High inflation and the consequential policy rate increases are likely to impact domestic growth in the future, said the Reserve Bank of India (RBI) in its Financial Stability Report released today. A slowdown in investment demand and the slackening global recovery also pose downside risks to growth.
The central bank said inflation was likely to remain high, as the entire impact of the rise in oil and coal prices was yet to be felt. The government's higher expenditure on subsidy and rise in wages and raw material prices would prevent inflation from declining.
“Growth is likely to moderate, while inflation is likely to remain firm due to rising commodity prices,” RBI said in the report. Rising commodity prices are expected to have an adverse impact on the fiscal consolidation process, it said, adding there were risks to the fiscal deficit projections of 2011-12, since subsidies were likely to exceed budgetary provisions, owing to higher international commodity prices.
Headline inflation numbers again picked up in May on the back of higher prices of food and non-food manufactured goods. While the wholesale price index stood at 9.1 per cent in May, up from 8.7 per cent in April, food inflation rose to 8 per cent in May, compared with 7.6 per cent in April. Non-food manufactured inflation rose to 7.2 per cent from 6.3 per cent in April.
Higher oil and commodity prices may also led to widening of the current account deficit, though higher growth in software export and remittances is likely to provide cushioning.
According to the central bank, financing the current account deficit would be a challenge, as advanced countries exit their accommodative monetary policy stance. “This could slow down capital inflows to emerging market economies, including India, as investors rebalance their portfolios,” RBI said.
There is considerable uncertainty in the global financial recovery, owing to recent developments like the eurozone debt crisis, the earthquake in Japan and the geopolitical turmoil in major oil producing countries, RBI said. It added these developments may hit the confidence of investors and the spending decisions of corporations and households.
The central bank also cautioned against uncertainties in the West Asian and North African (Mena) countries. “If tensions in Mena continue, or spill over into bigger economies in the region, the impact on Indian financial markets would be difficult to contain, particularly because India’s fiscal improvement is expected to slow this year,” it said.