Monetary Policy: Has RBI Governor Shaktikanta Das erred in trusting govt's fiscal deficit promise

The expectations on easing of interest rates have receded dramatically in the last couple of months. The last bi-monthly monetary policy 2019/20 of the Reserve Bank of India (RBI) is expected to keep the repo rate unchanged at 5.15 per cent in view of the rising retail inflation. But the key to watch would be RBI's assessment or commentary on inflation outlook, GDP projection and fiscal deficit. In the last three years, the central bank's track record in forecasting all the three key variables hasn't been encouraging.

Inflation outlook still hazy

The recent retail inflation rate has surprised everyone as the consumer price index (CPI), which the RBI tracks, has touched a high of 7.35 per cent in December compared to 5.54 per cent in November last year. The upper band in the 4 per cent inflation targeting is at 6 per cent. The sharp rise in food inflation has resulted in inflation overshooting the target. The RBI had time to time revised inflation projections in the last one year. In the December policy, RBI had revised the projection upwards to 5.1 -4.7 per cent in the first half of 2019/20 and 4-3.8 per cent for the first half (April-Sept) of 2020/21. In the December policy, RBI had also said that in the judgement of six members monetary policy committee, inflation is rising in the near future, but is likely to moderate below target by second quarter (July -Sept) of 2020/21.

Also Read: Why RBI's MPC decided to halt easing of repo rate

More clarity needed on GDP bottoming out

The RBI had earlier revised the GDP estimate of 2019/20 downward from 6.1 per cent in October policy to 5 per cent in the December policy. The GDP could even go down below 5 per cent as the fourth quarter numbers are still not out. The Economic survey released recently has pegged GDP at between 6-6.5 per cent in 2020/21, while the Union Budget 2020/21 talks about a nominal GDP of 10 per cent. If one takes the Economic Survey's real GDP number, inflation based on 10 per cent nominal GDP projection as per Union Budget 2020/21 comes out to be 4-4.5 per cent. If inflation projection remains at 4-4.5 per cent for the year, it would be very difficult for RBI to ease interest rates in the near future.

Fiscal deficit slippages

The targeted fiscal deficit for 2019/20 was at 3.3 per cent of the GDP whereas the actual number is 3.8 per cent as per the revised estimates. It could even slip further once the last quarter figures are out. In the past, the RBI seems to have too much trust in the government's assurances of keeping it at the targeted level as stated in Budget 2019/20. The RBI Governor had often said that he has no reason to doubt the commitment of the government to maintain the fiscal deficit numbers at 3.2 per cent. In fact, the Governor had gone a step ahead to state that the government has several sources of revenues to meet the shortfall (if any, from corporate tax reduction) or making it through other sources. The next year's budget has given a new target of 3.5 per cent. Should RBI again trust the government's promise of meeting the new target in 2020/21?

Also Read: RBI may put rate cuts on hold after spike in retail inflation