Wary of inflation, RBI vows policy action

Sounding a note of caution on inflation, the Reserve Bank of India said high and generalised inflation has persisted this year even though the downside risks to growth were much lower. The central bank reiterated its commitment to containing inflation through monetary policy actions, while assessing risks to both inflation and growth.

The impact of a deficient monsoon on growth is weakening, whereas the impact on inflation continues to be significant, the central bank said in its annual report. The identification of sources of inflation is important for the conduct of monetary policy. When the inflationary pressures are dominated by adverse supply shocks, monetary policy could be less effective in containing price pressures, it said.

In its July policy review, RBI had raised its growth forecast for the fiscal to 8.5 per cent from the earlier 8 per cent with an upward bias. It had also raised its inflation projection to 6 per cent by March, compared with 5.5 per cent in April.

RBI also cautioned on the possibility of a return of another phase of capital flows into the country, indicating it may pose a challenge for currency and interest rate management. It highlighted the fact that international opinion now favours the use of soft controls to deal with excessive capital flows.
 

NOTE OF CAUTION

* Growth outlook robust, but supply-issues have to be addressed 

* Volatile inflows could complicate macroeconomic management 

* Global situation now offers ‘less comfort’ than earlier

* Autonomy of regulators must not be compromised 

* Market conditions show liquidity likely to be in deficit mode 

The central bank has also cautioned commercial banks regarding a decline in profitability and asset quality.

Net interest margins of commercial banks are likely to come under pressure due to mark-to-market losses on their investment portfolio, higher provisioning and daily calculation of savings bank interest rates, a stress test carried out by the banking regulator said.

Yields on government bonds are on the rise, amidst tight liquidity conditions coupled with the central bank’s efforts to tighten monetary policy to tackle inflation. RBI has asked banks to make higher provisions for non-performing assets and to reach a provisioning coverage ratio of 70 per cent by September this year. Though most banks have reached RBI mandated norms, large players like ICICI Bank and State Bank of India have asked for an extension. According to RBI officials, it will not extend the deadline for all banks, but would consider only specific requests.

The autonomy of regulators should not be compromised, either in fact or perception, RBI said. It added that since the global crisis of 2008, there has been a decisive shift towards assigning increased responsibility to central banks for both “systemic oversight and macro-prudential regulation”.