Reserve Bank of India’s monetary policy committee on Wednesday voted to increase the central bank’s policy rate by 0.25%, the second straight increase. The tone of the monetary policy statement, however, suggests that RBI is not really perturbed by the trajectory inflation will follow over the next few months. The statement increased its inflation forecast for the second half of 2018-19 to 4.8% from 4.7% it forecast in June. GDP forecast for 2018-19 was retained at 7.4%, with quite a few indicators showing that the economy has bounced back from last year’s slowdown.
Looking ahead, the policy statement highlights risk factors to inflation. Crude oil price, hovering around $75 a barrel, remains under the influence of geopolitical events. Another risk factor which has gained prominence in recent weeks is the escalation in the trade battle between US and China. These factors have led to uncertainty in financial markets which influences India’s inflation trajectory. There is little that either RBI or government can do about external risks. Therefore, the appropriate approach at this stage is to ensure that domestic policy developments do not enhance economic risks.
The most potent domestic risk is fiscal slippage in an election year. In the recent past, state government finances have in general deteriorated. Responding to an agrarian crisis, states have implemented farm loan waivers. Separately, NDA government has announced a marked increase in support prices for the kharif season. RBI has hedged its assessment of the impact this development will have on inflation. But the larger point is that it’s important that NDA sticks to budget targets for deficits. Given the uncertainty stemming from external sources, the best way to insulate the economy is to hold the line on fiscal targets.