July 31 (Bloomberg) -- Indian inflation is a major challenge for monetary policy even as economic expansion remains weak, the Reserve Bank of India said.
Threats to the economy “have been amplified by decelerating global trade and domestic supply constraints,” the central bank said yesterday ahead of its rate decision in Mumbai today. At the same time, “persistent inflation limits the space for monetary policy to revive growth.”
Governor Duvvuri Subbarao faces inflation above 7 percent even with expansion at a nine-year low, curbing his scope to join a stimulus drive extending from China to Europe. Nearly all analysts in a Bloomberg News survey predict he will leave borrowing costs unchanged as a drop in the rupee, a scanty monsoon and infrastructure gaps, underscored yesterday by India’s worst power-grid failure in a decade, stoke price pressures.
“The Reserve Bank has rightly pointed out significant risks to inflation,” said Brinda Jagirdar, an economist at State Bank of India in Mumbai. “That leaves it with little headroom to cut rates to support growth. New Delhi has to act on fiscal tightening and accelerating reforms.”
The rupee has plunged more than 20 percent against the dollar in the past year as Europe’s debt crisis and India’s trade deficit hurt demand for the currency. It slipped 0.4 percent to 55.585 per dollar at the close in Mumbai yesterday. The BSE India Sensitive Index, down about 6 percent in the past 12 months, climbed 1.8 percent.
“Monetary policy has to continue to remain guarded against a build-up of inflationary risks as well as to sustain the growth potential,” the Reserve Bank said. “Monetary policy space needs to be created through fiscal adjustment and structural measures to improve supply conditions and boost the investment climate, so that the revival is supported in a non-inflationary manner.”
The impact of deficient rains on crops, the slide in the rupee and energy costs are among the risks that may fan price increases, the central bank said.
Subbarao raised rates a record 3.75 percentage points from March 2010 to October last year to damp inflation. He lowered the repurchase rate by 0.5 percentage point in April to 8 percent, the first reduction since 2009, before deeming inflation too high for another cut in June.
Monetary and liquidity conditions have eased in the current fiscal year that began April 1, the central bank said. It added that inflation remains “above the comfort level,” complicating policy choices. Subbarao said earlier this month that the threshold level for inflation may be about 5 percent.
The monetary authority has previously said that April’s reduction “frontloaded” a cut on the assumption the government will restrain the budget deficit and take steps to ease supply bottlenecks.
The economy may expand 6.5 percent in the year through March 2013, based on a compilation of forecasts from other organizations, yesterday’s report showed. April’s survey projected 7.2 percent growth. Inflation may average 7.3 percent, the survey said, compared with an earlier 6.9 percent estimate.
Gross domestic product climbed 5.3 percent in the three months through March, the least since 2003, hurt by a moderation in investment and a global slowdown as the impact of Europe’s turmoil fanned through the world economy.
Benchmark wholesale-price inflation was 7.25 percent in June, the fastest pace in the BRIC group of largest emerging markets that also includes Brazil, Russia and China.
Fiscal and trade deficits and gridlock in the ruling coalition over proposed steps to liberalize the economy have set back Prime Minister Manmohan Singh’s development agenda.
The monsoon is adding to challenges. The rains, pivotal for the incomes of about 235 million farmers as well as food supply, may be 15 percent to 20 percent below average in August, according to government estimates.
More than two-thirds of India’s 1.2 billion people still live on less than $2 per day. The nation suffered its worst electricity grid failure in a decade yesterday, cutting supplies to about 360 million people and underscoring gaps in infrastructure from power to roads.
The government forecasts record borrowing of 5.69 trillion rupees ($102 billion) to plug a targeted budget gap of 5.1 percent of GDP in 2012-2013. The goal is at risk of being missed due to spending on subsidies and a shortfall in revenues, the Reserve Bank said yesterday.
Singh took charge of the finance ministry in June, vowing to revive growth after Standard & Poor’s and Fitch Ratings said they may demote India’s credit rating to junk.
All but three of 34 economists in the Bloomberg News survey said Subbarao will keep the repurchase rate unchanged at 8 percent for a second meeting today. The others forecast a reduction to 7.75 percent.
“The Reserve Bank is facing a dilemma on policy action in the current stagflation-type environment,” said Chetan Ahya, an economist at Morgan Stanley in Hong Kong. “The inflation outlook is far from being comfortable.”
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