High inflation warrants continued tight monetary policy: RBI

The Reserve Bank of India (RBI), in its quarterly report on Macroeconomic and Monetary Development, accepted that the economic growth have moderated in the first quarter of the current financial year. Signs of moderation were visible from deceleration in IIP growth in April-May, poor performance of certain core industries, especially cement and natural gas and consumption deceleration in cement, steel and automobiles. Manufacturing and services PMIs also showed that growth is turning softer, the RBI said.

Since, March 2010, RBI has increased the repo and reverse repo rates for 10th time in order to control inflation, which was hovering around 9%. Following up on a series of rate hikes through 2010-11, policy rates were raised by 75 bps in Q1 of 2011-12, through a 50 bps hike in May and 25 bps in June. Altogether, in a span of 15 months starting March 2010, operational policy rates were raised by 425 bps - one of the sharpest monetary tightening seen across the world.

However, the aggressive stance adopted by RBI has adversely affected the economic growth of the country. Accepting making balance between inflation and economic growth is a challenging task, RBI said, “Indications of moderation in growth have surfaced, making the policy challenge even more complex. However, the persisting high inflation and its expected slow decline warrant that the Reserve Bank continue with its anti-inflationary policy stance” RBI added.

The RBI’s survey of forecasters reduced its projection for growth for the current financial year to 7.9% from 8.2% made earlier. It has also increased its outlook for WPI headline inflation to an average of 8.6% from 7.5 previously. Admitting that the slowdown in investment and consumption is due to high inflation, central bank noted that there are chances of further moderation in both investment and consumption as high inflation erodes real consumption and monetary policy actions to restrain demand in the short run work through the system.

'The downside risks to growth emerge from uncertainties relating to Southwest monsoon, likely moderation in private consumption and investment demand, high input costs, escalating cost of capital and uncertain global outlook,' the RBI said.

During the last financial year, Indian economy registered a growth of 8.5% which is higher than 8% registered in 2009-10. However, because of hovering inflation and increased interests rate, the pace of economic growth, in the fourth quarter of last financial year was slower than expected 7.8%. However, RBI expects Indian economy to grow by 8% in current fiscal, which is less than the government’s projection of 8.6%.

RBI is expected to go for another hike in its key policy rates, as inflation is still remaining at the elevated levels, it increased to 9.44% in June from 9.06% in May and government also revised inflation figures upward for 9.74% from 8.66%, which is the highest in the first quarter of 2011-12. 'The emerging growth risks are likely to be factored in the policy reaction,' the RBI said by adding further it said even near-normal summer monsoon rains may not ease food prices because of a rise in government-set minimum food prices. However, RBI expects inflation to stay at elevated level as the pass-through of global commodity prices are incomplete, revision in the Minimum Support Prices of food grains, and increased wages.

However, there is other side of picture too, the key policy rates where reduced during the time of financial crisis to support the growth momentum. 'Monetary policy will have to preserve the broad thrust on tight monetary stance till there is a credible evidence of inflation trending close to a level within the Reserve Bank's comfort zone,' the report said.