In its recent review of monetary policy, the Reserve Bank of India has listed high inflation as its foremost concern. Even as food price inflation and, more generally, consumer price inflation are showing some moderation, they are still in double digits. Non-food inflation is on the rise and demand side pressures are clearly evident.
Economic growth, however, is getting consolidated fast in India and is becoming broad-based. In fact there are increasing concerns over capacity constraints emerging in a wide range of sectors. The RBI puts it succinctly: “With growth taking firm hold, the balance of policy stance has to shift decisively to containing inflation and anchoring inflationary expectations.'' Amplifying that policy stance, the RBI makes the following points.
WPI inflation has been in double digits since February. Headline inflation was 10.6 per cent in June 2010. This was higher than the 10.2 per cent recorded in May. Inflation figures for March and April were revised upwards. There is a strong possibility that the revised data for May and June will reveal higher inflation than earlier estimates showed.
Second, price rise in primary food articles continues to be in double digits. Non-food manufactured products inflation (which has a substantial 52.2 per cent weight) has risen from (-) 0.4 per cent to 7.3 per cent. Non-food items inflation (WPI excluding food products and food articles), which was near zero in November 2009, rose sharply to 10.6 per cent in June. Significantly non-food items contributed over 70 per cent to WPI inflation. This suggests that inflation has become much more generalised.
Baseline projection
Three, despite some moderation, consumer price inflation remains in double digits. The central bank's baseline projection for WPI inflation for March 2011 has been raised to 6 per cent from the 5.5 per cent indicated in the April policy statement. A number of developments since April have influenced the RBI. There has been an increase in prices of many administered/regulated items. Petroleum products, for long subject to administered prices, have been partially deregulated. The immediate impact will be about one percentage point rise in WPI inflation, assuming global oil prices remain stable.
The near term outlook for inflation will be conditioned by a number of factors. The spatial and temporal distribution of rainfall in the remaining period of the south-west monsoon is one critical factor. A good kharif harvest will dampen inflation over the short-term. Other important factors that have a bearing on inflation are the levels of oil and other commodity prices globally. Idle global capacity in a number of sectors can facilitate imports at competitive prices. However, strong growth in India has pushed up demand side pressures.
Growth revised to 8.5 %
The RBI has revised its growth projection for the current year to 8.5 per cent, up from the 8 per cent with an upward bias indicated in the April policy statement. This is in line with all recent official forecasts. The Prime Minister's Economic Advisory Council had just a few days earlier forecast an identical growth rate. According to the RBI, the main risks to growth will emanate from abroad. With weak recovery in the industrialised countries, the performance of countries such as India will be affected. A more significant risk is from a potential slowdown in capital inflows. India's current account deficit has widened. Robust domestic growth drivers have pushed up imports widening the trade deficit.
Capital inflows have played a crucial role in the balance of payments. If due to increased risk aversion capital inflows decline the comfortable buffer between inflows and current account deficit will be narrowed. Lower inflows may also constrain domestic investment, which is critical to achieving and sustaining high growth rates.
On the other hand, given that central banks in the advanced economies are likely to continue with accommodative monetary policies, flows to emerging markets in search of higher return may increase. Large capital inflows beyond the absorptive capacity of the domestic economy will however pose a challenge for monetary and exchange rate management.
