The Reserve Bank of India (RBI) is unlikely to cut interest rates till it has exorcised the inflation monster. This is the message that comes through in its annual report for 2013-14, released on Thursday.
High and persistent inflation has become a key risk to growth and to overall macroeconomic stability, the report said.
This observation indicates that the central bank will not cut interest rates unless it sees clear signs of inflation coming down. This could disappoint industry, which has been clamouring for lower interest rates.
Since Raghuram Rajan took charge as Governor in September 2013, the RBI has raised the repo rate — the rate at which it provides short-term liquidity to banks — three times to rein in inflation, by 25 basis points each, to 8 per cent.
High food inflation Retail inflation increased to 8 per cent in July (against 7.5 per cent in June) as the prices of vegetables increased substantially on the back of deficient rainfall.
Despite the recent decline in global crude oil prices, the RBI cautioned that any threat to crude oil supply (due to geopolitical tensions) could have a sharp impact on prices and as such remains a risk.
It also said the revisions in administered prices in 2014-15, which include railway passenger fares and freight fares apart from the staggered increases in diesel prices, could exert some pressure on general price levels.
The inflation (retail) projection of 8 per cent by January 2015 remains within reach. However, the RBI observed that risks around the medium-term inflation path, and especially the target of 6 per cent by January 2016, are still on the higher side.
In other words, setting interest rates in a manner that steers clear of inflation and economic weakness will remain a challenge. “The Reserve Bank remains committed to supporting the disinflationary process,” the report said.
Pointing out that the economy stands at a crossroads that could take it from a slow bumpy lane to a faster highway, the RBI said some acceleration is likely in 2014-15, which could take growth to around 5.5 per cent (from 4.7 per cent in 2013-14).
Revival on the cards Deficiency in rainfall during this monsoon season poses some downside risks, but the overall growth in 2014-15 is likely to be better than the previous year, with the likely revival in industrial and construction activities.
“With greater political stability and a supportive policy framework, investment could turn around. The economy is poised to make a shift to a higher growth trajectory,” it said.
The RBI observed that the economy requires policies that address growth through higher productivity, as well as greater investment and use of labour.
The RBI said fiscal consolidation, which is key for both internal and external stability, can be achieved by further expenditure reduction. This can be done through better targeting of subsidies, frequent price revisions of domestic LPG and fertilisers, and considerably limiting interest subventions, said the report.