The RBI has toughened its stance, belying expectations of a 25 basis point rise, even as bankers had suggested a ‘pause’ in rate revision as they saw signs of credit growth slowing while deposits were rising. In its First Quarterly Review (April-June) of Monetary Policy, 2011-12, RBI rated inflationary risks staying high above comfort as the dominant macro-economic concern for the best part of the current fiscal year.

Indeed it has raised the baseline projection for WPI inflation for March 2012 from 6 per cent “with an upward bias” in its Annual Policy Statement of May 3 to 7 per cent. This is “keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario”. Inflation is expected to remain at an elevated level for a few more months, before moderating towards the later part of the year, it hopefully added.

In its first quarter review, RBI has not touched the Bank Rate and CRR which continue to remain at 6 per cent both. The tenor of the latest review is that the economy, with its notoriously unchecked high inflation over three years, will continue to remain gripped by price pressures ,partly fuelled by the volatility in global commodity prices, while domestic private consumption demand is strong with no corresponding supply side responses.

The Review is not unduly concerned about some moderation in growth in opting, for the second time, to effect a 50 basis point increase in the key lending rate, after the May 3 revision. It has retained its growth projection at 'around 8 per cent'. But the sizeable rise in key lending rate, would not be welcome to large segments of borrowers besides the corporate sector, and RBI has also conveyed a strong message for Government in regard to both actions needed on the supply side to moderate prices as well as fiscal management in ways that do not generate expansionary impact on prices. .

How the UPA manages the economy and the polity in one of the most turbulent periods in the country's history since independence would also have a critical bearing for the Congress which is leading the alliance at the Centre, in the context of impending state elections in UP, Punjab and a few other states.

Growth has certainly eased in the first quarter, as reflected in industrial slowdown in April-May. This, RBI noted, reflected in part “a lagged response” to the monetary tightening effected since October 2009. Moderating domestic growth would certainly help ease inflationary pressures, which may be reinforced by possible softening global commodity prices. But the RBI has kept its May 3 growth projection of “around 8 per cent.

But inflation remains the dominant macroeconomic concern, it says. Provisional figures of WPI April to June, all above 9 per cent, are likely to be revised upwards, and thus the headline for the first quarter of 2011/12 has remained “stubbornly close to double digits” and inflationary pressures are also broad-based, food and non-food. Both the level and the persistence of WPI inflation are a cause for concern, RBI said. High non-food inflation (7.2 per cent in June) suggests that producers are able to pass on rising commodity input prices and wage costs to consumers.

In the current fiscal, policy rates were raised by 75 bps in Q1, and this had raised operational policy rates by 425 bps in a span of 15 months since mid-March 2010 – one of the sharpest monetary tightening seen across the world, RBI said but it helped keep the real lending rates positive despite high inflation. Tight monetary and deficit liquidity conditions are bringing desired adjustments and are likely to prevail in near term. Deposit growth picked up and credit growth, though decelerating in the first quarter, remained above indicative trajectory of 19 per cent and has not showed the seasonal slack. Non-bank finance to commercial sector also increased significantly.

Reserve money growth has decelerated, but money supply remains above trajectory. Keeping in view the evolving growth-inflation dynamics, RBI has revised down broad money supply growth from 16 per cent, set out in May 3 policy statement, to 15.5 per cent. Non-food bank credit growth projection is also revised downwards from 19.0 per cent to 18.0 per cent. At the same time, RBI emphasizes the importance of appropriate actions for addressing supply bottlenecks, especially in food and infrastructure, without which questions about the ability of the economy to sustain the current growth rate without significant inflationary pressures come to the fore. “The economy's ability to grow rapidly for any length of time without provoking inflation is dependent on implementing policies, with corresponding resource allocations, which will allow the supply of various products and services to keep pace with demand.”

On price developments, RBI has cited the revision of administered petroleum product prices in June which would have direct impact on inflation while the increase in minimum support prices would exert upward pressure on food inflation. The outlook for the coming months would be shaped by, firstly, the overall performance of south-west monsoon as any shortfall in rains or its uneven spread could again pose significant risks to food inflation. Secondly, uncertainty surrounds the crude oil price trends. Thirdly, further revisions in administered prices of POL products or electricity following the revision of coal prices would all add to inflationary pressures. The timing of these changes is uncertain but it would have a bearing on inflation path, RBI noted.

The impact of Government policies and actions in relation to both administered prices and fiscal management on growth and inflation is also highlighted in the RBI review. Referring to the Centre’s budgeted fiscal deficit 4.6 per cent of GDP for 2011-12, RBI says, subsequent developments have made the achievement of this target much more of a challenge. On the expenditure side, the subsidy burden will, in all likelihood, overshoot the budgeted amount in 2011-12 significantly, despite the recent revision in petroleum product prices. On the revenue side, while the tax cuts announced in June 2011, as part of the upward price adjustment of petroleum products, will primarily help in bringing down the magnitude of under-recoveries of oil marketing companies (OMCs), the revenue loss to the Central Government from such tax cuts (about 0.3 per cent of GDP) will impact both the fiscal and revenue deficits.

Since large fiscal deficits have been a key source of demand pressures, RBI says fiscal consolidation is critical to managing inflation. While meeting quantitative targets, the Government also needs to focus on the quality of expenditure to sustain the fiscal consolidation process, which, in turn, will help contain aggregate demand and raise potential output, the review added. A rebalancing of demand from government consumption to private investment is necessary in 2011-12. This rebalancing will require shifting of government expenditure from revenue expenditure to capital expenditure, beyond what has been envisaged in the budget. Reduction in subsidies through better targeting is also needed. Despite recent initiatives to scale down subsidies, there is likelihood of a fiscal slippage in 2011-12, according to RBI.

Summing up, RBI says its latest policy actions would reinforce the cumulative impact of past actions on demand, maintain the credibility of the policy commitment to controlling inflation and thereby keep medium-term inflation expectations anchored. Significantly, RBI adds that in the absence of complementary policy responses on demand and supply sides (on the government side), stronger monetary policy actions would be required in taming inflation. (IPA)