RBI policy: The good news for Narendra Modi government on economic rebound is fraught with risks

The Reserve Bank of India (RBI) expects better days for the economy this financial year. That’s the dominant tone of the first bi-monthly Monetary Policy Statement, 2018-19 by the Monetary Policy Committee (MPC) announce by the central bank on Thursday. The MPC expects retail inflation to cool down and economic growth pick up if things are on the expected course. To be precise, the MPC expects the CPI (consumer price index) inflation for 2018-19 to hover around 4.7-5.1 percent in first half of this fiscal year and 4.4 percent in second, adjusting the HRA impact for central government employees. Growth, the MPC says, will rebound to 7.4 percent in 2018-19 from its projection of 6.6 percent in 2017-18. These forecasts should come as good news to the Narendra Modi government which badly needs a convincing economic revival before the nation goes to polls in 2019. The economy, in the Modi-era, hasn’t been in the best of shape. It was indeed on the path of recovery when Modi took over in 2014 but lost steam thereafter in subsequent quarters and particularly after the onset of demonetisation in November 2016. The sluggishness in the economy worsened after the flawed roll-out of the Goods and Services Tax (GST), an otherwise landmark reform for an ambitious economy of 1.3 billion people. If indeed the MPC and RBI have their predictions correct, Modi will have the right economic boost at the most needed time in his five–year term, right before the crucial general elections. But, there are serious upside risks to inflation that has been acknowledged by the policy document. [caption id=“attachment_4095761” align=“alignleft” width=“380”] File image of RBI Governor Urjit Patel. AFP.[/caption] To begin with, the inflation picture remains tricky. Many a times in the past, the RBI has gone wrong in its inflation predictions and has faced flak for its inability to foresee the course. This time too, it may not be different. These include the impact of MSPs on inflation. The MPC notes that the revised formula for MSP as announced in the Union Budget 2018-19 for kharif crops may have an impact on inflation, although the exact magnitude will be known only in the coming months. Second, the staggered impact of HRA revisions by various state governments may push headline inflation up. While the statistical impact of the HRA revisions will be looked through, there is a need to watch out for any second round effects. Third, in case there is any further fiscal slippage from the Union Budget estimates for 2018-19 or the medium-term path, it could adversely impact the outlook on inflation. There are also risks to inflation from fiscal slippages at the level of states on account of higher committed revenue expenditure. Fourth, should the monsoon turn deficient temporarily and/or spatially, it may have a significant bearing on food inflation. Fifth, firms polled in the Reserve Bank’s Industrial Outlook Survey expect input and output prices to rise, going forward. Sixth, recent volatility in crude prices has imparted considerable uncertainty to the near-term outlook. If inflation risks materialise and manifests in CPI numbers going ahead, the MPC will be forced to hike interest rates which will slowdown growth. On the growth front, the reasons it suggests for the pick-up are the following: 1) The output gap is closing as reflected in a pick-up in credit off take in recent months. 2) The large mobilisation of resources from the primary capital market should support investment activity further. But, here too there are risks. These are outlined by the policy document: “The deterioration in public finances risks crowding out private financing and investment. Furthermore, even as global growth and trade have been strengthening, rising trade protectionism and financial market volatility could derail the ongoing global recovery. In this unsettling global environment, it is especially important that domestic macroeconomic fundamentals are strengthened, deleveraging of distressed corporates and rebuilding of bank balance sheets persisted with, and the risk-sharing markets deepened.” To sum up, the RBI governor Urjit Patel has indeed brought some good news for economy despite the absence of a rate cut boost and the Modi government can cheer these but this optimistic assessment is fraught with risks.