The Reserve Bank of India (RBI) today set the stage for a series of rate hikes to tackle inflation, which the central bank believes is likely to remain above the comfort zone in the near term. Though RBI expressed satisfaction on growth prospects, it said higher growth is expected to coexist with high inflation.
“The inflation outlook, which is being conditioned by both demand-side and supply-side factors, suggests slow-paced moderation in inflation, with the possibility of rigidity at above the comfort level in the near term,” RBI said in its macroeconomic and monetary developments report today.
Inflation based on the wholesale price index was at 8.43 per cent in December. RBI, which has projected March-end inflation at 5.5 per cent, is expected to revise its projection upward.
The central bank said sectoral imbalances in several non-cereal food items may not be addressed by higher policy rates, but aggregate demand-side pressures on inflation would have to be contained in a forward-looking manner.
“The anti-inflationary focus of the monetary policy would have to continue, recognising the limits of monetary policy in dealing with structural pressures on inflation, and the need for forward-looking response to demand-side pressures. Since a lower inflation regime is essential for sustainable high growth, containing inflation becomes the dominant policy objective in the current environment,” RBI said.
Despite stubborn inflation, most economists expect the central bank to hike interest rates by 25 basis points in its third-quarter review of monetary policy so that the growth momentum is not hampered. RBI’s confidence in the growth prospects has, however, surprised many economists.
“The return to a high-growth path in 2010-11 materialised despite an uncertain global environment. Though the overall outlook suggests some moderation in growth in both advances and emerging economies in 2011, downside risks to India’s growth momentum have receded considerably,” RBI said.
According to RBI, persistently high inflation endangers growth. “Since persistent high inflation could endanger the growth objective and also amplify risks to inclusive growth, containing inflation will have to be the predominant objective of monetary policy in the near-term,” the central bank said.
At the same time, RBI highlighted the limitations of policy tools to tackle inflationary pressures arising from supply-side bottlenecks. “While growth prospects remain robust, persistence of high inflationary expectations poses a complex challenge for the conduct of monetary policy. The challenge is exacerbated by the fact that inflationary pressures are emanating from sources that are not very sensitive to monetary policy measures,” RBI said.
The central bank also said that while the inflation spike has largely come from supply-side elements, monetary policy would need to factor in near-term risks to inflation from high input cost pressures transmitting to output prices.
“The risks to generalised inflation cannot be overlooked, as inflation expectations are currently ruling high. Anchoring inflationary expectations would be necessary to mute the second-round impact of supply-side shocks,” RBI said.
