Mumbai: The Reserve Bank of India (RBI) on Thursday reiterated its concerns on an impending rise in inflation and said the biggest challenge before the central bank is to deal with the “unpleasant” combination of “subdued growth” and the “emerging risk” of high inflation.
The other concerns of RBI include low growth in bank credit and large government borrowing programme—as much as Rs4.51 trillion—to bridge an estimated 6.8% fiscal deficit in 2009-10.
Such a high government borrowing and fiscal deficit, according to RBI’s annual report, could worsen inflation and put upward pressure on interest rates.
Policy matter: The Reserve Bank of India. The central bank says it will not make inflation targeting its lone policy objective. Harikrishna Katragadda / Mint
A deficient monsoon has also aggravated fears of possible spike in inflationary expectations. The rainfall shortage could affect both the growth and inflation outlook, the annual report said.
The report, which contains the central bank’s balance sheet, traditionally looks back at the year gone by and also assesses prospects of the Indian economy in the current fiscal year.
RBI follows a July to June financial year.
Among other things, the report stressed the need to divest government stake in public sector undertakings to generate resources, financial sector reforms with special emphasis on insurance and pension, and a vibrant bond market.
In its quarterly review of monetary policy in July, the central bank revised the economic growth projection to “6% with an upward bias” and the year-end inflation projection from 4% to 5%. The annual report has not revised any of these projections.
Since June, inflation based on wholesale prices has been declining but RBI expects this to grow from October. While inflation based on wholesale prices has been negative, retail inflation, based on the consumer price index, has remained high, in double digits.
RBI has admitted that inflationary expectations have not declined but it will not make inflation targeting its lone policy objective and instead continue with multiple objectives of price stability, growth and financial stability.
A key to economic recovery is low interest rates but the massive borrowing by the government has already pushed up the government bond yield with the 10-year benchmark bond yield rising to 7.29% on Thursday, up from 4.86% seen in January. Bankers and bond dealers expect RBI’s policy rates to rise some time next year.
Since October 2008, in the aftermath of the collapse of Wall Street investment bank Lehman Brothers Holdings Inc., that plunged the global financial system into the worst ever credit crunch, RBI has cut its cash reserve ratio, or the portion of deposits that banks are required to park with the central bank, by 400 basis points to 5% and policy rate by 575 basis points to 3.25%. One basis point is one hundredth of a percentage point.
It has also opened several other windows to pump Rs5.6 trillion of liquidity into the system.
The report has emphasised on the need to withdraw “monetary accommodation” as an expansionary monetary policy, which puts pressure on inflation and a higher inflation in turn works against economic recovery.