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. 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 likely.
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.
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. 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.