RBI unlikely to cut rates as inflation risk soars

In view of high inflation and deficient monsoon rainfall, the Reserve Bank may find it difficult to cut the key lending rate to boost the economy as is being demanded by the industry.

Last Updated: Jul 30, 2012, 23:05 PM IST

Mumbai: The Reserve Bank on Monday hinted at holding on to its elevated rates in the quarterly monetary policy review on Tuesday, saying there are increased risks on inflation scenario and lack of action on the fiscal front.

"Monetary policy space needs to be created through fiscal adjustment and structural measures to improve supply conditions ..." the Reserve Bank said in its report on Macroeconomic and Monetary Developments, released on the eve of the policy announcement.

The near-term outlook on inflation is marked by a slew of upside risks despite significant slowdown in growth, the RBI said, adding that suppressed inflation, poor supply responses and a weaker monsoon are risks to price-situation.

"Persistence of inflation, even as growth is slowing has emerged as major challenge for monetary policy," it said.

For the month of June, the headline or WPI inflation stood at 7.25 percent while the consumer price index was at double-digit level of 10.02 percent.

The pro-growth lobby, which is alarmed over quarterly growth slipping to a nine-year low of 5.3 percent for the March quarter, wants the RBI to slash interest rate to prop-up growth.

In its last review of June 16, the RBI had refrained to cut policy rate despite hard lobbying by industry to ease policy rate.

RBI also said that the growth in the current fiscal is likely to be below the reduced potential of 7.5 percent because of "global headwinds, inflation and policy uncertainty".

RBI noted that monetary and liquidity conditions have eased and are not significantly impinging on growth.

"A 0.50 percent repo rate cut, following a 1.25 percent CRR (Cash Reserve Ratio) reduction, coupled with active open market operation purchases have significantly eased monetary and liquidity conditions during 2012-13 so far," it said.

Interestingly, policy uncertainty, a favourite phrase with the corporates and investor class, also found favour with the RBI for the first time.

"Revival of investor confidence would need to be supported by addressing concerns over policy stasis, while putting in place complimentary actions that address macro-economic weaknesses," the RBI report said.

A study of professional forecasters done by RBI revealed that growth will slip to 6.5 percent for the fiscal against RBI's projection of 7.3 percent. For inflation, forecasters upped their expectations to 7.3 percent from the earlier 6.9 percent by fiscal-end.

RBI said high prices of protein items, which it cites as the main factor of driving inflation in the last two years of high growth, are unlikely to wear-off even if the growth slips.

For the Centre, RBI said there is an urgent need to control expenditure. "Removing constraints on FDI and improving the investment climate by moving quickly to address bottlenecks in infrastructure space are important," it said.

It also noted that due to fiscal imbalances, the Centre's space for stimulus is limited compared to 2008-09 when the government moved in quickly with stimulus packages.

On the movement of monsoon, RBI said the deficiencies can have an adverse impact on food inflation.

Until July 27, the monsoon was deficient by 21 percent compared with the long period average.

This is likely to impact kharif crops, especially coarse cereals and pulses, RBI said.

"Risks to inflation remain from unsatisfactory monsoon and increases in MSP (Minimum Support Price) even as growth slowdown eases demand pressures," it said.

While core inflationary pressures are currently muted, it said, "a continued rise in real wages may spill over to core inflation," it said.

On the current account deficit (CAD), RBI said softening of global crude oil prices and moderation of gold imports may slightly lower CAD in 2012-13, but risks remain, especially with slowing global growth and trade and low price elasticity of import demand.

With regard to global economy, it said, persistent euro area problems and weakening growth in emerging and developing economies (EDEs) will be a drag on global growth in 2012.

"The deceleration in growth in the BRICS nations, which have so far been drivers of EDEs' growth, has added a new dimension to the global slowdown, making near-term recovery difficult," it said.

"Global financial market stress resurfaced due to the deepening crisis in the euro area, especially in Greece and Spain; the Libor fixing scandal has added to the uncertainty," it added.