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The Reserve Bank of India is set to tighten interest rates through the major part of this fiscal.
This is because the central bank sees high global crude oil and other commodity prices keeping the inflation rate above its comfort level, and affecting growth.
Persistent inflation calls for an anti-inflationary monetary policy stance for sustaining growth over the medium term, the RBI said in its report on Macroeconomic and Monetary Developments in 2010-11. Tacking inflation to sustain growth is the underlying theme of its 50-page document released on Monday, a day ahead of its Monetary Policy Statement for 2011–12.
Analysts expect the central bank to raise its key short-term rates by 25-50 basis points on Tuesday to rein-in inflationary pressures. “It is important to lower inflation as quickly and as decisively as possible,” said the RBI. Empirical evidence, according to the RBI, suggests that high growth, on an average, has coexisted with low inflation and that episodes of high inflation have typically been followed by slowdown in growth rates.
“Inflation path remains sticky and risks are on the upside. Headline inflation could remain elevated in the first half of 2011-12 before declining gradually in the second half, but could remain above the Reserve Bank's comfort level,” the document said.
The RBI's discomfort with inflation stems from the fact that the March 2011 WPI inflation reading was higher at 8.98 per cent against the RBI's projection of 8 per cent for FY2011. Since March 2010, the central bank has increased policy rates by 350 basis points to tackle the rising inflationary pressures.
“While India's macroeconomic outlook for 2011-12 remains favourable, high oil prices pose the biggest risk to both growth and inflation…Inflation during 2011-12 is likely to moderate slowly but remain above the comfort level as the pass-through of international commodity prices is likely to continue,” the RBI said.
Further, downside risks to growth also arise from higher cost of capital and any weakening of consumer confidence as the cost of leverage goes up.
The RBI also cautioned that the expenditure on subsidies is subject to upside risks. Fertiliser and oil subsidies are likely to exceed budgetary provisions and generate pressures on the fiscal situation in case there is a delay in adjusting the domestic prices to rising international prices.
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