Macroeconomic and Monetary Developments : Third Quarter Review 2009-10
-Released on January 28, 2009
Inflation emerged as a major concern during the third quarter, dominated by significant supply factors.
On year on year basis, WPI headline inflation in December 2009 was at 7.3 per cent, whereas WPI inflation excluding food articles was 2.1 per cent, which suggests the concentrated nature of the inflation so far.
Food items (i.e. primary and manufactured) with a combined weight of 27 per cent in the WPI basket have exhibited 21.9 per cent increase in prices.
In December 2009, there have been signs of emergence of generalised inflation.
Weekly WPI data on primary articles indicate that primary food articles prices have increased by 17.4 per cent (y-o-y) for the week ending on January 16, 2010.
The concentrated pressure on headline inflation arising from high food prices entails the risk of getting transmitted over time to other non-food items through expectations driven wage price revisions, and thereby magnifying into a generalised inflation.
While anchoring inflation expectations becomes important in such a situation, addressing supply constraints would be critical for enhancing the effectiveness of any anti-inflationary policy measures.
Growth and Inflation Outlook
In view of the dominance of food price inflation, balancing the policy needs of supporting durable return to the high growth path while avoiding a situation of generalised increase in inflation through monetary policy actions has emerged as a delicate challenge for the Reserve Bank.
The upside prospects for further acceleration in growth in the near term derive support from several factors, including signs of revival in private demand, both consumption and investment; possibility of strong industrial recovery continuing; outlook for a better Rabi crop; export growth remaining positive; favourable capital market conditions; and the general improvement in business sentiments as per the Reserve Bank’s business expectations survey as well as similar surveys of other agencies.
According to the Reserve Bank’s Professional Forecasters Survey conducted in December 2009, the outlook for 2009-10 growth has been revised upwards from 6.0 per cent to 6.9 per cent.
The downside risks to growth in the near-term could be seen in terms of the adverse impact of the deficient monsoon on kharif crop in the GDP of next quarter, weakness in services activities that are dependent on external demand, notwithstanding the signs of improvements in recent months; and possible pressures on interest rates that may emerge from revival in demand for credit from the private sector as well as inflation expectations. Risks to global growth and higher oil prices also need to be given due consideration.
The outlook for inflation will be conditioned by the upside risks in terms of persistence of supply side pressures in the near term, possible return of pricing power with stronger recovery in growth, further revival in private demand with improving consumer and business confidence, possible spurt in global commodity prices in response to recovery in the EMEs and advanced economies, and the possibility of high CPI and food price inflation spilling over to cause a generalised inflation.
The possible sources of comfort that could ease some of the pressures on inflation include arrival of certain new crops in the market – particularly vegetables, additional release from the high level of buffer stocks of foodgrains, and negative output-gap persisting for some more time, which in turn may help in containing the demand side pressures.
The growth and inflation mix for India is increasingly becoming asymmetric vis-ŕ-vis the pattern in other G-20 countries. The possibility of surges in capital inflows and the associated domestic liquidity conditions may also affect inflationary expectations, besides the impact of the rebound in international commodity prices in response to global recovery.
With a stronger recovery in India, the risk of food price inflation causing generalised inflation cannot be ignored.
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