Was the RBI repo rate cut a result of government pressure?

When the Narendra Modi-led BJP government presents its second budget next month, there will be support from a new corner. Turning a deaf ear to the demand from the government, the RBI Governor Raghuram Rajan had stubbornly stuck to the theory that India's current inflation could not support rate cuts: inflation was high and needed a headmaster's control.

Now that wall has given way. Rajan has decided to kick-start the rate-easing cycle. The governor, felt that the inflationary indicators were supportive of a rate cut and growth led by cheaper capital could be pursued more actively.

For finance minister Arun Jaitley, Rajan's conviction could not have come at a better hour. While the first budget was more in line with the earlier Congress-led government, there was hardly little time to present a radical budget. 2015 is different, it is BJP's second year, expectations are high, and Modi is raring to move into high-growth gear. It will in many ways define the Indian economy that Modi wants to give shape to.

Though there were favourable data swings for Rajan to decide on introducing the rate cut era after a gap of 19 months, it still caught many in the banking and industry circles by surprise. Was there more than data that made Rajan move to the other side of the coin?

Even as the crude oil prices fell and inflation had been tamed, Rajan possibly felt that he needed to listen to the political voice. He could have rationalized that he wasn't compromising his position as a RBI governor anyway; he was just being flexible to change.

There was a new Rajan speaking…and it was visible.

In April before the BJP government was sworn in at the centre Raghuram Rajan sounded like an inflation hawk when he presented his first bimonthly credit policy. In less than a year on December 2, when he presented his fifth bi-monthly credit policy he sounded more dove-like, believing that the fall in the commodity prices was here to stay and the crude oil prices would not reverse. Of course the data supported him but did he believe that the commodity prices are going to be steady?

For now, North Block has won over Mint Street after RBI cut the rate at which it lends to banks by 25 basis points to 7.75 %. For the finance minister it is a huge relief as he had been looking forward to create a conducive environment for growth, where he believes that the cost of capital may be a key ingredient.

A top finance ministry official told dna, "Consumer price inflation hit below 6% in November last year. RBI had a target of 6% of consumer inflation by January of 2016. It would have refrained from a rate cut unless it was confident of maintaining that target. In our view, growth is indeed a priority and steps need to be taken to revive the investment cycle."

The newly-formed National Institute for Transforming India (Niti Aayog) though, feels that the RBI governor would have practiced restraint anyway. A top official from the Niti Aayog told dna, "Globally, the central banks tend to practice caution."

On December 30, Jaitley said, "Costly capital is one of the factors impacting manufacturing." In mid-November, Jaitley said, "RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital, (this) will give a good fillip to the economy."

Rajan, meanwhile, said at a FICCI event in Delhi. "Monetary stimulus will not do. The government needs to work on infrastructure."

He always emphasized that rate cuts will have to wait until the disinflationary trends are firmly entrenched in the economy. He needed to fight to the finish so that growth could return to the economy.

Was there government pressure to cut rates? Yes, if the recent statements of the finance ministry were anything to go by, where the cost of capital was blamed for being too high blocking growth in the economy. And a surprise cut from RBI when everyone was expecting it only after the budget many believe there could have been some pressure from the government.

"India is a complex animal," he said once, and his policy statements reflected the dichotomies of the Indian economy.

In April last year, Rajan said, "If inflation continues along the intended glide path of 6 % by January 2015 and 8 % by January 2016, further tightening in the near term is not anticipated at this juncture. At the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases undertaken during September 2013 through January 2014 to work their way through the economy."

By the time the guard changed in Delhi, with the Modi-led BJP government storming Delhi with a overwhelming majority, the first in 20 years, the inflation guard was falling off and Rajan began talking of a rate-easing cycle. Here is what he said in his second bi-monthly policy on June 3. This was perhaps the first time he started talking of rate easing.

Rajan said, "RBI remains committed to keeping the economy on a disinflationary course.. If the economy stays on this course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance."

On August 5, 2015, when he presented the third bi-monthly credit policy, Rajan seemed undecided and the cries for rate cuts were beginning. The moderation in CPI headline inflation for two consecutive months, despite the seasonal firming up of prices of fruits and vegetables since March, is due to both base effects and the steady deceleration in CPI inflation excluding food and fuel, he said. The recent fall in international crude prices, the benign outlook on global non-oil commodity prices and still-subdued corporate pricing power should all support continued disinflation. But he preferred to keep a vigil on the monetary policy stance as in June, while leaving the policy rate unchanged.

By 30th September, Rajan was happy with the slide in the inflation levels. "The most heartening feature has been the steady decline in inflation excluding food and fuel, by a cumulative 111 basis points since January 2014, to a new low. With international crude prices softening and relative stability in the foreign exchange market, some upside risks to inflation are receding. Yet, there are risks from food price shocks as the full effects of the monsoon's passage unfold, and from geo-political developments that could materialise rapidly." He concluded further policy action would be contingent on the inflation data.

On December 2, 2015, the inflation hawk turned into a dove. Rajan said, if the current inflation momentum and changes in inflationary expectations continue, the fiscal developments are encouraging, a change in monetary policy stance is likely early next year, including outside the policy review cycle. But the surprise factor was that no one expected it to come so early in the year.