First Quarter Review of the Monetary Policy for 2011-12
-Announced on the 26th July 2011
II. Outlook and Projections
Domestic Outlook (contd)
39. In its May 3 Policy Statement, the Reserve Bank made a baseline projection for WPI inflation for March 2012 at 6.0 per cent with an upside bias. Some of the upside risks have subsequently materialised and added to inflation pressures.
40. First, prices of petroleum products such as petrol, diesel, kerosene and LPG were raised in May/June 2011. The increase in administered petroleum product prices in June 2011 will add about 70 basis points to WPI inflation as a direct impact. In addition, there will be an indirect impact which will play out during the course of the year. There will be further upward pressure on inflation due to another one-off factor. The sharp upward revision in domestic crude prices under the minerals category, with a weight of 0.9 per cent in WPI, added about 40 bps to WPI inflation in April 2011. A similar impact may be felt in March 2012 unless crude prices moderate significantly.
41. Second, minimum support prices (MSPs) for some agricultural commodities, particularly rice and pulses, were increased significantly. This is likely to exert upward pressure on food inflation even if the harvest is good.
42. Third, non-food manufacturing inflation persists at elevated levels, reflecting underlying demand pressures. While early corporate results for Q1 of 2011-12 indicate some moderation in margins, suggesting reduced pricing power, the pass-through of higher commodity prices into more generalised inflation remains significant.
43. Going forward, the inflation outlook will be shaped by the following factors. First, it will depend on the overall performance of the south-west monsoon. Even if there is no major deficiency at the aggregate level, an appropriate spatial and temporal distribution of rainfall during the whole season is crucial. As price pressures in respect of protein-rich items persist, any shortfall in rainfall or its pattern could pose significant risks to food inflation.
44. Second, the outlook for crude oil prices in the near future is uncertain. The price of the Indian crude basket rose to US$ 114 per barrel as on July 21, 2011 after declining to US$ 110 per barrel in May from US$ 118 per barrel in April. Going by the recent trend, the price of oil could remain volatile as a consequence of the pace of global recovery, liquidity conditions and, importantly, the overall oil supply situation.
45. Third, there is still an element of suppressed inflation in the economy. Despite the recent increase in administered fuel prices, under-recoveries on account of subsidised fuel are estimated at over `1,00,000 crore (1.0 per cent of GDP) of which a major portion may have to be borne by the Government. Regardless of how this issue is handled, there will be implications for inflation. If the Government raises administered prices, the inflation implications are straightforward. If the Government absorbs this in the fiscal accounts, the resultant expansionary impact will add to inflation pressures. Notwithstanding the inflationary impact, if the crude prices do not moderate in the near-term, it will be desirable to pass on the increase, both from the perspective of energy conservation and containing demand.
46. Fourth, there are administered items in the WPI basket, whose prices might be increased in the coming months. For instance, coal prices were increased significantly in February 2011. Since coal is an input into electricity generation, administered electricity prices might also increase. But the timing of changes in administered prices is uncertain, which will have a bearing on the inflation path.
47. Keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario, the baseline projection for WPI inflation for March 2012 is revised upward from 6.0 per cent with an upside bias, as indicated in the May 3 Policy Statement, to 7.0 per cent (Chart 2). As indicated in the May 3 Policy Statement, inflation is expected to remain at an elevated level for a few more months, before moderating towards the later part of the year.
48. Notwithstanding the current inflation scenario, it is important to recognise that in the last decade, the average inflation rate, measured in terms of both WPI and CPI, had moderated to around 5.5 per cent. As mentioned in the May 3 Policy Statement, the Reserve Bank is strongly of the view that controlling inflation is imperative both for sustaining growth over the medium-term and for increasing the potential growth rate. This is a critical attribute of a favourable investment climate, on which the economy's potential growth depends. Fiscal consolidation can contribute to a sustainable growth path by rebalancing demand away from government consumption and towards investment.
49. Monetary policy will, therefore, condition and contain perceptions of inflation in the range of 4.0-4.5 per cent, with particular focus on the behaviour of the non-food manufacturing component. 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. The achievement of this objective will be helped by concerted policy actions and resource allocations to address domestic supply bottlenecks, particularly on the food and infrastructure fronts.
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