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RBI Report reiterates strong growth prospects

The economy has shown the resilience to withstand supply shocks, but risks do exist

— Photo: Shanker Chakravarty

OPTIMISTIC PROGNOSIS: An inside view of the Reserve Bank of India in New Delhi.

THE RESERVE Bank of India Annual Report is in two parts. Part one deals with the economy. Here, the RBI reviews recent developments while assessing future prospects. Part two is on the working and operations of the central bank. The latter is hardly confined to the RBI's accounts and human resources and organisational matters (though the heading suggests that it is a conventional report).

There are valuable inputs on the bank's operational aspects including monetary policy operations, regulatory and developmental role, financial sector regulation, public debt management and currency management. Also included in the second part is a chapter on the new payments and settlements systems that the RBI has helped develop by relying increasingly on information technology. Some of these new practices and procedures are set to transform commercial banking.

Assessment of economy

In 2004-05, India's macro economic growth was commendable despite unsatisfactory monsoons and heightened risks caused by global oil prices. Industrial recovery was strong and evenly distributed and the manufacturing sector exhibited a new dynamism. Indian industry became globally competitive and there was a pick-up in investment thanks to a higher level of business confidence. The performance last year was especially commendable as growth had peaked in the previous year.

The RBI feels that the Indian economy "is poised to build upon the gains of macro economic performance secured in 2004-05.'' The positive factors that lead to the optimistic prognosis are the revival of the southwest monsoon, robust manufacturing activity, high corporate profitability, buoyant equity markets, robust merchandise imports and exports, sustained demand for non-food credit and the continuing momentum in the services sector.

The central bank has, however, not revised its growth forecast for the current year made in its Annual Credit Policy statement (April 2005) and reiterated in the first quarterly review. Both the GDP estimate and the inflation targets (on a point to point basis) remain unchanged at 7 per cent and between 5 and 5.5 per cent respectively.

The estimated growth and the containment of inflation within a relatively narrow band will be possible only if the ongoing momentum in industry and services sectors is maintained, the southwest monsoon turns out to be satisfactory and last but not the least, the impact of oil prices is fully absorbed with minimum pain.

The monetary policy's traditional objectives have been to provide price stability while ensuring that genuine credit needs of the real sector are met. Reviewing last year's price situation, the RBI says that while it managed to moderate inflationary expectations (through successive increases in the reverse repo rate by 0.25 percentage points each time), the outlook for this year hinges on one important variable: it was certainly not the first time in recent months that the central bank had said that the pass-through of crude prices remained the most critical factor influencing domestic inflation.

The demand for bank credit has surged, the Government's borrowing programme is under way and monetary conditions so far this year have remained easy. That is due to the RBI injecting primary liquidity in the system. Given the volatility in the inflation rate during 2004-05, the RBI says there is a need to consolidate the gains obtained in recent years from reining in inflationary expectations, which can turn adverse in a very short time.

Risk of higher inflation

In the context of oil prices that are likely to remain high, there must be a credible inflation containment strategy. Otherwise high oil prices will translate into wage-price spirals. Also, on the domestic front, the manoeuvrability on oil prices is getting limited. While the economy has so far shown the resilience to withstand supply shocks, upside risks do exist .Any complacency in monitoring inflation will have adverse consequences on both growth and stability. On agriculture, the RBI points out that in the context of dependence on rain, providing stability to farm incomes becomes crucial. Globalisation, rising incomes and urbanisation have brought into focus the need for diversifying agriculture and providing value addition.

The industrial sector has benefited in the liberal policy environment and has become highly competitive. Further consolidation through economies of scale is likely to remain an important driver of growth in the future.

The service sector already contributes more than 57 per cent of GDP. This is expected to benefit from the ongoing liberalisation of the foreign investment regime in the sector. To improve international confidence and realise the full potential of the software and services sector, there ought to be renewed emphasis in regard to infrastructure as well as in the implementation of security solutions.

Altogether, despite the threats, prospects for economic growth are strong, says the RBI. Inflation has been contained so far. "Maintaining macroeconomic and financial stability in an environment of sustained high growth in the future would, however, depend critically on policies relating to oil prices, diversification of agriculture, improvement in urban infrastructure, determined methods of fiscal consolidation and above all on the continuation of the positive investment climate in the country.''

C. R. L. NARASIMHAN

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