RBI unlikely to cut rates on fiscal deficit, inflation worries

Reserve Bank of India (RBI) Governor Raghuram Rajan, who will review monetary policy on Tuesday for the second time after the new government under Prime Minister Narendra Modi took charge, has another bad news in store that leaves little room for him to cut interest rates.

The most recent worrying news is about the fiscal deficit. The government has targeted a very ambitious fiscal deficit target of 4.1 per cent of gross domestic product by March 2015. This translates to Rs 5,31,000 crore. But in the first quarter (April-June) of 2014/15, the deficit has already reached Rs 2,97,800 crore. This is 56 per cent of the budget estimates.

While Rajan should take into account the new government's intention to cut wasteful expenditure, it is anybody's guess where the deficit would stop in the next nine months of the current fiscal year.

A higher fiscal deficit is expected to add to inflationary pressure.

There is also no respite from high food inflation, which has a 50 per cent weight in consumer price inflation (CPI). In the last fortnight, tomato and chilly prices zoomed to more than Rs 100 a kg in the retail market. With monsoon rainfall still likely to be below average, food inflation is likely to remain firm.

The recently released CPI figure for June is at 7.31 per cent. Though it was lower than the previous month, there is no clear long-term trend yet. The RBI has targeted CPI inflation at 8 per cent by January 2015 and 6 per cent by January 2016.

In the currency markets, the rupee has been stable around 60 to a US dollar for the past few months. But the danger of imported inflation by way of higher crude oil prices lingers on because of recent geopolitical tensions.

Considering that no longer-term trend is visible, the RBI is widely expected to maintain status quo on interest rates. The repo rate, the RBI's main lending rate, is currently at 8.0 per cent.