There is a new government at the Centre and the sentiment is optimistic. But inflation remains stubbornly high and GDP growth for 2013-14 remained under 5 per cent.

The Reserve Bank Governor, Raghuram Rajan, clearly faces a dilemma as the bi-monthly monetary policy review comes up on Tuesday — the first under the Modi Government’s watch.

Though the new Government would like to spur growth and look for some cuts in policy rates, Rajan is most likely to hold the key rates (the repo rate is at 8 per cent) and wait for the Budget in July to synchronise his moves with the Finance Minister’s.

Fighting inflation Rajan’s hands may also be tied by the commitment to the “glide path” of taking consumer price inflation to 6 per cent by next year. According to the RBI’s forward guidance given earlier, rates can come down only if inflation eases faster and is of a reasonably permanent nature; not just a monthly blip.

Although the WPI (wholesale price index) inflation eased a bit to 5.2 per cent in April, the CPI (consumer price index) inflation moved up to 8.59 per cent — beyond the RBI’s comfort level. The Urjit Patel committee, which now serves as a guidepost for the RBI’s moves on rates, had recommended that the apex bank bring down CPI inflation to under 8 per cent by 2015 and below 6 per cent by January 2016.

As of now there is no sign of the price pressure easing; in fact, indications are that prices could rise which, if seen as a sustaining trend, may even force Rajan to raise rates. An emerging risk on the inflation front is the prospect of less-than-normal monsoon as the El Nino weather phenomenon looms.

With the political establishment not too vociferous about a rate cut, it would appear the Finance Minister, Arun Jaitley, is on the same page as Rajan on combating inflation. Rajan met both Jaitley and Prime Minister Narendra Modi last week

Will he surprise? Yet, given his penchant to surprise, Rajan may weigh in with a rate cut which would come as a booster for the economy and lift sentiment further. It would come as a shot-in-the-arm for the Modi Government that has won an overwhelming mandate on the growth plank.

The economy has been growing under 5 per cent for two years now and many blame the high interest rate regime. Industry bodies have all been clamouring for a rate-cut.

Banks may not respond But as Rajan himself has made clear earlier, it is a moot point if banks will act on his signals. That is, even if he does cut the repo rate, it is debatable whether banks will immediately respond with interest rate cuts of their own. Most likely, they won’t. If they did, they would simply run the risk of losing out in the war for deposits.

To consider lowering rates, Rajan will need Budget moves to boost long-term growth, cut deficits, and tame the inflation. Till then, as a via media, the RBI may hold the rates.