The fiscal sops announced in the Interim Budget on Friday may dent the prospects of a rate cut by the Reserve Bank of India at its upcoming policy review this week as it increases the potential upside risk to inflation on account of fiscal slippages, according to financial analysts.
As the measures aimed at wooing farmers, the middle class and the unorganised sector are seen likely to stock inflationary pressures, analysts believe that the Budget will delay fiscal consolidation for a while — especially when projections on revenues are seen as being aggressive.
The government has budgeted for a marginal increase in the fiscal deficit for FY19 at 3.4 per cent, compared to the earlier 3.3 per cent, making it the second time that the target has been breached during its term. A higher market borrowing, besides making the RBI’s job difficult, will result in a higher bond yield in FY20, putting upward pressure on interest rates.
Full Budget could give additional guidance to RBI
The impact of populist measures announced in the Interim Budget on the fiscal situation is likely to be felt on the Reserve Bank of India’s monetary policy. The RBI is likely to wait till the post-election budget in June or July, which should provide additional guidance on the medium term outlook and the possibility of a rate cut. The stance of global central banks in the context of slowing growth and the trajectory of oil prices could also weigh on any decision of the RBI. However, the central bank is likely to change its stance from ‘calibrated tightening’ to ‘neutral’.
Although the RBI could change its monetary stance to neutral from calibrated tightening in its February 7 policy review, the dynamics of a rate cut will become a difficult exercise more so under the evolving global situation, India Ratings said in a report. For FY20, the gross borrowing is pegged at Rs 7.09 lakh crore, compared to Rs 5.7 lakh crore (revised estimate) for FY19. The proposed market borrowing is much higher than the market expected, and the bond market reacted adversely to this news.
“We believe the RBI to be cognizant of the risk to inflation from fiscal slippage, and we continue to expect it to keep rates on hold in the upcoming policy review on February 7. That said, we expect a change in its policy stance from ‘calibrated tightening’ to ‘neutral’,” said Gautam Chhaochharia, analyst, and Tanvee Gupta Jain, economist, UBS Securities India.
The Reserve Bank is likely to wait till the post-election budget in June or July, which should provide additional guidance on the medium term outlook and the possibility of a rate cut, said an analyst. What could also weigh on any decision of the RBI is the stance of global central banks — in the context of slowing growth and the trajectory of oil prices.
Bond yields are likely to remain at elevated levels as market borrowing numbers for both the current fiscal and next fiscal are higher than market assumptions. “The RBI and the MPC (Monetary Policy Committee) may view the fiscal compromise, aggressive assumptions and the potential inflationary nature of the Budget and leave interest rates unchanged,” said Arvind Chari, head, Fixed Income & Alternatives, Quantum Advisors.
According to Tata Mutual Fund senior fund manager Akhil Mittal, the revenue targets, especially on GST collections and disinvestment for FY20 looks quiet stretched and optimistic. “As far as RBI is concerned, we believe the Budget pushes back possibility of rate cut in near future and expect the RBI to highlight potential upside risk to inflation on account of slip in fiscal,” he said. Fiscal deficit is pegged at 3.4 per cent for FY20, a little higher than market expectations. Post these announcements, gilt prices have fallen and yields have risen.
“We expect mood to remain a bit subdued and focus to shift to the monetary policy review on February 7 where we expect the RBI to maintain status quo on rates and shift stance from ‘calibrated tightening’ to ‘neutral’. We remain cautious and have reduced duration in our debt funds in run up to the budget,” said Bekxy Kuriakose, head, Fixed Income, Principal Mutual Fund.
Gross borrowing in FY20 is budgeted to grow 33.1 per cent (FY19: compression of 9.3 per cent). However, net market borrowing is budgeted to grow at 11.9 per cent in FY20 (FY19: compression of 6.2 per cent). On December 5, 2018, the central bank, in its bi-monthly monetary policy, cut its inflation projection to 2.7-3.2 per cent by March 2018 from its earlier view of 3.9-4.5 per cent.
However, it also forecast inflation picking up again to 3.8-4.2 per cent in the first half of fiscal 2019-20, with risks tilted to the upside.
In his last monetary policy, former Governor Urjit Patel kept the Repo rate — the rate at which RBI lends funds — steady at 6.50 per cent and decided to maintain the stance of calibrated tightening. The central bank also slashed the statutory liquidity ratio — mandatory investment in government bonds — by 150 basis points to 18 per cent of total deposits over the next six quarters starting from January 2019.
However, the RBI retained the GDP growth to 7.4 per cent for the year 2018-19. “If the upside risks we have flagged do not materialise or are muted in their impact as reflected in incoming data, there is a possibility of space opening up for commensurate policy actions by the MPC,” Patel had said, while hinting that conditions are gradually changing and they await more robust inflation signals and data points to consider any change in the policy.