Monetary Policy Statement for 2011-12 Press Statement by Dr. D. Subbarao, Governor
20. Inflation has been, and remains, a primary macroeconomic concern. Last year, inflation was driven by a combination of structural and transitory factors. Based on drivers of inflation, the year gone by, could broadly be divided into three periods.
In the first period from April to July 2010, WPI increased by 3.5 per cent, and this was driven largely by food items.
During the second period from August to November 2010, WPI increase decelerated to 1.8 per cent, with the major driver being non-food primary articles.
In the third period, from December 2010 to March 2011, WPI increased sharply by 3.4 per cent, driven primarily by non-food manufactured products.
Inflation pressures, which initially emanated from food, clearly became generalised as the year progressed.
21. Going forward, the inflation outlook will be shaped by the following factors:
The first factor is, when administered fuel and power group prices might be revised and by how much.
Second, the outlook for crude oil prices in the near future is uncertain given the geopolitical situation in the Middle East and North Africa. In any case, the likelihood of oil prices moderating significantly is low.
The third factor that will shape the inflation outlook is the sharp increase in the prices of several important industrial raw materials such as minerals, fibres, rubber, coal and crude oil. In addition, there is also upward pressure on wages. To the extent the increase in input prices translates to output prices, it will have an influence on the inflation path.
Finally, the behaviour of the monsoon will be a critical factor in shaping inflation expectations on the way forward.
22. Keeping in view the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, our baseline projection for WPI inflation for March 2012 is 6 per cent with an upward bias.
23. As regards the trajectory over the year, inflation is expected to remain at an elevated level in the first half of the year, before gradually moderating to 6 per cent by March 2012. This trajectory is conditional on appropriate policy actions over the year.
Monetary and Liquidity Conditions
24. Liquidity conditions remained abnormally tight for much of last year owing to a combination of structural and frictional factors. The LAF corridor stayed almost entirely in the injection mode during the year. You will recall that the Reserve Bank had instituted a number of measures to ease the excessive tightness in the system.
25. Liquidity conditions have eased significantly in recent weeks, following a sharp reduction in government cash balances, and moderation in the credit-deposit ratio of banks. The liquidity situation is now within the comfort zone of the Reserve Bank.
26. A brief, albeit important, comment about the external sector. Exports showed remarkable buoyancy in the last quarter of last fiscal. The current account deficit (CAD) was 3.1 per cent of GDP for the first three quarters, April-December 2010. Factoring in the better performance in the last quarter, CAD is now estimated to have moderated to around 2.5 per cent of GDP for the full year, 2010-11 as compared with 2.8 per cent for the year before, 2009-10.
27. Now let me highlight the risks to our growth and inflation projections:
First, there are several downside risks to global growth at this stage such as: (a) sovereign debt problem in the euro area, (b) high commodity prices, especially oil prices, (c) possible abrupt rise in long-term interest rates in advanced economies with implications for fiscal adjustment; and (d) accentuation of inflationary pressures in emerging market economies. Should the global recovery slacken because of any or some of these factors, it will impact our economy through trade, finance and confidence channels.
Second, global commodity prices are a significant risk factor for both domestic growth and inflation. The future path of crude oil prices is uncertain.
Third, the budgeted fiscal deficit for the current year gives some comfort on the demand front. However, the achievement of the fiscal targets set out in the budget could be challenged by the higher subsidy burden stemming from higher international crude oil prices.
Fourth, persistently high food prices are likely to exert sustained upward pressure on wages, thus transmitting through to wider cost pressure on prices.
Finally, if oil and commodity prices remain elevated, both the level of current account deficit, and its financing could pose a challenge.
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