First Quarter Review of the Monetary Policy for 2010-11
-Announced on the 27th July 2010
II. Outlook and Projections
34. WPI inflation moved to double digits in February 2010 and has remained there since then. Even as food price inflation and consumer price inflation remain at elevated levels, inflation is now being significantly driven by demand side factors.
35. In its policy statement of April 2010, the Reserve Bank had placed the baseline projection for WPI inflation for March 2011 at 5.5 per cent. Subsequently, there has been an increase in prices of many administered/regulated items such as petroleum products, iron ore and electricity. The recent partial deregulation and increase in administered prices of petroleum products is welcome from the long-term fiscal consolidation and energy conservation perspective. Nevertheless, it will have an inflationary impact in the short term. Assuming that global crude oil prices remain stable, the immediate impact on inflation will be about one percentage point on WPI inflation, with second round effects coming through in the months ahead.
36. Minimum support prices (MSPs) for some agricultural commodities have also been increased to incentivise farmers. Food price inflation has remained at an elevated level for over a year now, reflecting structural bottlenecks in certain commodities such as pulses, milk and vegetables. The Reserve Bank’s quarterly inflation expectation survey conducted during the first fortnight of June 2010 indicates that short-term inflationary expectations have increased marginally.
37. Going forward, the outlook on inflation will be shaped by the following factors. First, the spatial and temporal distribution of rainfall in the remaining period of south-west monsoon 2010 is critical. A good kharif harvest will act as a major dampener on short-term food price inflation. Second, global energy and commodity prices have been showing distinct signs of softening over the past few weeks as expectations of global growth have moderated. If energy prices continue to decline, this will offset the inflationary impact of the recent fuel price hike. Further, idle global capacity in a range of sectors will allow competitive imports to reduce the momentum in domestic prices. Third, consequent on the strengthening of domestic growth drivers, demand-side pressures are building up.
38. Taking into account the emerging domestic and external scenario, the baseline projection for WPI inflation for March 2011 has been raised to 6.0 per cent from 5.5 per cent as indicated in the April policy statement (Chart 2).
39. The Reserve Bank will endeavour to achieve price stability and anchor inflation expectations. In pursuit of these objectives, the Reserve Bank will continue to evaluate an array of aggregate and disaggregated measures of inflation in the context of the evolving macroeconomic situation.
40. Notwithstanding the current inflation scenario, it is important to recognise that in the last decade (2000-01 to 2009-10), the average inflation rate, measured both in terms of WPI and CPI, moderated to around 5 per cent from the historical trend rate of about 7.5 per cent. A combination of factors played a role in this transformation. One of these was a monetary policy committed to keeping inflation low and stable. This record is an important foundation for the credibility of monetary policy and, more generally, the broader inflation management framework. Against this backdrop, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5 per cent. This will be in line with the medium-term objective of
3.0 per cent inflation consistent with India’s broader integration into the global economy.
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