RBI governor Urjit Patel warns of fiscal stimulus, says it could push deficit, inflation higher

The Reserve Bank of India (RBI) governor today warned that the government needs to be cautious on fiscal stimulus even as the economic growth slows.

“We should be very cautious lest fiscal action undermine macroeconomic stability,” Patel said at the MPC press conference.

The central bank also cut the real GVA (gross value added) to 6.7 percent for FY18 from the earlier projection of 7.3 percent.

The MPC warned that any economic stimulus along with farm loan waivers could push up the fiscal deficit by 1 percentage points accelerating inflation.

It further said that the combined fiscal deficit to GDP ratio could increase by around 100 basis points in 2017-18.

In the quarter ended June, growth slowed to a three-year low of 5.7 percent. Finance Minister Arun Jaitley said that the government is looking to speed it up.

The government has been mulling a stimulus package of nearly Rs 50,000 crore to revive the muted economic growth in the current financial year.

Referring to a 2005 study, the central bank said, “higher fiscal deficit per se can lead to an increase in inflation expectations and actual inflation".

It explained that there exists a long-running relationship between fiscal deficit 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".

The Reserve Bank has been persistently flagging concerns on fiscal slippages and also on farm loan waivers, which it fears will wreck the credit culture.

In upside risks to its inflation forecast, where the RBI expected price rise to move up to 4.6 percent by the March quarter of 2018 from 3.4 percent in August, the central bank flagged possible fiscal slippages due to farm loan waivers and potential stimulus measures.

The RBI estimated headline inflation to rise to 4.2 percent by the December quarter.