While the central bank regards growth outlook as robust, revising its own estimate to 8.5 per cent, the report cautions that “inclusive growth” is impeded by supply side bottlenecks with “asymmetric impact on different sections of the poor”, (as reflected in sustained double-digit food price inflation). RBI is caught in a dilemma of “stabilizing output versus containing inflation”. Recent experience suggests, it says, despite possible trade-off between growth and inflation, in the short run, inflation containment may have to get precedence over other policy objectives in India for RBI.

Consumer price inflation has remained high at 13/14 per cent and increasing generalization of inflationary pressures require active demand management policies in the near term. The focus of medium term inflation management must be to ease supply constraints in key sectors where demand will continue to grow, especially manufactured products. Undoubtedly, the boost to purchasing power of the large contingent of government employees, central and state, through generous implementation of the Sixth Pay Commission recommendations and other pre-election ploys is one of the factors. This along with revision of administered prices had helped to transmit food price inflation into a generalized (headline) inflation which has remained in double-digit for five months consecutively. (Coal, fertilizer, electricity and oil product prices have been revised).

RBI now treats inflation, which is also demand-driven apart from supply constraints, as its major concern in macro-financial management, while calibrating monetary policy “without risk to recovery”. By mid-2010, inflation had become so generalized that the balance of monetary policy had to shift from recovery to inflation, not just in food articles but both manufactured products and the fuel group. However, growth concerns apart, an uncertain global environment warrants “caution” in the formulation of monetary and credit policy during 2010/11. Volatile global markets have tended to keep Indian market down and the near term outlook for trade and capital flows is also uncertain.

Overall, economic growth prospects this year are rated good with improved industrial sector performance, better monsoon than last year and sustained resilience of services. Investment demand has accelerated judged from trends in growth of capital goods production while private consumption demand is noticed in corporate sales, consumer durables and auto sales. In exiting accommodative monetary stance, RBI has so far effected a cumulative increase in repo rate by 125 basis points and CRR by 100 basis points between February and July. On the flip side, earlier softening of interest rates had also led to slowdown in the growth of time deposits with negative return for customers..

Sustaining growth and containing risks to inflation call for addressing structural constraints in several critical sectors, the RBI report said. Improving macro-economic environment through fiscal consolidations, a low and stable inflation regime, strengthening of financial stability framework and progress on structural reforms would help sustain growth and boost productivity. For its part, RBI says it would continue to address the medium-term objective of improving the contribution of finance to rapid and inclusive growth.

To overcome supply constraints in items of mass consumption, RBI calls for special attention to agricultural productivity, especially in pulses, oilseeds, vegetables and dairy products, as demand would keep growing with rise in middle class. Also, it urges greater policy attention to the “timely use” of the adequate buffer stocks maintained for food security through “more efficient distribution during periods of adverse shock to farm output”. Deficiency in regard to use or buffer stocks was also cited earlier by the Prime Minister' Economic Advisory Council. In RBI's view, with high levels of food stocks and better supply management, the pressures on food inflation could have been moderated.

Rather than maintain high food stocks involving significant carry costs, RBI suggests a shift from policy intervention in the form of minimum support prices toward building capital infrastructure for agriculture, which would” crowd in” private investment and help realize full potential agricultural growth. While partial deregulation of oil prices was important and long overdue reform, it came at a time when headline inflation was already high. Complete deregulation of POL prices in due course would have to be the next logical step for beneficial impact on both government and oil company finances.

Continued high inflation entailed the risk of complicating investment and consumption planning affecting capital formation and savings. Large sections of poor not being able to increase their income matching inflation might suffer decline in real incomes. With costs of services also going up as in private education and health care, RBI says, from the point of view of consumer welfare, a more representative national measure of consumer inflation that covers consumer goods of all sections of society including consumption of services is needed. It would help RBI identify the sources of inflation better.

Drag on growth plus inflation also comes from the critical infrastructure gap in relation to other countries, especially power, and already growing domestic demand is affecting overall productivity of investments, RBI says while banking finance for infrastructure continues to be primary source, alternative non-banking financing has to be attracted with appropriate policies including “more accommodative FDI”, development of corporate debt market and creation of debt funds.

Given the lags in transmission of monetary policy, RBI says it should be forward-looking and hopes the “Base Rate” which came into force on July 1 would impart transparency to loan pricing process and improve assessment of policy transmission and promoting competition in credit market. But in its view, deregulation of administered rates for small savings would reduce scope for cross-subsidisation in terms of under-pricing of credit for corporate and over-pricing of loans to agriculture ad small and medium enterprises. To advance Financial Inclusion, RBI proposes a National Rural Financial Inclusion Plan with a target of providing access to financial services to at least 50 per cent of excluded rural households by 2012 and the remaining households by 2015.

Two other areas in RBI report relate to fiscal consolidation and the autonomy of the central bank which had recently cropped up with certain Finance Ministry moves at a time globally central banks were being entrusted with greater responsibility and independence. Fiscal consolidation would create space for dealing with future shocks to growth and inflation while it increases flexibility for monetary policy operation. Current year's deficit had been lowered by the trebling of budgeted receipts under 3G spectrum auction, a one off gain, and emphasis in consolidation should be on quality of fiscal adjustment. On regulatory autonomy, RBI noted Government's assurance during debate on the Securities and Insurance Laws Amendment bill and said it was important “ to ensure that autonomy of the regulators is not compromised either in fact or in perception”. (IPA Service)