Cutting its growth estimate for the current fiscal, the RBI on Wednesday warned that any economic stimulus and farm debt waivers could push up fiscal deficit by 1 percentage point, potentially stoking inflation.
Such measure could lead to inflation surging by 0.50 per cent, the Reserve Bank of India (RBI) said in the Monetary Policy Report released along with the fourth bi-monthly monetary policy statement for 2017-18 on Wednesday.
"Real GVA (gross value added) growth is projected at 6.7 per cent for 2017-18 -- 6.4 per cent in Q2, 7.1 per cent in Q3 and 7.7 per cent in Q4 -- with risks evenly balanced around this baseline path," it said.
The RBI, in August, had pegged growth at 7.3 per cent for 2017-18 on a GVA basis.
With the government mulling a stimulus package to revive the sagging growth, the RBI cautioned that a 0.50 per cent slippage in the Centre's fiscal deficit alone can increase inflation by 0.25 per cent.
"... the combined (Centre plus states) fiscal deficit to GDP ratio may increase by around 100 bps in 2017-18," it said.
Referring to a 2005 study, the central bank said, "higher fiscal deficits per se can lead to an increase in inflation expectations and actual inflation".
It explained that there exists a long-running relationship between fiscal deficits and inflation in India.
Empirical estimates, according to the RBI, suggest "that an increase in fiscal deficit to GDP ratio by 100 bps could lead to a permanent increase of about 50 bps in inflation".
Under pressure because of a slowing growth, which slipped to a three-year low of 5.7 per cent in April-June, the government is weighing steps for economic revival, which may include a stimulus package of up to Rs 40,000 crore, according to news reports.
In upside risks to its inflation forecast, where the RBI expected price rise to move up to 4.6 per cent by the March quarter of 2018 from 3.4 per cent in August, the central bank flagged possible fiscal slippages due to farm loan waivers and potential stimulus measures.
Other upside risks to its estimate include the expected increases in salaries and allowances by state governments and short-term uncertainty because of GST.
The RBI estimated headline inflation to rise to 4.2 per cent by the December quarter.
Professional forecasters expect inflation to rise to 4.5 per cent by the March quarter, it said.