Though RBI monetary policy review retained its FY16 GDP forecast at 7.4% and Jan-March 2016 inflation at 5.8% – with a mild downside risk to both – it has done well to not cut rates after the 50bps of front-loading in September. It is true CPI inflation rose to 5% in October from 3.7% just two months prior to that, but that was more related to the base effect since CPI had dropped a lot in the same period last year – more realistic CPI numbers will emerge after December. Given the continued global deflationary pressure, under normal circumstances, RBI should have been able to meet its 2017 targets as well. That is why Citi economists are holding on to their view that another 25-50bps of cuts will be seen in 2016, with 25bps coming right after the budget. This is something RBI has also hinted at when, in its review, it said “the Reserve Bank will use the space for further accommodation, when available, while keeping the economy anchored to the projected disinflation path … to 5 per cent by March 2017”.
There are, however, too many wild cards for RBI to be sanguine. For one, as RBI itself says, the rabi sowing data along with the poor reservoir situation means the government’s food management will have to be very good. While the past suggests this may well happen, the Seventh Pay Commission (SPC) will be a lot trickier. The RBI is optimistic about how this will be handled – the direct impact on aggregate demand, RBI says, “is likely to be offset by appropriate budgetary tightening as the Government stays on the fiscal consolidation path”. If that is indeed true – which is why it is important to wait for the Budget – that is good news, though it would have its implications for the consumption-led growth most are banking upon. The SPC impact, it is true, will be lower than the previous one since there will be less arrears, but it has to be kept in mind that government emoluments rose from 2% of GDP in FY08 to 2.9% in FY10 (due to the staggered, but large, arrears) and finally settled at 2.5% of GDP after a few years. Apart from the salaries, it is the pension impact – especially the one-rank-one-pension type of recommendation – that is the most worrying. As SPC points out, the department of posts has 4.6 lakh employees according to one official source, 2.1 lakh according to another while SPC itself puts the number at 1.9 lakh – imagine what this will do to the pension bill. There is, also, the impact on teachers and PSUs that will follow the SPC award and, in a year or two, the states will also follow. Worse, unlike the case in FY16 where falling oil prices allowed the government to net 0.3% of GDP by way of additional taxes, FY17 is unlikely to afford such easy solutions. Waiting for the budget will give RBI clearer signals.