RBI hints at raising rates to tame inflation

‘Price pressures are expected to persist in the second quarter'

Reiterating its commitment to reign in inflation and indicating a hike in its policy rates, the Reserve Bank of India on Monday said that “taming inflation warrants continuation of anti-inflationary monetary stance.”

“Generalised inflation with near-term upside does not provide any comfort,” said the RBI in its first quarter review of macroeconomic and monetary developments in the current fiscal.

Structural reforms

Inflation remained high in the first quarter of 2011-12, in line with the projections made in the May policy statement. There has been generalisation of inflation since December, 2010, with dominant contribution from non-food manufacturing products. Inflation is being driven by cost-push and demand-side factors.

“Food inflation has declined,” said the RBI. However, the central bank said “near-normal monsoon may not ease pressure on food inflation further due to increases in wage costs and support prices,” adding that “these trends necessitate structural reforms to enhance supply response, while the anti-inflationary bias of monetary policy anchors inflation expectations.”

Inflation risks stay, while growth showed signs of moderation. On current reckoning, growth is likely to stay around trend growth of around 8 per cent. However, downside risks have increased. Overall some moderation in growth is expected in 2011-12. “Various expectation surveys also indicate the same,” the RBI said.

Near-term upside risks to inflation remain significant. Price pressures are expected to persist through in the second quarter as well and then moderate towards the later part of 2011-12. “Breaking inertial dynamics of wage and food price rise is important for arresting inflation.”

The RBI said risks to baseline growth and inflation projections might arise from three factors: significant departure of monsoon from normal; a collapse or re-build of global commodity price bubble; and euro zone debt crisis assuming full-blown proportions.

Growth showed some moderation in the first quarter of 2011-12. These were visible from deceleration in IIP during April-May, 2011, and in consumption of cement, steel and automobiles during the first quarter of 2011-12. There has been timely arrival and advancement of monsoon. However, after a good rainfall in June, the monsoon appears to be weakening a bit. Agricultural growth is expected to stay broadly on track. IIP growth, though having moderated, has turned more broad-based. Services sector has sustained its momentum. Going forward, there is a possibility of some softening in industrial growth, as a result of implied input costs. Aggregate investment as well as corporate investment intentions dipped in the second half of 2010-11 and are yet to show signs of improvement.

The improvement in deficit indicators augurs well for growth rebalancing, but subsidies are likely to overshoot budget estimates. “Even after the administered price hike in June, 2011, total fiscal slippage for the Centre from the oil sector may still be about one per cent of GDP.”

The RBI said that FII inflows remain volatile, but FDI inflows have picked up in 2011-12 so far. “Tight monetary and deficit liquidity conditions are bringing the desired adjustments and are likely to prevail in near term,'' the RBI said.

  • Agricultural growth is expected to stay broadly on track
  • Improvement in deficit indicators augurs well for growth rebalancing

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