core sector communique

Difficult year ahead for economy, cautions RBI

The Reserve Bank of India has cautioned that the Indian economy needs to brace up for a difficult year ahead.

Inflation continues to be a macroeconomic challenge due to weak supply response, the central bank said in its Annual Report for 2010-11, released on Thursday.

If global financial problems amplify and slows down global growth markedly, the RBI may have to lower its 8 per cent growth projection, it warned.

Currently, global oil and commodity prices, even after some correction, remain high and could affect growth.

The RBI has assessed that a 10 percentage points increase in oil price inflation, if passed through fully, would lead to a reduction in real GDP growth by about 0.3 percentage points.

“We continue to expect that inflation is likely to remain high and will moderate only in the latter part of the year to about 7 per cent. The decline in global commodity prices has not been very significant.

“Should global recovery weaken, global commodity prices may decline further, which may have a positive effect on domestic inflation. But till that starts happening we should not anticipate and draw comfort from it,” said Dr Subir Gokarn, Deputy Governor, RBI.

So, post November-December, if inflation begins to cool, that is when the RBI can review its anti-inflationary stance, he added.

“Even though you have seen an upward adjustment in petroleum product prices recently, the gap is still not fully covered. There is still a bit of latent hidden inflation,” explained the Deputy Governor.

In the context of a weakening global economy and the likelihood of some spillover to the domestic economy, the twin deficits — fiscal and current account — require close monitoring.

On current assessment, the fiscal deficit is likely to overshoot the budgeted projection of 4.6 per cent of GDP for 2011-12.

On the other hand, in the baseline scenario, the current account deficit would remain at a sustainable level in 2011-12.

Capital Flows

The public debt fragilities in the Euro Zone and the growth slowdown in the US may impact capital flows.

The inward FDI flows are likely to be much larger in 2011-12.

Portfolio flows could be volatile, though India is likely to remain one of the preferred destinations due to the differential growth rates.

The balance of payments situation remains manageable, though it necessitates continuous monitoring due to the global uncertainties.