Fiscal deficit slippage least of RBI MPC's concerns

This is what is coming out after reading the minutes of the monetary policy committee (MPC) meeting that decided a 25 basis point cut in repo rate to 5.15 per cent in early October. This meeting took place after the GDP growth numbers fell to 5 per cent in the first quarter of 2019-20. Then corporate tax cuts meant a revenue loss of Rs 1.45 lakh crore. GST collections are also not on expected lines.

All this has put a question mark on the targeted fiscal deficit of 3.3 per cent of GDP in 2019-20. But the six member MPC seems to be not very worried except Chetan Ghate, Professor, Indian Statistical Institute. 'We need a more informed discussion of fiscal policy in India," he said while adding he finds it premature, without a proper 'dynamic scoring' analysis, to speculate on the impact of the tax cut on fiscal deficit."

"Overall, the tax cut leads to a decline in fiscal deficit in the long run, although the size of this effect is negligible. The lowering impact on the fiscal deficit however depends on a very strong investment effect from tax cuts, which may not happen in the current economic climate," said Ghate.

Ravindra Dholakia, another external MPC member and a former professor of IIM (A) says concerns of likely slippages of the combined deficit during the year are misplaced. "The overall impact of all current announcements on the combined fiscal deficit is likely to be hardly 10 to 20 basis points assuming GST revenues are as per budgeted target," said Dholakia.

RBI Governor Shaktikanta Das did make a mention that there is need to be watchful of the fiscal situation. He, however, said that the government has indicated that it would maintain the fiscal deficit at the targeted level.

Is RBI making an error of judgment in believing the Government's budgeted 3.3 per cent fiscal deficit number for 2019-20? Clearly, the corporate tax rate creates a big hole in budget numbers, which will require new sources like an interim dividend from RBI or increasing disinvestment target from Rs 1 lakh crore to a higher target. Similarly, there can be drastic cut in expenditure too to meet the targeted fiscal deficit numbers.

There is another surprise for MPC on inflation. The consumer price index (CPI) has moved up sharply by 71 basis points to close to 4 per cent in September on the back of higher food prices. The RBI's medium term target is to maintain the inflation below 4 per cent with plus and minus of 2 per cent tolerance. In June 2016, RBI was mandated by the government to target a medium term inflation target of 4 per cent with a band of +/- 2 per cent for a 5 year period up to March 2021. The powers of the RBI Governor to fix the interest rates were also shifted to a six member MPC with the casting vote with Governor.

The benign inflation all through the last 12 months has encouraged the RBI to reduce the repo rate by 135 basis points to 5.15 per cent. If the inflation continues to rise, the six member MPC, which is scheduled to meet in the first week of December, will now be cautious.

The RBI does its own calculation to predict the inflation. It has projected a CPI inflation of 3.5 to 3.7 per cent in the second half of 2019-20. The September print of 3.99 per cent is much higher than their projection. If it remains at that elevated level, the RBI will have to revise its inflation estimates. The projection for first quarter of 2020-21 is 3.6 per cent.

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