Monetary tightening on cards

Written by fe Bureau | Mumbai | Updated: Jan 29 2010, 06:58am hrs
Front page
While confirming the existence of several factors that could further accelerate economic growth in the near term, the central bank on Thursday conceded that delicately balancing the need to support a sustainable return to a high-growth path without stoking inflation through monetary policy action has emerged a challenge. According to RBIs Professional Forecasters Survey conducted in December 2009, the outlook for FY10s growth has been revised upwards from 6.0% to 6.9%.

In its third-quarter macroeconomic & monetary developments review released on Thursday, RBI said there were signs of a revival in private demand, both consumption and investment, and there was a possibility that the strong industrial recovery would continue. The rabi crop was expected to be better, while capital market conditions were seen to be favourable. Moreover, export growth was positive, as was business sentiment, RBI said quoting a survey it had commissioned.

The central bank admitted that food price inflation remained a concern. With a stronger recovery in the country, the risk of food price inflation causing generalised inflation cannot be ignored, RBI observed. Its industrial outlook survey conducted between October and December showed further improvement in sentiment in the manufacturing sector, in continuation of the optimism seen the previous quarter.

Survey respondents expect industrial growth to gather further momentum in the last quarter of FY10, which has to be seen in the context of a significant acceleration in IIP growth in AugustNovember 2009. Inflation emerged a major concern during the third quarter, dominated by significant supply factors. Concentrated pressure on headline inflation, arising from high food prices, risks being transmitted to non-food items through expectation-driven wage price revisions, thereby magnifying into generalised inflation, RBI explained.

While anchoring inflation expectations becomes important in such a situation, addressing supply constraints would be critical to enhance the effectiveness of any anti-inflationary policy measures, RBI said. The growth and inflation mix for India is increasingly becoming asymmetric vis--vis the pattern in other G-20 countries. The possibility of surges in capital inflows and the associated domestic liquidity conditions may also affect inflationary expectations, besides the impact of a rebound in international commodity prices in response to global recovery, cautioned the central bank.

Similarly, the downside risks to growth in the near term may be reflected in the adverse impact of deficient monsoons on kharif crops in next quarters GDP, weakness in services activities dependent on external demand despite signs of recent improvements, and possible pressures on interest rates that may emerge from a revival in demand for credit from the private sector as well as inflation expectations. Risks to global growth and higher oil prices also need to be given due consideration, the central bank said.

RBI further said that the outlook for inflation would be conditioned by upside risks in terms of persistent supply-side pressures in the near term, a possible return of pricing power with stronger recovery in growth, a further revival in private demand with improving consumer and business confidence, a possible spurt in global commodity prices in response to recovery in emerging and advanced economies, and the possibility of high CPI and food price inflation spilling over to cause generalised inflation.

However, possible sources of comfort that could ease some of the pressures on inflation include the arrival of certain new crops to the market, additional release from the high buffer stocks of foodgrains, and a negative output-gap persisting for some more time, which in turn may help contain demand-side pressures, RBI said.