The consumer price index (CPI)-based inflation has been on a roller-coaster ride over the last few months. The retail inflation has covered quite a lot distance in a short period of time. From 3.15 per cent in July, it moved to 3.28 per cent in August. A month later, it jumped to 3.99 per cent in September. The October figure is shocking. The CPI has pole-vaulted to 4.62 per cent, the highest in 16 months, on the back of higher food prices.
The sharp rise in CPI is scary for borrowers both individual and corporate as the Reserve Bank of India (RBI) targets retail inflation to fix the short-term repo rate. The repo rate is the rate at which banks borrow short-term fund from the central bank. The current repo rate is 5.15 per cent.
What is worrying is that the retail inflation has crossed the RBI's targeted level of 4 per cent. The benign inflation over the last one year had created right conditions for the monetary policy committee (MPC) to soften interest rates and support growth, which has been losing momentum. The repo rate has already been reduced by 135 basis points to 5.15 per cent since January this year.
The CPI was 1.97 per cent in January and remained below 3 per cent until May this year.
The market was earlier expecting another 50-100 basis points cut in the repo rate because of expected lower inflation. This was based on the RBI's projected CPI inflation of 3.5 to 3.7 per cent in the second half of 2019-20. The current inflation trajectory completely changes the calculations. There are now expectations that the CPI will settle in the range of 4-4.5 per cent in the second half of the year. This new inflation trajectory will force the MPC to press the pause button on any easing of interest rates.
The six-member MPC is expected to meet on December 5 to take a call on interest rates. By that time, the second quarter GDP (gross domestic product) numbers will be out. The SBI Research has pegged the second quarter GDP at 4.2 per cent. While a lower GDP makes the case for the RBI to support the growth, there is a also a danger of fiscal slippages.
The recent corporate tax cuts of Rs 1.40 lakh crore creates a huge hole in budget numbers. It remains to be seen how the government bridges such a big number. The GST (goods and services tax) collections are also not on the expected lines. There is some headway in non-tax revenues, especially disinvestment, where the government has targeted Rs 1 lakh crore, but all depend on the actual fund mobilisation. The government is also banking on RBI for interim dividend. The only additional item is Rs 58,000 crore that has come from the RBI as surplus capital.
The public sector borrowings have also reached 6-8 per cent of the GDP. This was earlier pointed out by the former RBI Deputy Governor Viral Acharya in one of the MPC meetings before he quit the central bank. Although the RBI Governor Shaktikanta Das recently said that he believes the government would adhere to fiscal deficit numbers of 3.4 per cent of GDP in 2019-20, the slowdown in the economy and recent corporate tax cuts has created new worries on the fiscal deficit front. There is a likelihood of fiscal deficit slipping to 4 per cent.
In June 2016, the RBI was mandated by the government to target a medium-term inflation of 4 per cent with a band of +/- 2 per cent for a five-year period up to March 2021. The power of the RBI Governor to fix interest rates was also shifted to a six-member MPC with the casting vote with the Governor.