RBI to continue its tight monetary policy against the rampant inflation in coming months

With the domestic inflation persisting at uncomfortable levels, Reserve Bank of India (RBI) has furthered its aggressive stance against the rampant inflation and hiked repo rate and reverse repo rate by 25 basis points each to 7.50 per cent and 6.50 per cent respectively, in its mid-quarter policy review. While, the central bank has left cash reserve ratio, which is the amount of funds that banks have to keep with RBI, unchanged at 6 per cent. In the coming months, further increase in policy rates is possible as RBI said it will continue its tight monetary policy as inflation is spreading to non-food segment also, which is a concern. The inflation in the economy is expected to remain at elevated level because of high domestic demand and hovering global oil and commodities prices, given the current situation, central bank expects an upward revision in inflation numbers. Moreover, the headline numbers understate the pressures because fuel prices have yet to reflect global crude prices.

The headline WPI inflation rate was 9.7 per cent in March 2011. In April 2011, it was 8.7 per cent and rose to 9.1 per cent in May 2011. The numbers for April and May 2011 are as yet provisional and, given the recent pattern, these numbers are likely to be revised upwards. Thus, the headline WPI inflation rate remains elevated, consistent with the projections made in the Annual Policy Statement of May 3. The main drivers of WPI inflation in April-May 2011 were non-food primary articles, fuel group and non-food manufactured products. The consumer price inflation for industrial workers (CPI - IW) rose from 8.8 per cent in March 2011 to 9.4 per cent in April 2011.

Non-food manufactured products inflation was 8.5 per cent in March 2011. Provisional data indicate that it increased from 6.3 per cent in April to 7.3 per cent in May 2011, numbers much above its medium-term trend of 4.0 per cent. This pattern in non-food manufactured products inflation is a matter of particular concern. Besides, reflecting high commodity prices, it also suggests more generalized inflationary pressures; rising wages and costs of service inputs are apparently being passed on by producers along the entire supply chain.

On liquidity condition it said, “As articulated in the May 3 Policy Statement, the Reserve Bank will continue to maintain liquidity conditions such that neither surplus liquidity dilutes the monetary policy stance nor large deficit chokes off fund flows to productive sectors of the economy”.  In its mid quarter policy review RBI observed, recent global macroeconomic developments pose some risk to the growth of domestic economy. Expressing concern over unstable global environment RBI said, “Lead indicators suggests that growth moderated in both advanced economies and emerging market economies (EMEs) under the impact of high oil and other commodity prices, the spillover from the Japanese natural disasters and monetary tightening in EMEs to contain inflationary pressures. Uncertainty about the resolution of the sovereign debt problem in the euro area has increased. These developments increase downside risks to global growth prospects”.

The domestic growth outlook as indicated in the Annual Monetary Statement of May 3 remains unchanged. However, given the high degree of integration with the global economy, recent global macroeconomic developments pose some risks to domestic growth. Domestic inflation remains high and much above the comfort zone of the Reserve Bank.  Particularly, non-food manufactured products inflation rose in May 2011 after showing some moderation in April 2011. Domestic fuel prices do not yet reflect the current trends of global prices. Although global commodity prices moderated in recent weeks, it is too early to downgrade this as a risk factor. Monetary transmission has strengthened. The impact of the Reserve Bank’s recent monetary policy actions is still unfolding. The challenge of containing inflation and anchoring inflation expectations persists.

Thus, while the Reserve Bank needs to continue with its anti-inflationary stance, the extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.