Mumbai: The Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC) is all set to start deliberating whether it plans to hike key interest rates or if it plans to put it on hold as predicted by experts. While the apex bank is expected to leave the rates unchanged this time, it is expected to toughen its stance on inflation later in the year, paving way for a price hike in 2018.
The RBI had earlier warned that a rise in inflation is unavoidable, after a period of historically low levels that allowed it to cut repo rate by two percentage points to the current rate of 6 percent. There are several factors that the MPC, headed by RBI Governor Urjit Patel, is worried about – global crude oil prices, higher spending in this year’s Budget, and the introduction of a major healthcare scheme are some factors that have kept the head honchos at the apex bank busy.
Considering that the RBI would be looking to keep the near-term outlook hawkish, a cut in rates is highly unlikely at present, taking into account the current sentiment after the Budget. However, a rate cut at a later stage this year should not be surprising as inflation is expected to rise amid higher government spending, propelling chances of increased fiscal slippages.
The government has allocated a bulk of its budgetary funds to the rural sector, despite failing to meet fiscal deficit target this year. Besides, the government has also increased the fiscal deficit rate this year to 3.3 percent. While the government had little choice but to fulfill the demands of the rural sector, analysts predict that higher spending would have an adverse effect on the banking sector.
As discussed earlier, inflation is one of the most important factors that would be taken into consideration by the RBI’s MPC. Inflation uptick is expected later this year with a rise in food inflation due to rise in minimum support price (MSP) for farmers.
While it would be extremely beneficial to the ailing farmer, it would be troublesome for the top bank, as it would be forced to change the rates due to rise in inflation. MSP for Kharif crops is expected to rise 47 percent and at least at one-and-a-half times the cost for Rabi crops.
It may also be noted that the budget allocation for the agriculture ministry has been increased by 13 percent to Rs 58,080 crore for the 2018 -19 fiscal, from Rs 51,576 crore for this year, while the allocation for food processing ministry has been doubled to Rs 1,400 crore for the said period.
Apart from that, the farm credit target has also been bumped up to Rs 11 lakh crore FY2018-19 from Rs 10 lakh crore in FY17-18. Likewise, funds for Pradhan Mantri Fasal Bhima Yojana (PMFBY) has been increased to Rs 13,000 crore from Rs 10,698 crore. That apart, the government announced two separate funds with a corpus of Rs 10,000 crore to create infrastructure in fishery, aquaculture, and animal husbandry sectors, Rs 2,000 crore as agri-market infrastructure fund and Rs 1,290 crore for the national bamboo mission.
Taking into account the large pool of funds showered on the rural and agri sector, a period of inflation awaits citizens.
Global oil prices
Another point that would play a vital role in the MPC’s deliberations is the rising global crude oil prices. It may be noted that increased global oil prices have increased significantly over the past few months – a reason why the central bank may try to maintain status quo. In November, a Nomura report indicated that with every $10 rise per barrel, India’s fiscal balance will worsen by 0.1 percent, in addition to the current account balance by 0.4 percent of the total GDP. The report also said that a country like India would face the full plight of rising prices as it is the third-largest importer of oil in the world.
“Higher oil prices are tantamount to a negative terms-of-trade shock that weakens growth, pushes up inflation and deteriorates the twin deficits (current account deficit and fiscal deficit),” the report said.
The RBI is largely expected to adopt a hawkish outlook later and contain the rates this time in order to provide some stability, however, investors are nervous as it has led to a dip in sentiments on D-street, coupled with the US market tumble.
Radhika Rao, an economist at DBS Bank in Singapore, confirmed to news agency Reuters that the top bank will maintain a neutral stance due to higher fiscal targets, oil prices and higher MSP prices for crops.
It may be noted that RBI has kept rates constant since it cut it by 25 BPS in August last year. However, an increase in rate is inevitable due to increased annual inflation of 5.21 percent in December – higher than the central bank’s medium-term target of 4 percent.
Taking into consideration all the aforementioned points, a rate hike seems inevitable but it remains to be seen whether RBI acts on it now or holds it off to balance norms in future.
Reason for maintaining status quo
CPI likely to be largely inline; but risks emerging on upside
Nascent stage of growth recovery
RBI may retain ‘Neutral’ stance; but hawkish commentary
May acknowledge sustained increase in core inflation
Risk of high crude prices, potential increase in MSPs
Fisc slippage & Slower pace of Fiscal consolidation
Global risks; monetary policy normalization
Comments to watch
Bond markets: How RBI perceives slower Fiscal Consolidation, Fiscal slippage
RBI’s view on potential MSP increases & its possible impact
Allocation for National health protection scheme
Fed rate hikes; Global monetary policy normalization