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A cautious approach

Extrapolating the broad macroeconomic trends of 2006-07, the Reserve Bank of India in its annual report is generally optimistic about robust economic growth continuing this year. Inflation however will remain a threat. In July this year, the RBI in its first quarter review of monetary policy stuck to its forecasts of GDP growth and inflation for 2007-08 first made in April while issuing the annual policy statement. The economy is projected to grow by 8.5 per cent and infla tion is to be contained within 5 per cent. The RBI’s growth estimates have tended to be on the lower side. Practically all the others, including the Prime Minister’s Economic Advisory Council, have forecast a GDP growth of 9 per cent or even higher. Despite headline inflation coming down significantly in recent months, the RBI’s caution on the price situation is warranted. For, consumer price inflation continues to remain higher than wholesale price inflation mainly on account of high food prices. Very recently, the extreme volatility seen in the domestic stock markets is attributed to large portfolio and other overseas investors moving in and out of emerging markets in response to the sub-prime mortgage crisis in the U.S. financial system. The threats to domestic monetary and financial stability from external developments require constant vigil and monitoring. Besides, global commodity prices, particularly of oil, remain high. Among other strategies to contain inflation within the target range the RBI has once again laid stress on aggregate supply management and hinted at a proactive approach in dealing with capital flows.

Although the share of agriculture in the overall GDP has declined from around 40 per cent in 1980-81 to below 20 per cent in 2006-07, its importance to the Indian economy can hardly be overemphasised. Recent volatility in agricultural production has had its impact not only on economic growth but on price stability as well. In the context of ensuring food security and promoting inclusive growth, strategies to revitalise agriculture become highly relevant. The services and manufacturing sectors have underpinned recent growth. Infrastructure deficiencies can hold back further growth in the industrial sector while the booming software sector faces the prospect of a talent shortage. The growing integration of India with the rest of the world poses certain challenges to monetary policy. Fiscal deficits as a proportion of the GDP have come down but are still high by global standards. Despite liberalisation of the real economy, there are still some policy rigidities that need to be addressed. Like its reading of the macroeconomy, the RBI’s assessment of monetary policy is both exhaustive and realistic.

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