In its Mid-Quarterly review of Monetary Policy, RBI makes the assessment that while growth momentum of the economy persists, despite industrial production index continuing to be volatile, continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory. In particular, the weak performance of capital goods in the IIP suggests that investment momentum may be slowing down.

But, RBI notes, the underlying inflationary pressures have accentuated, even as risks to growth are emerging. After a slight moderation in January, headline WPI inflation reversed in February 2011 at 8.31 per cent, accompanied by a sharp increase in non-food manufactured products inflation. Further upside risks have stemmed from high international crude prices, their impact on freely priced petroleum products, the increase in administered coal prices and pick-up in non-food manufactured product prices. The March 2011 WPI inflation is now estimated to be higher - around 8 per cent instead of its earlier projection of 7 per cent.

The major contributor to both developments, growth and inflation, is the rising global commodity prices, particularly oil. Domestic fuel prices in India are yet to adjust fully to global prices and thus risks to inflation remain on the upside. This is reinforced by the persistence of demand-side pressures as reflected in non-food manufacturing inflation. The Union Budget for 2011-12 indicates some easing of demand pressures from the fiscal side, thus creating space for private investment, but this will materialise only if commitments to contain subsidies are adhered to.

RBI takes note of the effort at fiscal consolidation as well as measures indicated to increase agricultural productivity, particularly in items facing structural supply-demand imbalances, but it points out this will contribute to easing food inflation over time. Meanwhile, fuel prices remain high, reflecting the global trend, with potential for further rise, it says.

Significantly, non-food manufactured products inflation, an indicator of demand side pressure, rose sharply from 4.8 per cent in January to 6.1 per cent in February and continues to stay well above its medium-term trend. The acceleration was spread across manufacturing activities, indicating that producers are able to pass on higher input prices to consumers, the Mid-Quarterly Review notes.

While the budgeted level of fiscal deficit for 2011-12 gives some comfort on the demand front, a potential increase in the subsidies on petroleum products and fertilizers as a result of high crude prices could put pressure on expenditure. 'It is critical, therefore, to focus on the quality of expenditure, keeping the aggregate under control without compromising on the delivery of services. Only by doing this can the fiscal situation contribute to demand-side inflation management'?, the review suggests to Government.

On the global scene, RBI says while recovery in advanced economies may be gaining momentum, the sharp increase in oil prices as a result of the turmoil in the Middle East and North Africa is adding uncertainty to the pace of global recovery. Further, coming on top of already elevated food and other commodity prices, the spike in oil prices has engendered inflation concerns. Headline inflation has risen noticeably in a number of advanced economies, especially in the Euro area and the UK so much so that an increasing number of emerging economies have begun monetary tightening.

Apart from international oil and other commodity prices, RBI has not referred to the likely impact on global economy of the earthquake, tsunami and the nuclear disasters in Japan. It is too early to make such an assessment of macro-economic consequences but as normalcy gets restored (which could be too gradual), RBI says, expenditure on reconstruction may provide a boost to the economy. However, substitution of thermal for nuclear energy in Japan may exert further pressure on petroleum prices.

With the latest policy rate tightening — the eighth times since March 2010 — RBI expects it would help continue to rein in demand-side inflationary pressures while minimising risks to growth. While hoping it would also help to manage inflationary expectations and contain the spillover of food and commodity prices into more generalised inflation, RBI has given clear indication that it is likely to persist with the current anti-inflationary stance, given the current and evolving growth and inflationary scenario.

What is left unsaid is that there is no lkelihood of inflation easing up, as policy-makers in the Government would like the country to believe. Economists and market analysts expect further rises in key policy rates by at least 50 basis points during the latter half of 2011. RBI itself would come out with a more detailed assessment when it announces the Monetary and Credit Policy for 2011-12 on May 3 next.

On the current account deficit, contrary to earlier apprehension of its exceeding 3 per cent to 3.5 per cent of GDP, RBI says it would be contained at 2.5 per cent in 2010/11. While the CAD this year has been financed comfortably, it is necessary to focus on the quality of capital inflows with greater emphasis on attracting long-term components, including foreign direct investment (FDI), so as to enhance the sustainability of the balance of payments (BoP) over the medium-term, RBI statement said. (IPA Service)