Reserve Bank of India's first interest rate hike since Prime Minister Narendra Modi came to power, came at the worst time possible as the government finds itself busy dealing with spending constraints, voter discontent in rural areas and rising oil prices. The first in more than four years, the rate increase is likely to be followed by one or two more this year, as predicted by economists. They said 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 gross domestic product.
“This could be the worst year for us, as budget calculations are under stress,” a senior finance ministry official said. They added there was a worry of at least one 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.” Setbacks to flagship reforms have already threatened the government's spending plans. An estimated $1.2 billion to $1.5 billion Air India privatisation plan flopped when the stake it was selling in the flag carrier failed to attract a single bid by last week's deadline, putting at risk its Rs 800 billion rupees divestment target.
The RBI raised its key repo rate last week by 25 basis points to 6.25 per cent, the first change since a cut of the same size in August last year, as higher oil prices, a sharp fall in the rupee and potential stronger consumer spending threatened to spur inflation beyond its 4 per cent medium term target. Soumya Kanti Ghosh, chief economist at State Bank of India, said, “The rate hike will push up the government's interest financing cost and add to the fiscal deficit pressure on one hand. And on the other hand, the nascent recovery in growth on the back of consumption demand will also slow down as retail lending rates will go up sooner than later.”