Time to budget some tough love from RBI

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The Reserve Bank of India (RBI) should be extremely worried by the Union budget of 2018-19.

A promise to ensure minimum support price of key crops at 1.5 times that of cost of production would mean at least a 50-70-basis-points increase in the headline inflation number, reckon analysts.

Recall that retail inflation has already hit a 17-month high of 5.21% in December.

The government has freed itself from the oath of frugality and pegged the fiscal deficit at 3.3% of gross domestic product (GDP) for 2018-19 against the earlier indicated 3%.

Moreover, there is little confidence that the government will be able to keep the deficit even within the budgeted number. Input prices are on the rise and global crude oil prices have also continued to climb since the last monetary policy committee (MPC) meet.

This is the perfect concoction for policy rates to go up, but MPC is unlikely to vote for a rate hike immediately.

A hike in policy rates swiftly after the budget would send an alarm signal, which the central bank wouldn’t want. Also, the budget will be viewed in its entirety and not for the deficit only. RBI is likely to take succour from the fact that compared with the current fiscal, the government’s budgeted expenditure for the next year hasn’t shot up. Of course, the mammoth health protection scheme to cover 500 million citizens has not been budgeted at all. Even so, the revenue benefit from long-term capital gains tax and the uncertainty over goods and services tax collections will prompt RBI to hold back from hiking rates immediately.

What RBI will do is set the stage with some tough talk in its statement. If the central bank sounded cautious in December, it would sound downright hawkish this time around. After all, at stake is its credibility again since RBI is now by law required to keep inflation within the 2-6% band. The distance to 6% is narrowing every month. The budget just upped the ante on inflation and RBI will respond in kind.livemint