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PM Modi’s Election Budget May Advance Interest Rates Higher

Prime Minister Narendra Modi delivered an election year budget focused on load down rural discontent ahead of crucial elections, spending that could efficient the central bank to raise interest rates in the arriving months.
With less than a week to go before the Reserve Bank of India meets to decide on policy, Finance Minister Arun Jaitley disclosed a budget that opens the taps for barren farmers, guaranteeing higher minimal crop prices and more spending on infrastructure projects in the country’s big rural hinterland.

That may efficient some of the six-member monetary policy committee to turn more hawkish. A Bloomberg survey expects the RBI to hold rates at 6 % through this year, but in the swaps market, investors are pricing in a hike to 6.5 % before the end of 2018.

“Improving advance prospects, rising boom and lingering fiscal slippage risks all point towards tighter monetary policy this year,” said Priyanka Kishore, lead Asia economist at Oxford Economics, Singapore. “We are penciling in two rate hikes.”

Finance Minister Arun Jaitley delivered a pre-election budget aimed at boosting rural incomes but at the cost of a larger-than-expected loss — likely confirming the central bank’s hawkish bias.

PM Modi’s Bharatiya Janata Party faces elections in eight states this year and general elections in the first half of 2019.

“The finance minister fails the economic consolidation test and this failure will have serious consequences,” Congress leader Palaniappan Chidambaram said. Already, sovereign bond yields have spiked to their highest since June 2016, boding ill for the government’s financing plans and interest payments. A sustained rise in profit could also see banks raise lending rates, a move that could choke a nascent recovery in Asia’s third-biggest economy.

Various high-frequency indicators show an economic recovery will collect pace over the next few quarters. That is likely to see a narrowing in the output gap and probably higher rates.

Spending Increment

The government hopes this budget will allay discontent in the countryside, while creating desperately needed jobs.

However the spending increment means the government missed its fiscal deficit target and disappointed investors with a long-term capital gains tax on fairness investments. And while complex initiatives — from boosting aquaculture to health care — may not materialize fast enough to alter electoral sentiment, the budget suggests PM Modi’s government is trying to balance deficit targets while not going all out with election freebies.

“It’s not a budget that’s too populist, it doesn’t look like they’ve thrown caution to the wind,” said Reshmi Khurana of Kroll, a risk consultancy. “I don’t think it’s absolutely going to trickle down to the point where this means he sweeps elections.”

The budget, as expected, focused densely on rural India after a voter backlash in PM Modi’s home state of Gujarat.

The depth of anger across the country was underscored by a new survey suggesting “clear rumblings of discontent” among not just farmers, but traders and shopkeepers who traditionally support the BJP.

“These wide-ranging measures will help to develop rural support for the BJP in upcoming elections,” said Rajiv Biswas, Asia-Pacific chief economist for IHS Markit Ltd., adding the BJP is concerned they might still “require the support of coalition partners to pursue his reform agenda.”

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