Poor monsoon to raise prices & subsidies, says RBI

Releasing its annual reports for 2008-09, the RBI said that deficient monsoons may affect the inflation outlook more than growth prospects of the country. India’s annual June-September monsoon rains, a key factor for the country’s farm output and growth, are 25 per cent below normal so far in 2009, and nearly half the country’s districts have been declared drought areas.

The pressure on the fiscal situation could only increase if drought related policy response involves further expansion in government expenditure and the additional costs associated with possible import of essential commodities to improve domestic supply conditions, it said.

High food prices

Given that the food prices remain high, despite low overall WPI inflation, and that all CPI indices exhibit little moderation in inflation, the supply side of food management would assume critical significance for the Government, it added.

However, the report, did not specify as to when it thought the policy accommodation should be withdrawn, but said if it was maintained for too long it could fuel inflation in the near term and constrain growth over the medium term. Emerging signs of recovery are yet to indicate any clear trend, it said.

Returning to a high growth path at the earliest remained the key near-term policy challenge, it said, adding a credible action plan on fiscal consolidation was necessary to achieve that. The unemployment effects of a long phase of economic slowdown, with weakly developed social security system, suggest that the Government’s preparedness for dealing with situations as in 2008-09 should be strengthened. More importantly, the public expenditure was also not reoriented to address constraints to high growth, such as physical and social infrastructure.

Policy management

The manner in which Indian policies could manage the contagion from the global crisis would have further improved the global perception of India. The global crisis, when it started to spread, did not differentiate countries on the basis of soundness of their macroeconomic policies.

Overall, the reportsaid, Indian growth continues to be driven by domestic demand and domestic saving, with foreign capital supplementing within the prudent approach to sustainable current account deficit. Further, RBI said it faced a complex dilemma from the unpleasant combination of subdued growth alongside an emerging risk of high inflation.  The government’s large borrowing plans and fiscal deficits complicated policy by adding to inflationary expectations, which could put upward pressure on interest rates, it said.  The Centre is borrowing a record Rs 4.51 trillion in 2009/10 (April/March) to fund a fiscal deficit forecast at 6.8 percent of gross domestic product, a 16-year high. Last month, RBI raised its inflation projection for the end of 2009-10 (April/March) to 5 percent from 4 percent — a forecast that analysts say may be too low — and tweaked its growth outlook to 6 percent with an upward bias.