The Reserve Bank of India (RBI) has long been troubled by food inflation, but the elections have given the RBI another reason to postpone rate cuts for the time being: a possibly altered fiscal picture driven by populist expenditure.
The BJP-led National Democratic Alliance was expected to win a sizable majority, according to exit polls conducted last week.
Due to this, there was a great deal of conjecture in the bond markets that the Center, which had got a record-high surplus dividend from the RBI, would utilize the additional money to drastically cut the budget deficit. On the other hand, the outcomes show a different picture.
"While political stability should help ensure continuity in policy agenda, we see risk of populist bias in the third term targeted towards lower income strata and change in economic policy dynamics with tougher reforms getting pushed further out," said Tanvee Gupta Jain, UBS Securities economist "In the upcoming budget (in July), our base case is for the government to stick to a medium-term fiscal consolidation roadmap but with a populist bias."
The possibility of the Center making significant progress toward fiscal consolidation and reducing its borrowing would have given the central bank plenty of confidence on aggregate demand conditions in the economy, even though markets did not anticipate a rate decrease at the RBI's next policy announcement on June 7.
Remarkably, traders' assessment of the possible inflationary effect of increased public spending on Tuesday pointed to extremely low prospects of rate decreases in 2024 in India's overnight indexed swap market.
"The BJP will adjust its policies in accordance with its reliance on regional allies such as Telugu Desam and Janata Dal (Secular)." Second, the BJP and its partners would want more to boost economic spending," stated Madhavi Arora, head economist at Emkay Global Financial Services.
The government's only hope is the significant fiscal leeway created by the RBI's transfer of Rs 2.1 lakh crore to the government as surplus, which is more than double the amount that was planned for dividends from PSU institutions and the central bank.
The RBI's excess transfer permits the government to increase expenditure without seriously upsetting the fiscal applecart, should the government really need to spend more to increase consumption in the economy—a situation that may become more important now, ahead of state government elections.
"The extra ₹1 lakh crore that the government now has may be used to many uses. The administration doesn't seem to be facing any significant challenges, according to Bank of Baroda chief economist Madan Sabnavis.
"Let's assume that there were no constraints at all, the government could have probably targeted a 4.9% fiscal deficit this year instead of 5.1%, but I don't think there is a rush to do it right now because we are following the prudential path of gradually going back to 4.5%."
