At the same time, the central bank remained confident of meeting its March 2017 retail inflation target of 5 percent. "Assuming that the government implements the 7th Pay commission recommendations by the second quarter of 2016-17, CPI inflation could be, on average, 100-150 bps higher than the baseline in 2016-17. Its impact is expected to persist up to 24 months," Governor Raghuram Rajan said in the a report released along with the monetary policy document.     

The report, however, noted that the pay hike will boost GDP by around 40 bps during the current fiscal.

The pay hike impact will also jack up food prices, the report said, adding that "food prices could consequently increase, leading to inflation rising above the baseline by 80-100 bps in 2016-17, even assuming effective government policies relating to food stocks, procurement and minimum support prices".

On achieving the inflation target (6 per cent in January this year), the Governor said inflation has evolved along the projected trajectory and the January 2016 target was met with a marginal undershoot.

"Going forward, CPI inflation is expected to decelerate modestly and remain around 5 per cent in FY17 with small inter-quarter variations," he said, but warned that there are uncertainties surrounding this inflation path emanating from recent unseasonal rains, the likely spatial and temporal distribution of monsoons, the low reservoir levels by historical averages, and the strength of the recent upturn in commodity prices, especially oil.

Also read: RBI monetary policy review: Raghuram Rajan cuts key rate by 0.25 percent

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