s slump is a challenge to the central bank’s credibility as it strives to slow inflation to its 5 per cent target by March 2017. Consumer-price gains are currently on pace for 5.40 per cent by then, Michael Patra, a top RBI official, told analysts in December.
An expected increase in government salaries and military pensions risks stoking demand further. Economists see only a single quarter point rate cut this year after 125 basis points of reductions in the past year. Swaps are pricing in the possibility of a half-point reduction.
Deficit risks
Modi’s administration may have to reassess its budget deficit target for the year starting April 1 if growth slows, the government’s top economic adviser warned in December.
"Any weakening of the commitment to fiscal consolidation would provide even more reason for the RBI to bring the rate- cutting cycle to an end," said Shilan Shah, Singapore-based India economist at Capital Economics.
A larger deficit would force Modi to borrow more, giving Rajan leverage to press for fiscal discipline in return for keeping benchmark rates low. Since the government meets about 85 percent of its deficit funding needs from the market, yields will stay elevated if the supply of bonds outstrips demand, Nagaraj Kulkarni, senior Asia rates strategist at Standard Chartered Plc, wrote in a January 14 note.
Rajan on Friday warned the government against boosting growth by borrowing more from the markets. "Deviating from the fiscal consolidation path could push up government bond yields, both because of the greater volume of bonds to be financed and because of the potential loss of government credibility on future consolidation," Rajan said in a lecture in New Delhi.