5% inflation target a challenge; macro stability key: Moody's

NEW DELHI: RBI's target to bring down retail inflation at 5 per cent by March 2017 will face some risks from monsoon uncertainty and execution of 7th Pay Panel recommendations, while macro-economic factors will be critical for sustaining growth, Moody's Investors Service said today.

It also said that a growth-oriented forthcoming Budget, while controlling inflation at the same time, will help support India's sovereign credit rating.

The Reserve Bank expects retail inflation to be around 6 per cent in January 2016 and lower further to 5 per cent by March 2017.

"The budget announcement at the end of February should offer some insight into the Pay Commission implementation, other fiscal measures and their likely impact on growth and inflation.

"If they are successful in promoting growth, while keeping inflation in line with targets, the combination would support the sovereign credit profile," Moody's Investors Service Associate MD (Sovereign Risk Group) Atsi Sheth said.

Finance Minister Arun Jaitley will present the Budget for 2016-17 on February 29.

Sheth said uncertainty will prevail on monsoon until the middle of calendar year.

"Because of the links between weak monsoons and high inflation, monsoon uncertainty will likely constrain monetary policy in 2016, even as subdued global growth poses headwinds to India's economic recovery," she said.

Sheth said this target faces some risks from the implementation of the Pay Commission recommendations and if 2016 is a third consecutive year of weak monsoon.

In its final monetary policy for current fiscal, RBI today left the key policy rate unchanged but indicated at accommodative stance saying with "inflation moving closer to the target" there would be more room for rate cut to support growth.

Sheth said RBI's statement underscored that macro-economic stability - as reflected in inflation, fiscal deficit and current account deficit trends - holds the key to sustaining India's growth at a higher level.

"This is largely in line with our view, which is based on our observation that while India's GDP growth has accelerated to much higher levels before, sustaining this high pace for an extended period has often been impeded in the past by a build-up in macro-economic imbalances - such as high inflation and/or twin current account and fiscal deficits," she said.

Therefore, from a sovereign credit perspective, avoiding a build-up in the above imbalances is as important as supporting an acceleration in growth.

"The RBI's statement today suggests that policy-makers too are focused on the combination of macro-economic variables (growth, inflation, fiscal and current account deficits), rather than growth alone," she added.