Announcing the Monetary Policy for 2011-12, Governor Dr D. Subbarao said: 'High and persistent inflation undermines growth by creating uncertainty for investors, and driving up inflation expectations. An environment of price stability is a pre-condition for sustaining growth in the medium-term. Reining in inflation should therefore take precedence even if there are some short-term costs by way of lower growth'.

The Governor had a word of cheer for millions of bank customers by raising the savings bank deposit interest rate from 3.5 to 4 per cent. This is being done, he said, pending a final decision on the interest rates based on feedback received on the discussion paper which RBI had put out recently. Many banks have been averse to raising the present savings rate on bank balances.

The new Monetary Policy stance in a way resolves the riddle of growth- inflation trade off, given the seriousness of a generalised inflation that grips the economy. The new policy also seeks to do a bit of 'cooling' the economy from getting over-heated as global commodity prices are likely to remain firm and may even increase during the year. Already, as RBI Governor points out, the headline and core inflation have significantly overshot 'even the most pessimistic projections' over the past few months.

The statement underlines the need for aggregate demand management as a moderation in demand should help reduce pricing power and the extent of pass-through of commodity prices. But more significantly, the statement calls attention to the need to cap petroleum and fertiliser subsidies, which could pose a test at the prevailing crude oil prices. Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, 'the Reserve Bank believes that this needs to be done as soon as possible. Otherwise, the fiscal deficit will widen and will counter the moderating trend in aggregate demand'.

Going forward, high oil and other commodity prices and the impact of the Reserve Bank’s anti-inflationary monetary stance will moderate growth, Governor said. Based on the assumption of a normal monsoon, and crude oil prices averaging $110 a barrel over the full year 2011-12, RBI's baseline projection of real GDP growth for 2011-12, for policy purposes, is 'around 8 per cent' (as against the Finance Ministry's 9 per cent assumption in the budget).

On prices, the central bank expects inflation, 'primary macro-economic concern' to remain elevated in the first half of the year close to around the 9 per cent seen in March 201l, before declining in the latter half of the year to 6 per cent by March 2012. 'Keeping in view the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, our baseline projection for WPI inflation for March 2012 is 6 per cent with an upward bias. This trajectory, RBI adds, is conditional on 'appropriate policy actions over the year'.

RBI says its policy statement is framed with the objective of maintaining an interest rate environment that moderates inflation and fostering a climate of price stability conducive to sustained growth in the medium-term coupled with financial stability. The monetary policy trajectory, initiated in this Annual Statement, according to RBI is based on the basic premise that high inflation, over the long run, is inimical to sustained growth 'as it harms investment by creating uncertainty. Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence'.

There are other risk factors, mainly global, listed in the Policy Statement, for both growth and inflation expectations. For growth, downside risks include sovereign debt problem in the euro area, high commodity prices, especially oil, and possible abrupt rise in long term interest rates in advanced economies, and accentuation of inflationary pressures in emerging market economies (China, for instance). If the current multi-speed recovery in advanced and emerging economies, already slow and fragile, slackens further because of any of these factors, the impact for India would be through trade, finance and confidence channels.

Given the uncertain path of oil prices for the future (due also to the ongoing unrest in oil-producing region of Middle East and North Africa), RBI says, global prices would remain a significant risk factor for both domestic growth and inflation. Higher subsidy burden could make budgeted fiscal targets difficult of achievement. Also, persistently high food prices are likely to exert sustained upward pressure on wages, thus transmitting through to wider cost pressure on prices. Lastly, oil and commodity prices at elevated levels could widen the current account deficit and pose a challenge for financing it.

The Policy statement has introduced a new Marginal Standing Facility (MSF) from which banks can borrow overnight but at interest rate one per cent above repo rate,which would be 8.25 per cent. Among developmental and regulatory changes, RBI has announced that bank loans to micro-finance institutions on or after April 1 will be eligible for classification a priority sector loans.

In regulatory measures for commercial banks, the provisioning requirements on certain categories of non-performing advances and restructured advances are being enhanced. Secondly, investment by banks in liquid schemes of debt oriented mutual funds will be subject to a prudential cap of 10 per cent of their net worth as on March 31 of the previous year. (IPA Service)