In the last policy review for the year, the RBI is totally focussed on inflation
The Reserve Bank of India recently released its mid-quarter monetary policy review. A review between quarterly announcements is a recent innovation of the central bank and has been prompted by a need to communicate more often with the markets in a structured fashion. The total number of policy statements is now eight — the annual policy statement, half yearly, two quarterly and four mid-quarter reviews — in a year.
Not long ago there were only two policy statements — the annual policy statement and a half-yearly review. The central bank's interface was subsequently enlarged to four with two quarterly reviews added to the policy statement and the half yearly review.
Has the more frequent reviews altered the basic structure of the reviews? Obviously, with more opportunities to communicate the RBI will have less to say each time. The annual statement is bulkier than the others as it covers substantial issues besides the core monetary issues.
It is the forum for the RBI to announce its annual targets — relating to inflation and growth, for instance. Along with the half yearly review and the other two quarterly statements, the annual policy statement is first announced by the RBI Governor at a meeting of banks' heads in Mumbai. The mid-quarterly statements are in the nature of press statements.
The latest mid-quarter review on March 17 is the last of the eight statements for this fiscal. Coming between the Union budget and the next year's annual policy statement (for 2011-12), the review probably has its own significance. In a widely anticipated move, the RBI hiked the short-term policy rates, the repo and the reverse repo rates, by 0.25 percentage point each. The new repo and reverse repo rates are 6.75 per cent and 5.75 per cent, respectively. The total number of policy interest rate hikes including the latest one, is eight. Among the central banks of major developing economies, the RBI has been in the forefront of moves to tighten monetary policies.
The big worry, of course, is inflation. In fact, right through the year, the RBI was focussed on inflation. In January, it appeared that the RBI was prepared to frame its monetary policy taking into account the totality of circumstances and not just on inflation. However, in a short while thereafter inflation has re-emerged as the major concern.
After a slight moderation in January, Wholesale Price Index-based inflation reversed itself in February. There has been a sharp increase in non-food products inflation, which has more than offset the fall in the prices of food articles since January. However, even among food articles, the prices of milk, fish, eggs and meat have remained high suggesting structural demand and supply mismatches. Fuel prices remain high and the prognosis is not good even over the medium-term.
Even more worrying is the fact that non-food manufactured products inflation, an indicator of demand side pressures, rose sharply from 4.8 per cent in January to 6.1 per cent in February, well above its medium-term trend. Inflation has, therefore, become more generalised. No longer can supply side factors be blamed. The rise in non-food manufactured prices is the principal reason behind the RBI's move to hike its WPI inflation target to 8 per cent for March from 7 per cent.
The latest budget plans to bring down the fiscal deficit sharply by compressing expenditure estimates and anticipating buoyant revenue. This should aid the monetary policy's anti-inflation stance. However, the budget may have underestimated certain expenditure items such as subsidies. It may be over optimistic on revenue growth.
The RBI, which had expressed concern over the widening current account deficit (CAD), is less worried now. The CAD is expected to be at a lower than expected level of 2.5 per cent of the GDP. However, concerns over the means of financing the CAD remain. It is necessary to take measures to attract these capital flows such as foreign direct investment, which are more stable. The dependence on short-term, volatile, portfolio flows should be reduced.
The CSO's estimate of 8.6 per cent growth for the current fiscal is in line with the RBI projections. Agricultural production is likely to be sustained at a high level. The Index of Industrial Production (IIP) remains volatile while other indicators such as direct and indirect tax collections, merchandise export growth and bank credit expansion suggest that the growth momentum persists. However, there is continuing uncertainty over energy and commodity prices. This may vitiate the investment climate and threaten the current growth trajectory.
The global economy presents a mixed picture. Growth in emerging economies remains strong while that in the U.S. and the Euro area is gathering momentum. However, the unrest in the Arab world and the consequent uncertainty over oil supplies has cast doubts over the recovery process. Since commodity and food prices remain at elevated levels, there are apprehensions over inflation returning to those economies. Headline inflation has, in fact, risen noticeably in a number of advanced economies, especially in the Euro area and the U.K.
Finally, it may be early days to assess the macroeconomic consequences of the natural disaster in Japan. According to the RBI, expenditure on reconstruction may give a boost to the economy. However, if thermal power is going to replace nuclear power in Japan, there will be a further upward pressure on global petroleum prices.