Notwithstanding the thaw in retail inflation, the Reserve Bank of India (RBI) is likely to keep the policy repo rate unchanged due to concerns on fiscal slippage emerging in FY19, in the wake of expenditure proposals outlined in the interim Budget. However, the Central bank may change its monetary policy stance from ‘calibrated tightening’ to ‘neutral’.

Neutral stance

While the retail inflation, as measured by the Consumer Price Index (CPI), has been continuously ruling below the official 4 per cent inflation target for the last five months, possibly allowing elbow room to change the policy stance and a rate cut, the upward revision in the fiscal deficit target for FY19 may now allow only a change in the policy stance to neutral.

In December 2018, retail inflation dipped to an 18-month low of 2.19 per cent. The interim Budget, presented by Finance Minister Piyush Goyal on February 1, has revised the fiscal deficit for FY19 from 3.3 per cent of GDP to 3.4 per cent, triggering fears of higher government borrowing and upward pressure on interest rates.

The fiscal deficit for FY20 has been pegged at 3.4 per cent of GDP in the interim Budget against 3.1 per cent projected under the Fiscal Responsibility and Budget Management (FRBM) Act. The RBI, according to market experts, may wait till the full Budget is presented in July to get a sense of possible revisions in revenue and expenditure projections before taking a call on interest rates.

“We believe the RBI to be cognizant of the risk to inflation from fiscal slippage, and we expect it to keep rates on hold in the upcoming policy review on February 7. We expect a change in its policy stance from ‘calibrated tightening’ to ‘neutral’,” said Gautam Chhaochharia, Analyst, and Tanvee Gupta Jain, Economist, UBS.

In the current financial year so far, the central has upped the policy repo rate twice by 25 basis points each — from 6 per cent to 6.25 per cent in the June monetary policy review and from 6.25 per cent to 6.50 per cent in August. It changed the monetary policy stance from ‘neutral’ to ‘calibrated tightening’ in the October policy.

Radhika Rao, Economist, DBS Group Research, said that the RBI may factor in the modest fiscal slippage at its February 7 review. Nonetheless, with the broader fiscal targets not deviating sharply from the consolidation path, she expects RBI to prioritise its price stability mandate.

She added, “Inflation has been downbeat this year; CPI inflation fell from 4.9 per cent year-on-year in April-May 2018 to 2.2 per cent in December, mainly due to disinflation in the food segment. The trend is likely to be benign at 2-3 per cent in the coming months, opening the door for the RBI to shift from ‘calibrated tightening’ to a ‘neutral’ stance at next RBI review.

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