The factors beyond RBI Governor Raghuram Rajan's control

With Reserve Bank of India (RBI) Governor Raghuram Rajan keeping interest rates unchanged in his first monetary policy after the new government under Prime Minister Narendra Modi took charge, the focus now shifts to fiscal consolidation and removing supply-side bottlenecks in the economy. And the new government, not the RBI, must take action in both areas.

If inflation persists at an elevated level for a long time, which looks probable considering high food prices and emerging threats from a likely weak monsoon, the new government has to cut wasteful expenditure and bridge supply-side bottlenecks in the agricultural chain by encouraging investments in rural infrastructure.

Modi's recent move to abolish all ministerial groups, which were created by the previous government to build consensus in contentious policy issues, would go a long way in a leaner government structure and cutting wasteful spending.

There is only one area where the previous government moved with lightning speed - controlling the current account deficit. The consequent strengthening of the rupee against the US dollar has drastically reduced the threat from imported inflation by way of a rise in the country's oil import bill. The current account deficit has been tamed at 1.7 per cent of gross domestic product (GDP) in 2013/14 compared with 4.7 per cent the year before. The rupee's appreciation will offset any rise in global oil prices.

For the new government, the first key issue is the road map for fiscal consolidation. The fiscal deficit in the year ended March 31 was 4.5 per cent of GDP. Finance Minister Arun Jaitley has already indicated that tough measures are required to contain the budget gap. The Fiscal Responsibility and Budget Management Act had earlier set a target for the fiscal deficit at 3 per cent by March 2008. It was never achieved and the deadline has now been extended to March 2017.

Rajan will surely look for concrete measures than just the numbers in the Union Budget 2014/15, which will be presented in the first week of July.

There are other measures required on the supply side to bring down inflation as food has been a major contributor to price rise. First and foremost is the need to do away with the archaic Agriculture Produce Marketing Committee Act by state governments or at least remove fruits and vegetables from the purview of this law.

Critics say the law leaves enough scope for price manipulation. Onion prices, for example, touched Rs 100 a kilogram just before assembly elections in five states in December last year. The prices came down once the results were announced.

The second big issue is wastage in agricultural produce, which also leads to shortages. A recent study by ratings firm CRISIL has revealed that the wastage and pilferage in agricultural output was Rs 70,000 crore in 2010/11, almost a third of the total production value.

The RBI's decision to hold rates, says ICICI Bank Managing Director and CEO Chanda Kochhar, reflects the level of inflation as well as the expectation of policy and administrative actions from the new government in coming months to tame inflation and boost growth. Clearly, the government has its task cut out before Rajan softens his stand on monetary policy.