The RBI stated that the “inflation outlook is clouded by several uncertainties on the upside” and “fiscal slippage as indicated in the Budget could impinge on the inflation outlook”.
Mumbai: The Reserve Bank on February 7 kept interest rates unchanged for the third time in a row saying that higher government spending would accelerate inflation. It also warned of risks from wider fiscal deficit.
The six-member Monetary Policy Committee (MPC), headed by RBI Governor Urjit Patel, retained the repurchase or repo rate at 6% and reverse repo rate at 5.75%.
It kept a neutral stance at its sixth and the last bi- monthly monetary policy review of the current fiscal, 2017-18.
Inflation, which surged to a 17-month high of 5.21% in December, is likely to accelerate further after the Budget for 2018-19 widened the fiscal deficit target so as to finance higher rural spend and mega healthcare plan.
“We are still awaiting some of specifics on that in terms of costing it… we have said that there could be impact but we have not said how much,” Patel said. “There is not enough information at the moment about what the costing would be.”
The Union Budget 2018-19 would stoke demand but worsening public finances may crowd out private funding and investment, RBI said in a statement.
RBI upped its inflation forecast to 5.1% for the current fourth quarter of the 2017-18 fiscal ending March 31.
It expects inflation to firm up further to 5.1-5.6% in first half of the next fiscal, before cooling down to 4.5-4.6% in the second half.
There is “need for vigilance around the evolving inflation scenario in the coming months,” it said. “Fiscal slippage as indicated in the Union Budget could impinge on the inflation outlook.”
Patel and four other MPC members voted for status quo on the interest rate while one member, Michael Patra favoured a 25 basis point rate hike.
Stating that it stays committed to keep headline inflation close to 4%, RBI put the Gross Value Added (GVA) – a key measure of growth – at 7.2% for the next fiscal year with risks evenly balanced.
For the current fiscal, it lowered the growth rate to 6.6% from previously projected 6.7%. This compares to 6.5% forecast by the government, down from 7.1% a year earlier.
“Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation,” RBI said.
MPC was of “the view that the nascent recovery needs to be carefully nurtured and growth put on a sustainably higher path through conducive and stable macro-financial management.”
The resolution of the MPC said “the inflation outlook is clouded by several uncertainties on the upside”, flagging risks from 7th pay panel implementation in states, high oil prices, hike in customs duties and fiscal slippage to 3.5% in 2017-18 and a higher target for 2018-19.
“Fiscal slippage as indicated in the Union Budget could impinge on the inflation outlook. Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation,” it warned.
RBI said however that it is too early to assess the impact of the minimum support prices hike in foodgrains and the impact on inflation.
On the positive side, MPC said there are mitigating factors like subdued capacity utilisation and moderate growth in rural wage, while welcoming the focus of Union Budget 2018 -19 on rural and infrastructure spending.
On volatility in global financial markets, RBI said it is due to uncertainty over the pace of normalisation of the US Fed monetary policy.
A majority of watchers were expecting the MPC to go for a status quo in rates with a hawkish commentary on inflation concerns.
At the last policy review, it had raised the inflation forecast to 4.3-4.7 % for the second half of the current fiscal.
Factors which can fuel price rise include a proposed increase in minimum support prices for grains, a rally in oil prices and the government deviating from the fiscal consolidation roadmap to target a wider 3.2% deficit in 2018-19.
On the economic growth front, there has been some improvement as the effects of the twin blows of demonetisation and GST implementation are waning. The government is expecting a 7-7.5% growth in 2018-19.
The RBI had switched stance to neutral from being accommodative in February last year as it saw rise in inflation. It had last cut the repo rate by 0.25% in the August 2017 monetary policy review.