The Hindu Business Line : Policy statement highlights global downside risks

Pitfalls ahead
Potential escalation and volatility in international crude prices
Disorderly unwinding of the macroeconomic imbalances of the major economies.
Hardening of international interest rates.
High credit growth rate and rising asset prices

New Delhi , April 18

The Annual Policy Statement and the stance of monetary policy for 2006-07, laid bare by the RBI Governor Dr Y. Venugopal Reddy, hoisted a host of downside risks which loom over the global economy that have manifest implications for the medium-term prospects for emerging economies like India.

The key global risks for India, as per the apex bank, include potential escalation and volatility in international crude prices, a disorderly unwinding of the macroeconomic imbalances of the major economies and a hardening of international interest rates along with the direction of movement in setting monetary policy, at least over the ensuing year.

Even as the evolving economic and business environment exhibits a number of encouraging signs that suggest reinforcement of the robust economic growth in recent years, the RBI argues that the sustenance of business confidence, enhancement of productivity and maintenance of growth momentum would depend on policy improvements in agriculture, improved quantity and quality of physical infrastructure and progress in fiscal consolidation.

Infrastructure critical

Recognising the risks embedded in domestic developments which could potentially jeopardise the growth momentum, the apex bank asserts point blank that sustaining the growth of manufacturing, the key driver of industrial recovery, would hinge critically on bridging the large gaps in physical infrastructure. "Structural reforms will have to focus on quantum jumps in the provision of physical and social infrastructure," it observed.

The bank's contention that getting infrastructure right will hold the key to maintaining real GDP growth in 2006-07 and 2007-08 at the level achieved in 2005-06 (assuming that the global economic milieu remains conducive and that there are no severe unanticipated shocks) should goad the authorities to get their act together in resolving several regulatory issues pertaining to the entry and performance of private operators in the infrastructure domain.

Even as the fiscal incentives extended to the special economic zones (SEZ) have become a bone of contention between the Ministries of Commerce and Industry and Finance, the RBI policy statement sets at rest any doubt in this respect by reiterating that "fiscal policy will obviously have to play a key role in improving the delivery of infrastructure services, in fostering public-private partnerships and in crowding in private investment."

Caution on credit growth

While highlighting how the cyclical expansion in bank credit has extended over an unprecedented 30 months without encountering any destabilising volatility, the RBI rightly underscores enhanced vigilance, as this situation demands. This is all the more important now than ever before, especially in an environment fraught with pressures from aggregate demand embodied in rising bank credit, high asset prices and above-trend growth in monetary aggregates as well as global risks from larger macroeconomic imbalances and higher oil prices than before. In this context, the RBI contends in no unmistakable terms that there has to be fuller pass-through of increases in international crude prices, failing which "inflation could turn out to be higher in 2006-07 than the current benign levels."

While there are compelling reasons to maintain the momentum in growth of output, the RBI minces no words in sticking to its stance that low and stable inflation will enable higher growth on a sustained basis in an environment of overall stability. The risks of not responding to modulation of aggregate demand and by firm and timely responses by all concerned would be substantial, the central bank cautions adding that the present rate of high credit growth and increase in asset prices seem to pose a downside risk to overall financial stability. Thus even as the RBI has kept bank rate, reverse repo rate, repo rate and cash reserve ratio unchanged, it has transmitted sufficient signals to the authorities and the government of the day to be on the guard as eternal vigilance is the price of an open economy.

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