RBI hints at another rate hike to tame inflation
With inflation remaining high, the Reserve Bank on Monday indicated that it may go for another round of interest rate hike on Tuesday even though the step may impact the economic growth.
"Inflation risk...persists. The policy choices have become more complex. In this backdrop, the monetary policy trajectory will need to be guided by the emerging growth- inflation dynamics even as transmission of the past actions is still unfolding," RBI said in its review released on the eve of mid-year monetary policy announcement on Tuesday.
Though the risk to growth is becoming visible, the challenge of bringing down inflation to an acceptable level on a sustainable basis remains significant, it further said.
On account of various global and domestic factors, the RBI said, "growth in 2011-12 is likely to moderate slightly from that projected earlier".
The RBI had projected the economic growth, or GDP expansion, for the current fiscal at 8 percent, down from 8.5 percent in 2010-11.
The Reserve Bank of India (RBI) has raised interest rates by 350 basis points since March, 2010 in its bid to contain inflation, which has remained near double-digit.
The rate of price rise was 9.78 percent in August, while food inflation was 10.6 percent for the week ended October 8.
The Reserve Bank said the investment demand is softening as a result of tightening of the monetary policy, deteriorating business confidence and project executions facing hindrances among other things.
While growth in the current fiscal is likely to moderate to below trend, agriculture prospects remain encouraging with the likelihood of a record kharif crop.
"However, moderation is visible in industrial activity and some services," the central bank said.
The country's industrial output as measured on Index of Industrial Production (IIP) grew by a dismal 4.1 percent in August (latest data) as high interest rates and gloomy global indicators weighed against the factory output.
In addition to domestic factors, the RBI said global factors may slow down growth.
"With the increasing linkage of domestic industrial growth with global industrial cycle, some further moderation is likely ahead..."
It said capacity constraints seem to be easing in some manufacturing segments, especially cement, fertilisers and steel. Besides, construction activity has slowed and leading indicators suggest that going forward, "services growth may slightly weaken".
According to the RBI, the planned corporate fixed investment in new projects declined significantly since the second half of 2010-11 and has stayed low in the April-June period of 2011-12.
"Consequently, the pipeline of investment is likely to shrink, putting growth in 2012-13 at risk," it said.
The central bank said high inflation is likely to persist in the next couple of months before moderating as falling global commodity prices so far has been offset by rupee depreciation.
"Incomplete pass-through is likely to limit the impact of falling global commodity prices. Financialisation of commodities leaves future commodity price path uncertain," it added.
The RBI's macro-economic review said that domestic price pressures still remain significant and broad-based.
"Food inflation is likely to stay elevated due to demand--supply mismatches in non-cereals and large MSP revisions," it said adding real wage inflation has extended into first quarter of the fiscal.
"In sum, the inflation challenge remains significant," it said.
Besides, the private consumption is also starting to soften in parts, but it remains robust overall as is evident from corporate sales performance. Sales growth continues to be healthy, but profits are under pressure, the RBI said.
Fiscal slippages during 2011-12 may complicate the task of aggregate demand management.
"Key to growth sustainability lies in supporting investment by rebalancing demand from government consumption to public and private investment," it said.
On financial markets, it said volatility was high in global markets in second quarter of 2011-12 and rising risk aversion caused credit spreads to widen.
"Volatility spillovers impacted domestic currency and equity markets in a limited way," the RBI said.
On the current account deficit (CAD), which widened in first quarter of the fiscal, despite a surge in exports and higher net invisibles receipts, the RBI said "invisible earnings may also decelerate as slowdown in US and euro area could impact software exports".
Going forward, the merchandise could also decelerate as global growth slows down, it said.
On rupee depreciation and the fall in equity indices in July-September quarter, RBI said they were comparable to the patterns in most other emerging markets.
Money market rates remained in line with policy signals, while G-sec yields hardened after the announcement of additional market borrowing.