RBI rate hike likely to upset Modi’s plan

Mumbai/ New Delhi: The RBI’s first interest rate rise since Prime Minister Narendra Modi came to power could not have come at a worse time for a government grappling with spending constraints, voter discontent in the rural heartlands and rising oil prices.

The rate increase, the first in more than four years, is likely to be followed by one or two more this year, economists predict, pushing up overall borrowing costs for the government and companies alike.

Higher interest rates are likely to make it tougher for the government to borrow from the market and hurt a recent pick- up in the economy, while dampening revenue collection and burning a bigger hole in the government’s fiscal deficit than the budgeted target of 3.3 per cent of GDP.

For Modi that represents a double whammy, as he looks to step up spending to woo disgruntled voters ahead of a general election next year without spooking skittish foreign investors. The fiscal maths are getting challenging on rising fuel prices, a weakening rupee and subdued investments.

“This could be the worst year for us, as budget calculations are under stress,” a senior finance ministry official, who declined to be named, told Reuters, adding there was a worry of at least one more rate hike by December.

“The rising crude oil prices are already giving sleepless nights as the government may have to cut tax on fuel products sooner rather than later,” the official added.

India’s economy grew at 7.7 per cent in the first three months of the year, the fastest pace in nearly two years. That would be an impressive clip for most countries, but more is needed to create enough new jobs for the 1 million young people entering the country’s workforce each month.

The spending plans have already been threatened by setbacks to flagship reforms.