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Cheers, concerns about India's rate cut

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Reserve Bank of India Gov. Raghuram Rajan attends a convocation ceremony for students at a university in Mumbai on Jan. 9.   © Reuters

MUMBAI -- It was so sudden. The Reserve Bank of India, the country's central bank, on Jan. 15 convened ahead of the planned Feb. 3 meeting to decide on a cut of its key interest rate.

     The surprise orchestrated by RBI Gov. Raghuram Rajan was welcomed by markets, sending India's benchmark Sensex stock index nearly 3% higher on Jan. 15.

     The timing was getting ripe for the rate reduction, considering the steep fall in crude oil prices since last year. In a statement on Jan. 15, Rajan said, "Lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil."

     India depends on imports for 80% of its oil needs, and crude oil and related products account for 30% of the value of its imports. So lower oil prices exert downward pressure on domestic prices.

     While the economies of oil-producing nations such as Malaysia, Russia, Venezuela and Middle East nations have been hurt by the fall in oil prices, India is benefiting from cheaper oil. The country has other things going for it, too.

     One of them is the central bank governor himself. India saw its currency, the rupee, plummet in the summer of 2013 when speculation grew about the U.S. curtailing its monetary easing measure, known as quantitative easing, to pump money into the market. Many market watchers feared that money from the U.S. that was invested in India and other emerging economies would be yanked out, which clouded the prospects for the Indian economy.

     Then Rajan was appointed as central bank governor in September 2013. Rajan, the former chief economist of the International Monetary Fund, skillfully dispelled fears about the Indian economy by adopting monetary tightening measures.

     A series of economic reform measures being promoted by the government of Narendra Modi, who became prime minister in May 2014, are also brightening the outlook for the Indian economy.

     On Jan. 11, Modi held forth on the abundant business opportunities in India for more than 30 minutes before an audience of several thousand people at the Vibrant Gujarat Summit in Gandhinagar, the capital of the western Indian state, to entice investors.

     The event was first organized when Modi was chief minister of Gujarat. The gathering gained the trappings of a national event this year when it was held for the seventh time with the attendance of Modi as prime minister of the country.

     The three-day summit was attended by political and business luminaries from more than 120 countries, including U.S. Secretary of State John Kerry, U.N. Secretary-General Ban Ki-moon, World Bank President Jim Yong Kim, British-Australian mining giant Rio Tinto Chief Executive Sam Walsh and Osamu Suzuki, chairman and CEO of Suzuki Motor, which dominates India's passenger car market. The brouhaha surrounding the event reflected high expectations at home and abroad for India under the Modi government.

Easy on the expectations

Still, there is some cause for anxiety about the Indian economy. Anyone who expects too much of the Indian economy because of low oil prices and the reform-minded Modi government might be in for a rude awakening.

     India, for example, runs a current-account deficit and owes significant debts to foreign lenders, which means its economic fundamentals look less attractive than those of many other Asian emerging economies. It should also be noted that it was only 18 months or so ago that the rupee ran into active selling as India was considered to be one of the so-called fragile five emerging economies, which were vulnerable to an end to the U.S. bond-buying monetary easing measure.

     India is a vast country, so economic growth strategies need to be fine-tuned to suit the characteristics of each locality. The Modi government, which is known to be business-friendly, seeks to nurture the growth of industries that would create jobs and reduce poverty. Meanwhile, not all of the states and union territories have the potential to become a major industrial hub like Gujarat. The states are trying to curtail bureaucratic red tape and trumpeting the potential demand for goods and services in their efforts to entice foreign investment. But the Modi government appears to lack a strategy for promoting the unique characteristics of each state and the growing industries that would suit them.

     Concerns are being expressed about the speed with which the government will likely implement reforms.

     Late last year the Bharatiya Janata Party, of which Modi is the leader, was unable to win approval of the parliament for the introduction of a goods and services tax that would integrate central and local levies and a proposed rule change on foreign insurance companies. After the parliamentary session closed, President Pranab Mukherjee signed an ordinance on raising foreign direct investment in the insurance sector, but it is due to expire in six months. "The government tends to take a lot of time deciding on major reform measures," said an official with a Japanese securities house.

     Meanwhile, there are observers who express concern about the central bank's latest move to lower interest rates. India's problem regarding inflation cannot be solved by monetary easing alone, and the government needs to come up with ways to solve problems concerning the supply side, one official with a foreign bank said. Rajan probably should have waited before moving ahead with a rate cut, the official said.

     In his Jan. 15 statement, Rajan also urged the government to do its bit, saying, "Also critical would be sustained high-quality fiscal consolidation as well as steps to overcome supply constraints and assure availability of key inputs such as power, land, minerals and infrastructure." Rajan had raised the issue with the government before.

     The previously cited foreign bank official said it is regrettable that the central bank cut interest rates at the request of the government and the business community before the government clarified how it intended to solve the supply-side problems, thus compromising the independence of the central bank.

     The Indian government is due to announce a budget plan for the year through March 2016 in late February. Programs that will be incorporated into the budget plan should serve as a gauge of how committed Modi is to economic reform.

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