RBI bullish on growth, looks to tame inflation

MUMBAI: India has probably decoupled from the Western world, as domestic consumption may sustain economic expansion, setting the stage for quicker normalisation of monetary policy instead of baby steps to arrest soaring inflation.

“Notwithstanding the impact of the base effect and possible weakness in global demand which may cause some moderation in the pace of growth, industrial activities could be expected to remain buoyant,” the Reserve Bank of India said in its review of the macro economy. “Private consumption and investment demand would be the two major drivers of growth in 2010-11.”

The central bank’s reading of the economy may lead to at least a 25 basis points increase in policy rates on Tuesday at the quarterly review.

A basis point is 0.01 percentage point. It may increase the reverse-repurchase rate, or the rate at which it absorbs excess liquidity from banks, to 4.25%. The repurchase rate, or the rate at which it lends to banks, may go up to 5.75%.

“Domestic factors do call for a faster pace of normalisation,” Citigroup economists, including Rohini Malkani, wrote in a note to clients. “We expect to see an upward revision to both GDP and inflation forecasts.”

The Reserve Bank has forecast an 8% growth, with an upward bias for the fiscal, and inflation as measured by wholesale prices at 8.5%. Wholesale prices rose 10.55% in June, after jumping 11.23% in April, the highest in 19 months. Industrial production has been growing at more than 10% since October. Services such as tourism and rail freight traffic are also expanding fast.

The Reserve Bank of India governor D Subbarao has been taking ‘baby steps’, raising policy rates by 75 basis points this year, to contain inflation, which is running at double digits since February, leaving increases ineffective. Some have accused the central bank of falling behind the curve. With concerns about the global economy slipping into a double-dip recession receding, he could take stronger actions to contain inflation expectations that is threatening sustained growth.

“For containing the inflation persistence and anchoring inflationary expectations, anti-inflationary monetary policy actions become a necessity, notwithstanding the importance of supply augmenting structural measures,” said the review note.

This may be in contrast to developed nations such as the US and the UK, where central bankers are worried about weak consumer demand due to high unemployment. Central banks, including the Federal Reserve, have promised to keep rates near zero for an extended period to stimulate demand which is proving elusive.

Price rises in the West are expected to remain modest due to spare capacities, with risk of even deflation, contrary to developing economies such as India and China. In India, non-food manufacturing inflation accelerated from near zero in November 2009 to 7.3% in June, reflecting higher input costs, recovering private demand and associated return of pricing power, the central bank said.

The Professional Forecasters’ Survey conducted by the Reserve Bank in June 2010 places median GDP growth rate for 2010-11 at 8.4%, higher than 8.2% in the previous survey. Industrial outlook survey suggests improvement in business sentiments. Improving government finances also provides room for the governor to roll back the easy stance at a faster pace. The spectrum bounty of more than Rs 1-lakh crore could cut the fiscal deficit by 1 percentage point, easing fears of higher government borrowing.

“The possibility of crowding out pressures has reduced after the better- than-expected collections through 3G/BWA spectrum auctions,” said the review. Reserve Bank may also factor in asset price increases and its impact on overall inflation. “A sustained and rapid rise in housing prices over successive quarters remains an area of concern from the standpoint of their possible spillover to demand pressures and the general price level as well as financial stability.”