Mumbai: The Reserve Bank of India (RBI) said on Thursday that lower interest rates alone can’t help prop up investment and put Asia’s third largest economy back on the growth path, reiterating that the government needs to embark on policy reforms to iron out structural issues and fast-track infrastructure projects.

RBI governor D Subbarao. Photo: Abhijit Bhatlekar/Mint

In the 31 July first quarter policy review, RBI lowered its growth projection for the economy to 6.5% from 7.3% for fiscal 2013. It also raised the year-ending inflation projection to 7% from 6.5%, while keeping the policy rate unchanged at 8%. RBI follows a July-June fiscal year.

According to the central bank’s assessment, money borrowed by companies from banks for new investments has fallen sharply—by 46% to about 2.1 trillion in fiscal 2012 from 3.9 trillion a year ago—and the completion of existing projects is getting delayed.

Investment in infrastructure has slumped 52% to 1 trillion from 2.2 trillion a year ago, with power and telecom accounting for most of the fall, even as investment in road, port and airport projects has also decelerated sharply.

The drop in corporate investment in large projects “has had a ripple effect on the economy", RBI said.

“What can stimulate a recovery?" the central bank asked in its annual report and also offered the answer: In the absence of signs of global recovery, domestic policies have to be adjusted to boost demand and investment.

There is limited fiscal and monetary space available to provide a direct stimulus to domestic growth, and the government should cut down on subsidies and step up capital expenditure, RBI said.

“Such an action would also provide some space for monetary policy, but, importantly, lower interest rates alone are unlikely to jump-start the investment cycle," it said.

With growth slowing, the government may fall short of the budgetary target on indirect taxes as well as non-tax revenue, it said.

The divestment target could also be hard to achieve in a falling equity market, RBI said. The divestment target for the current fiscal is 30,000 crore, out of which 124.97 crore has been achieved so far. The target was 40,000 crore last year and only about one-third— 13,894.05 crore—was raised.

Despite the growth slowdown, “inflation control remains the cornerstone of monetary policy as upside risks to inflation remain", the annual report said.

Even though wholesale price inflation has dropped to the sub-7% level in July—a 32-month low 6.87%—it may not be sustained at this level because of the erratic monsoon and the rise in the minimum support prices for foodgrain. RBI said there could be a considerable price rise in pulses— a drop in their production due to drought globally is likely to aggravate the situation.

Rainfall up to mid-August was deficient by 16%, according to government estimates, even as RBI’s own estimate pegged the deficiency at 21%. The deficient monsoon has emerged as a new uncertainty in the growth equation, the annual report said.

There are signs of suppressed inflation in diesel, electricity, coal and fertilizer prices that need to be adjusted upwards, RBI suggested.

“Inflation prevailed above the threshold level at which the growth-inflation trade-off stops working and high inflation turns inimical to growth and growth sustainability," it said.

The current high-inflation phase is one of the longest since the mid 1990s, the annual report said. Between January 2010 and November 2011, average inflation remained at 9.6%.

RBI governor D. Subbarao had said earlier that India’s inflation threshold is 5%, beyond which the price rise starts to eat into growth.

“The inflation outlook for 2012-13 remains better than the previous year, though the inflation trajectory could remain sticky," the annual report said.