7th Pay Commission: Will central govt employees HRA force RBI to impose status quo? Here is how it impacts inflation

7th Pay Commission HRA allowance: The Reserve Bank of India (RBI) has been very vocal about 7th CPC and its impact on inflation, which is why, the central bank has increased the target for this economic indicator in past policies. It is 7th CPC, house rent (HRA) allowance that RBI fears will continue to boost inflation. 7th Pay Commission recommendations including HRA allowance for central government employees was approved by Union Cabinet in 2016. While 7th pay commission gave good news to government employees, however, in RBI’s case it does impact inflation and hence central bank has to be very careful about passing on the benefit of a lower repo rate to citizens - in short, cutting repo rate has become tougher. In February 2019 monetary policy,   majority of experts are thinking about a status quo, and one of the reasons behind that may becore inflation, which has risen unexpectedly despite the Consumer Price Index (CPI) or retail inflation touching 18-month low in December 2018. 

Currently, CPI has eased to almost 18-month low at 2.19% for December 2018 month. This was due to deflation in  Pulses and products (- 7.1%) and Vegetables (-16.1%), Sugar and Confectionery (-9.2%) and Eggs (-4.3%). Strangely, core inflation showed an opposite trend, as they increased  to 5.73% in Dec18 due to huge jump in health (9.0%) and education (8.4%) inflation.

Core inflation has been a real spoilsport for RBI in passing on the rate cut benefit. Last year, with core inflation the danger was added from forex and global front as well. Boiling crude oil prices and weak Indian rupee in 2018, forced RBI under the then governor Urjit Patel to hike repo rate on two occasion by almost 50 basis points. With this, policy repo rate now stands at 6.5% at two-year high with calibrated tightening of monetary policy.

In December policy, RBI said, “7th Pay Commission HRA increase has continued to wane along expected lines. The projected inflation path remains unchanged after adjusting for the HRA impact of central government employees as this impact dissipates completely from December 2018 onwards.”

Therefore, RBI kept inflation target at  2.7-3.2 per cent in H2:2018-19 and 3.8-4.2 per cent in H1:2019-20, with risks tilted to the upside.

RBI says, “The staggered impact of HRA revision by State Governments may push up headline inflation. While the MPC will look through the statistical impact of HRA revisions, it will be watchful of any second-round effects on inflation.”

Shilan Shah, Senior India Economist says, "we think that rate cuts this year would be a policy mistake. After all, core inflation on both the consumer and wholesale price measures remains elevated by recent standards."

Shah added, "Hanging over all of this, the major concern will be that monetary policy under Governor Das is being kept loose for the benefit of the government. That will lead to a partial reverse of the success the central bank has had in reining in inflation expectations over the past five years. In turn, that would lead to a permanent rise in actual inflation over the medium term.”