* Tougher-than-expected talk from central bank surprises
* Government weakened by new crisis after rail fare hike
* Stocks down, bond yields up after RBI policy action
* Railway fare crisis bodes ill for government reforms
By Tony Munroe
NEW DELHI, March 15 India's monetary
policymakers left interest rates on hold and warned of resurgent
inflation risks, putting pressure on the government to trim the
fiscal deficit a day before the federal budget is announced.
But a political backlash against the already weakened
government's move to raise railway fares for the first time in
eight years may further undermine its ability to tame populist
spending or enact reforms to jump-start the economy.
"Given the coalition government's position, I would be quite
skeptical of any meaningful reforms coming out of the budget,"
said Ashish Vaidya, executive director and head of interest
rates at UBS in Mumbai.
The Reserve Bank of India has said progress on deficit
reduction is a key condition for cutting interest rates.
"The RBI is fighting a lone battle, and ideally, it would be
extremely positive if the government were to respond with policy
initiatives," Vaidya said.
Bond yields and swap rates rose and stocks fell after the
central bank kept its policy repo rate on hold at
8.50 percent. A rate cut that many had expected at the central
bank's April 17 review - which would be the first since the
aftermath of the global financial crisis - is now seen as less
The Trinamool Congress Party, a key ally of the Congress
party's fractious ruling coalition, called for the resignation
of Railway Minister Dinesh Trivedi, who is from the same party,
and a rollback in the fare increase announced on Wednesday.
Trivedi had not resigned as of Thursday evening, following a
chaotic day in parliament.
Prime Minister Manmohan Singh's Congress coalition was
already weakened after a drubbing in recent state polls and more
than a year of corruption scandals and policy paralysis that has
deterred investment and curbed growth momentum.
"None of this augurs well for the upcoming general budget,"
the Times of India said in an editorial on Thursday after
Trinamool leader Mamata Banerjee, who is chief minister in the
state of West Bengal and was previously railway minister,
spearheaded opposition to the fare increase.
"There'll be misgivings about Mamata playing to the gallery
by bashing any reform the finance minister proposes in the
budget. So he might think it better to play safe than sorry,"
the newspaper said.
LOW BUDGET EXPECTATIONS
Finance Minister Pranab Mukherjee will present the federal
budget to parliament on Friday and is under pressure from
investors to lay out a realistic plan to reduce a fiscal deficit
that is on track to bulge past 6 percent of GDP in the current
fiscal year, from a target of 4.6 percent.
He is expected to set a target in the range of 4.8-5.3
percent of GDP for the year from April, helped by improved
economic growth, tax increases, slowing growth in subsidy
expenditure and an increase in the sale of state assets.
Growth in Asia's third largest economy slowed to 6.1 percent
in the three months to December, the weakest in almost three
years, and is on track to fall just short of 7 percent in the
fiscal year that ends this month. Heavy government borrowing and
spending is blamed for pushing up interest rates, crowding out
corporate borrowing and fuelling inflation.
A finance ministry report on Thursday said growth could
accelerate to 7.6 percent in the coming fiscal year.
J. Moses Harding, head of the asset liabilities committee at
IndusInd Bank, said resistance within India's ruling coalition
to Wednesday's rail fare increase may have prompted RBI Governor
Duvvuri Subbarao to adopt a cautious stance.
"The ability of the FM (finance minister) to manage the
fiscal deficit within acceptable levels is in doubt," he said.
"The RBI has affirmed the need to cut rates, but no clear
indication on its timing and magnitude. The fear is that of
delay beyond April."
The RBI's tougher-than-expected stance on inflation
disappointed investors clamoring for a cut in borrowing costs.
"Upside risks to inflation have increased from the recent
surge in oil prices, fiscal slippage and rupee depreciation," it
said in its mid-quarter policy statement, adding that future
actions will be towards lowering rates but refraining from
giving a timeframe.
Brokerage Nomura lowered its forecast for rate cuts in 2012
to 75 basis points from 100 bps.
The RBI has said it will be constrained from cutting rates
in the absence of credible fiscal consolidation.
"A rate cut in April depends on what the government budget
delivers. If it is deemed expansionary/inflationary then chances
of a ...cut are reduced," said Jonathan Cavenagh, FX strategist
at Westpac in Singapore.
India's headline inflation picked up for the first time in
five months in February, to 6.95 percent, on higher food costs
but another measure of price pressures cooled,
sparking market talk that a rate cut might be in the
"Notwithstanding the deceleration in growth, inflation risks
remain which will influence both the timing and magnitude of
future rate actions," the RBI said.