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RBI's inflation worries remain, to impact growth
June, 17th 2011

The Reserve Bank of India (RBI) is still worried about the high level of inflation despite raising interest for the 10th time on Thursday and is unlikely to pause its tightening anytime soon.

While it says that there is no evidence of any sharp or broad-based slowdown, experts say growth is expected to further moderate in the quarters ahead as the central bank persists with its tightening cycle. The RBI acknowledged that there is deceleration in some sectors, notably interest rate sensitive ones, such as automobiles.

But it acknowledged that in the current circumstances, some short-run deceleration in growth may be unavoidable to bring inflation under control. "We see no reason to change our forecast that two more 25 basis points rate (100 basis points equals one percentage point) hikes would take place in the next two policy meetings. The RBI's hawkish tone in today's statement has reinforced our view that the central bank is ready to sacrifice some growth in order to bring inflation under control," Deutsche Bank said in a note.

Finance secretary R Gopalan said the interest rate increase could impact growth in the short-term. Finance minister Pranab Mukherjee said the RBI's decision was on expected lines, as core inflation hardened to 8.71% in May compared to 7.93% in April. He said there was a need to have better price stability for sustaining growth in the medium term, signalling that the government was also ready to see some moderation in growth.

Growth in the JanuaryMarch quarter slowed to 7.8% from 8.3% in the previous quarter and economists say overall GDP growth in the current fiscal year would be in the range of 8-8.5%, well below the 9% and above growth that policymakers had estimated.

The RBI said inflation persists at uncomfortable levels and the headline numbers understate the pressures because fuel prices have yet to reflect global crude oil prices. Data released on Thursday showed some minor moderation in food inflation.

Food inflation eased to 8.96% in early June, sliding marginally from the previous week's 9.01%. But the main worry for the central bank seems to be non-food manufactured inflation.

"This pattern in non-food manufactured products inflation is a matter of particular concern. Besides reflecting high commodity prices, it also suggests more generalised inflationary pressures; rising wages and costs of service inputs are apparently being passed on by producers along the entire supply chain," the RBI said in its monetary policy statement.

The government has raised petrol prices sharply but has delayed the decision to increase diesel and cooking gas prices. Any increase in diesel prices is expected to impact the inflation dynamics as most goods are transported by road and hike in diesel prices raises the input costs. "Pipeline pressures from input pass through, a likely diesel price hike and an increase in government controlled price of key food items is likely to take inflation to double-digits by June-August, 2011 and push average inflation for H1FY12 above the RBI's forecast of 9%," Abheek Barua, chief economist at HDFC Bank, said.

"This is likely to drive the RBI to hike its repo rate by at least another 50 basis points over the remainder of FY12 before it re-assesses the impact of past tightening measures and global headwinds to domestic growth," he added.

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