Interest rate setting to get complicated in the next one year

MUMBAI: Interest rate setting in the next one year will be complicated for the incoming Monetary Policy Committee as it would be struggle to factor in the implications of the implementation of the 7th Pay Commission’s recommendations which would distort prices, the Reserve Bank of India said in its annual report.

While prices may ease towards the end of the fiscal year, there is no `discernible’ trend at this juncture to conclude that manufacturing activity could turn around any time soon, it said.

``The impact of the pay commission is expected to peak by September 2017,’’ the RBI said in its annual report for 2015-16. ``Separating statistical effects from those that impart a durable upside to inflation will complicate the setting of monetary policy going forward, especially in the management of inflation expectations.’’

The central bank which will move to an interest rate setting by a Monetary Policy Committee of six members including the Governor, is for the first time admitting that forecasting inflation could be complicated. Consumer Price Index for July rose the highest in nearly two years. Although it was fuelled by food,
the impact of consumer demand is difficult to assess.

Governor Raghuram Rajan in his last monetary policy review left interest rates unchanged and said that inflation remains a worry. CPI rose to xxx in July, compared with a target of 5% by March 2017, and 4% a year after. The law mandates the RBI to keep inflation at 4% in a band of 2 per centage point on either side.

``Headline inflation is expected to trend towards the target of 5 per cent by the last quarter of the year, although at the current juncture, upside risks are prominent,’’ it said in the report. ``If the current softness in crude prices proves to be transient and as th output gap continues to close, inflation excluding food and fuel may likely trend upwards and counterbalance the benefit of the expected easing of food inflation.’’

RBI lauded the government for its fiscal commitment and said the passage of the Goods and Services Tax Constitution amendment bill by the Parliament would improve productivity and dawns a new era in co-operative federalism. But the GST rate will determine its impact on inflation.

``The impact of GST on CPI inflation would largely depend on the rate that would be decided by the GST council; however the impact is likely to be low, with around 54 per cent of the CPI basked exempt from the GST.’’

The central bank which has been in the habit of questioning the fiscal numbers thrown by the government, said the commitment was commendable.

``The central government achieved the budgetary targets set for 2015-16 through a revenue effort in contrast to preceding years when curtailment of expenditure, often across-the-board rather than targeted, was the main instrument of consolidation.’’