RBI cautions on impact of higher capital inflows on asset prices

The central bank cautioned that the strong rebound in asset prices needs to be monitored closely,given their implications for financial and macroeconomic stability. It also observed that a stronger recovery in India and the favourable interest rate differentials in the face of easy global liquidity conditions could lead to higher capital inflows,which may influence both exchange rate and asset prices. In sum,there is an overall improvement in business sentiments and economic activity,but concerns relating to elevated levels of inflation remain in the near term. It is likely that the growth impulses could further strengthen during 2010-11,and therefore,anchoring inflationary expectations without hurting the growth process continue to be the focus of monetary policy, the RBI observed. The RBI said the Indian economy has exhibited a clear momentum in recovery in 2009-10,despite deficient monsoon and has estimated a GDP growth of 7.2% for the in financial year 2010,up from 6.7% in 2008-09.

Experts said RBI’s statement on elevated levels of inflation remains a concern in the immediate term and signals the possibility of an interest-rate increase. It is likely that the growth impulses could further strengthen during 2010-11,and therefore,anchoring inflationary expectations without hurting the growth process continue to be the focus of monetary policy, the RBI said. Going forward,with the revival of credit demand from the private sector to normal levels,the government borrowing programme for 2010-11,despite planned frontloading,could exert some crowding out pressures,it said.

High inflation may hamper growth,the report said,pointing to the need to withdraw monetary stimulus. The RBI assessment clearly indicates that the policy focus has now shifted to inflation management. The double-digit inflation will clearly affect the future growth. However,the RBI is confident of a revival and highly concerned on the asset price inflation. Headline inflation,which remained at 9.9% in February-March 2010,has emerged as a major policy concern for the central bank. In the recent weeks,while food inflation is showing signs of slowdown,inflation in fuel and manufactured products are causing more generalised inflationary pressures,the central bank said.

According to the RBI,going forward,there could be an upward pressures on inflation on account of supply side,international commodity prices,especially of crude oil and industrial inputs have been rising in the recent months,thus limiting the option of imports that could contain inflation in India,return of pricing power of the corporates with stronger revival in demand,revival in private consumption demand coupled with revival in growth of credit and money supply on the demand side and the gradual exit of the fiscal stimulus measures which has and would entail roll back of excise and customs duty reliefs as well as measures to align domestic prices with international oil prices.