Interim Budget reduces RBI rate cut possibility in February, say economists

High expenditure, fiscal deficit slippage point to inflationary tendencies

Chances of a rate cut in the Reserve Bank of India’s (RBI’s) February monetary policy are almost ruled out because the Budget is inflationary in nature, say economists.

Though a section in the market still expects a rate cut in February, the rise in bond yields after the Budget points to a different direction. 

Yields rise, or prices of bonds fall, on oversupply of bonds and on expectations of hardening interest rates. 

The government once again missed the fiscal deficit target, registering a deficit of 3.4 per cent of gross domestic product (GDP) from the 3.3 per cent projection.

For the next year also, the deficit is projected at 3.4 per cent, deviating from the path to bringing down the deficit to 3 per cent of GDP. 

“The government pursued expansionary fiscal policy, seemingly prioritising populism over prudence,” noted UBS in a report. “We expect the RBI to be cognizant of the risk to inflation from fiscal slippages,” the brokerage said, adding a change in stance from “calibrated tightening” to “neutral” is possible, but a rate cut is not.

After the Budget, economists are certain the central bank cannot go for a rate cut because of inflation possibilities as well as due to the upturn in oil prices.

“The consumption push and growth stimulus will be positive for growth, but limits the scope for an aggressive monetary easing cycle,” said DBS Bank in a report.

The Budget announced sops for the rural and agricultural sectors, and offered tax benefits for the middle class, while retaining a broader social push. “With the broader fiscal targets not deviating sharply from the consolidation path, we expect the RBI to priortise its price stability mandate,” said DBS economist Radhika Rao.

She expects policy rates to remain in pause mode for the rest of 2019, because the pro-consumer Budget poses a lagged risk of stoking inflation.

The consumer price indexed inflation rate fell from 4.9 per cent in April-May 2018 to 2.2 per cent in December, mainly due to disinflation in the food segment. The price trend is likely to remain benign in the coming months, trending at 2-3 per cent. But that is not enough to initiate a rate cut.

Crude oil prices also exhibit volatility. While the Brent crude oil is now trading at around $62 a barrel, down from $84 a barrel in September, oil prices have remained a great uncertainty for the government and the RBI. 

However, the RBI risks losing its credibility if it moves to cut rates so soon after adopting a calibrated tightening stance just two policies away, said a senior economist with a bank.

“A rate cut at this point would be meaningless. Rather, the RBI may try to bring down high rates in the corporate bond market and narrow the spreads over government securities,” the economist said.

However, Kumar Sharadindu, managing director and chief executive officer of SBI Pension Funds, expects a rate cut in February, considering that the inflation rate has been lower than the RBI’s projections for a long time. Bank of America Merrill Lynch’s head of treasury Jayesh Mehta expects a rate cut this month.