India is likely to face elevated inflation risks from supply bottlenecks and lingering threats to economic expansion, the Reserve Bank of India said.
“Threats to stability are posed by the global sovereign debt problem and risk aversion, domestic fiscal position, widening current-account deficit and structural aspects of food inflation,” the central bank said in its Financial Stability Report released in Mumbai yesterday. While India’s financial system “remains robust,” challenges to stability have increased since the last assessment in December 2011.
Growth in Asia’s third-largest economy slowed to a near-decade low last quarter, hurt by a faltering global recovery, political gridlock that has deterred investment and price pressures. Prime Minister Manmohan Singh, who took charge of the finance ministry three days ago, faces a budget deficit requiring record borrowing as well as a trade shortfall as he tries to revitalize his development agenda.
“Sovereign default concerns and the need for substantial bank recapitalization in the euro zone have escalated fears of contagion and recession,” central bank Governor Duvvuri Subbarao said in the report. In India, an “already high fiscal deficit leaves little room for the government to stimulate the economy,” he said.
The rupee, which has slumped 21 percent against the dollar in the past 12 months, strengthened 0.6 percent to 56.8075 per dollar in Mumbai yesterday. Its tumble threatens to stoke the cost of imports. The BSE India Sensitive Index rose 0.1 percent.
The yield on the 9.15 percent government bonds due November 2024 increased one basis point, or 0.01 percentage point, to 8.42 percent, according to the central bank’s trading system. The rate was the highest since June 20.
Subbarao unexpectedly left the Reserve Bank’s benchmark repurchase rate unchanged at 8 percent on June 18, saying the following day that Indian inflation exceeds acceptable levels and that restraining it may require sacrificing economic growth.
Gross domestic product climbed 5.3 percent last quarter from a year earlier, the slowest pace since 2003. The trade deficit widened to a record $184.9 billion in the fiscal year ended March. The government projects unprecedented borrowing of 5.69 trillion rupees ($100 billion) in 2012-2013 to fund its budget shortfall.
“The RBI seems to be significantly skeptical about all the macroeconomic parameters,” said Madan Sabnavis, the Mumbai-based chief economist at Credit Analysis & Research Ltd. “It may not lower interest rates anytime soon.”
The nation’s wholesale prices rose 7.55 percent in May from a year earlier, compared with 7.23 percent in April, stoked in part by food costs.
“Inflation risks are likely to remain high, given the persistence of overall inflation, even in the face of significant growth slowdown which points to serious supply bottlenecks and sticky inflation expectations,” the central bank said in the report.
Singh pledged to restore confidence in India after resuming control of the finance ministry. He has urged senior officials to revive investor sentiment.
Subbarao said a recent oil-price drop, if sustained, could help the economy, adding “the projected normal monsoon and the inherent resilience of the Indian economy could provide the needed momentum to growth, provided appropriate policy actions are initiated to contain the deficits and improve the investment climate.”
Fitch Ratings and Standard & Poor’s have said they may strip India of its investment-grade rating, citing risks ranging from the fiscal shortfall to a current-account deficit that reached $19.6 billion in the three months through December, the most in at least six decades.
A potential “downgrade by rating agencies and a depreciating exchange rate may affect capital inflows,” posing “challenges” for funding the current-account gap, the Reserve Bank said. “Going forward into 2012-2013, downside risks to growth are likely to persist.”
A change in ratings could affect the availability and cost of foreign-currency borrowings for Indian banks and companies, the central bank said.