Citing persisting inflation, the RBI has refrained from cutting key policy rates despite industry citing a fall in industrial production and persuasion by the Centre.
The finance ministry had, just before the last policy review of the RBI, released a five-year fiscal consolidation plan, apparently to impress upon the RBI that it is serious about bringing down the fiscal deficit to 5.3% of the GDP this fiscal and further down to 3% by 2016-17.
This years 2012-13 Mid-Year review said, The seasonally adjusted annualised rate of inflation (SAAR) indicates the momentum of NFM inflation is currently on a decline. The review noted that in addition to the headline WPI (whole-sale price-based inflation) and CPI (consumer price index) inflation, RBI has been monitoring NFM inflation as the key measure of core inflation that will influence its policy stance.
The reason for this emphasis is partly because demand conditions, which can be affected by the RBI interest rate policy, are better measured by NFM inflation, which is also relatively sticky, it explained.
The WPI inflation in November had moderated to a 10-month low of 7.24% from 7.45% a month ago, while the retail inflation (CPI) rose to 9.9% in November from 9.75% in October. The industrial production data for October, denoting a 16-month high of 8.2% annual growth on the back of robust performance manufacturing and capital goods contrasting with negative growth reported in five out of the first seven months of the fiscal had brought some cheer recently.
The surge in October industrial output data and a slide in WPI inflation in November have given rise to expectations of RBI going by its previous indications of a cut in key policy rates in the January-March quarter. On food inflation, the review said, WPI food inflation has shown a sharper moderation during the period April 2010 to October 2012, because of its initial high levels.
Food inflation, however, is more structural and its response to monetary policy changes is relatively weak. However, the momentum of food inflation is also pointing towards moderation, it added.
Elaborating on NFM inflation, the review said within core inflation, while the inflation for capital goods has continued to remain muted, inflation for consumer durables has been showing signs of easing recently.
The review also found that the demand for consumer durables has remained high till recently, even while the demand for capital goods was more muted because of the slowdown in investment.
The inflation picture is complicated in India because of shifting consumption basket and the supply of proteins and micro-nutrients like fruits and vegetables has not responded quickly, the review noted. Interest rates are probably an inappropriate tool to shift peoples preferences. This is why it may be reasonable for the RBI to look through the rise in food prices, while trying to ensure that food inflation does not feed into wages and generalized inflation, the review said.
However, it said unfortunately, food is a big part of a workers consumption basket, and higher food prices do feed into higher wage demands. The review suggested that the government's efforts to create the conditions for greater protein supply are important. Referring to the significant increase in rural wages, the review recommended that tempering wage inflation that is not directly linked to productivity increases may also be worth exploring.