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Does a fiscally careful Budget create room for RBI to please India Inc?

Largely disappointed with Budget 2020, Indian Inc is now keenly watching what the monetary policy has to offer on Thursday. Is RBI’s monetary policy committee feeling the same way? Disappointed?

The monetary policy primarily assesses fiscal policy on the basis of how much growth in GDP it has triggered and in doing so, the extent to which it has stepped on to the inflation accelerator. As we go to press, the six members of the monetary policy are using their data charts to make this assessment. It will decide their response—to hold the interest rates or move it up or down.

The fifth bi-monthly monetary policy released in December had held the rates after five successive cuts and noted that “the forthcoming union budget will provide better insight into further measures to be undertaken by the Government and their impact on growth”. Significantly, it also said it “recognises that there is monetary policy space for future action”. Obviously there will always be space for monetary action, but in this case it can be safely interpreted as saying that a decision to cut the interest rates lower will depend on how well finance minister Nirmala Sitharaman met the demands of a prudent fiscal policy. The attention was consequently on how the finance minister and her team respond with their plans for the management of the economy, caught in a massive downturn. 

In Budget 2020-21, the minister was expected to principally offer three things. She was supposed to offer a transparent picture of government finances. She was expected to ease up on the fiscal deficit to create space for more public investment and finally offer a road map for the economy to revive private investment. She has partly scored on the first, done well on the second but has left the third priority dangling. The budget is based on the assumption that if the government keeps its house in order, it will be more or less sufficient to spur private investment and raise aggregate demand. 

Her fiscal strategy to stimulate aggregate demand stands on two legs, as economist Niranjan Rajyadhaksha writes. Income tax cuts on the one hand, combined with increased spending in select programmes on the other. The problem is despite the experience of 2019-20, her fiscal numbers for next year still assume a faster growth of tax revenues compared with the pace at which the economy will grow. Even for 2019-20, even after cuts of about Rs 3 trillion in the expected tax revenue, there could be gaps. How does she plan to fill in this gap? One of those could be monetisation of the deficit by selling bonds directly to the RBI, something the government has not done since 2003. 

Both these possibilities mean the government will spend more money than it has written out in Budget 2020-21. More printing of money means the spectre of higher inflation. However the finance minister and her team have said none of possibilities are not going to happen. Speaking with Business Standard, Ms Sitharaman said “the government is transparent and clearly showing where the money will come from and where it will go”. So while there are concerns, the fiscal situation seems to be in better control than it seemed to be through most of this year. But in doing so she has had to eschew any plans to revive investments. 

This is the lay of the land, that the finance minister has shown for the six wise men and women at the RBI. Most commentators are agreed that RBI might stiffen its commentary on the economy and offer a longer pause in the rates. But then But then, it also possible that having done a difficult job, and some greenshoots already in the offing like the PMI and electricity consumption data, with inflation not expected to worsen and at least one rate cut factored in this calendar year, the MPC could decide the time is now to give industry an early incentive. RBI could show North Block that they are on the same page!

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