RBI policy ahead

GDP forecast
Economic activity in India continues to be demand driven. A 0.3% decline in Private Final Consumption Expenditure and a 0.2% Govt Final Consumption Expenditure was offset by an increase in Gross Fixed Capital Expenditure by 2.1%. Increase in investment demand was also witnessed in the increased import of capital goods as well as a doubling of public issues of capital this fiscal. This is indicative of a continued buildup of capacity and is likely to continue this fiscal buoyed by strong corporate savings and improved public finances.

Consumption expenditure is also likely to pickup in view of increased personal disposable income and reduced excise duties. In addition, the Sixth Pay Commission will herald higher revenue expenditure. Apart from this, the report dwells upon improved tax to GDP ratios and forecasts of normal monsoons as favourable factors in the India growth story. Playing the part of the cheer-leader of the economy to the hilt, the RBI forecasts a real GDP growth rate of 8.0-8.5% for 2008-09.


Inflation fears
However, this forecast is subject to a lot of uncertainty fueled by fears of a global recession, higher food and commodity inflation and a financial meltdown with contagion risks. Supply-side inflation fears stem from a continuous hardening of global crude oil prices as well as more expensive steel, wheat and oilseeds. The RBI expresses confidence about their ability to bring down headline inflation from its’ current level of 7.57% to a more comfortable 5.5% in 2008-09 by actively managing capital flows and using all policy instruments. However, the RBI’s confidence could be misplaced due to two reasons. Firstly, the current inflation is primarily structural and fueled by global factors and with demand pressures likely to continue, it would only intensify in the coming months. Second, the RBI over-relies on the normal monsoons forecast.


Global Financial Crisis
RBI expresses major concern about the state of global credit markets in the aftermath of the sub-prime mortgage crisis. While Indian markets continue to be largely insulated from the immediate effects, our external financing conditions could suffer. The RBI also concludes that domestic sentiment has never been more linked to global factors and as such the uncertainty could spill over to domestic liquidity, equity and foreign currency markets. The RBI continues to actively absorb liquidity through CRR hikes, LAF absorptions and MSS auctions. LAF injections in late February were only inspired by local tightening rather than any signs of global capital outflows. Though liquidity continues to be comfortable, the possibility of a full-blown capital pullout from India and a weak rupee cannot be completely ruled out.