Downside risks to growth rising, but no hard-landing: RBI

The Reserve Bank today warned against accepting high inflation as the 'new normal', and said more downside risks to growth are emerging even as inflation remains very high, but ruled out any possibility of hard-landing of the domestic economy.

"The outlook for the domestic industrial sector for this fiscal remains uncertain, with the downside risks outweighing the upside risks," RBI Deputy Governor Subir Gokarn told reporters this afternoon here while releasing the central bank's Annual Report for the year ended June 2011.
"However, we are not seeing any hard-landing, which will be a possibility if the economy falls behind the trend growth of 8%," the Deputy Governor said adding accepting the sticky inflation as the new normal would not help serve the economy in the long term.
Growth prospects for this fiscal are "relatively subdued" compared with the previous year because of the increased global uncertainties, persistent inflationary pressures and higher borrowing costs, the report said and noted that "the economy needs to brace up for a difficult year from a macroeconomic perspective. With weak supply response, inflation remains an important macroeconomic challenge."
Stating that growth is likely to remain at 8% this fiscal, with a downward bias and lower than 8.5% clocked in FY11, the report warns that if the global financial condition deteriorates, it could further lower the growth
projections in the current fiscal.
"Growth prospects for FY12 seem to be relatively subdued compared to the previous year due to a number of unfavourable developments. Global uncertainties have increased," the report said.
"While the immediate challenge to sustaining growth lies in bringing down inflation, growth sustainability over the medium-term depends on addressing the structural bottlenecks facing the economy," Gokarn said.
Inflation, which still remains high despite near average monsoon, the Deputy Governor said, "our anti-inflationary stance as presented in the July 26 policy remains the same, while on the growth outlook front there have emerged more downside risks since then and now."
However he added, "as inflation starts going down (in view of the softening global commodity prices following the worsening debt crisis in the US and the Eurozone) and which is what we are anticipating post-November-December, that changes the overall perspective on the growth-inflation balance."
The RBI, which has raised interest rates 11 times since March 2010 by increasing the repo rate by a whopping 475 basis points, out of which 350 bps hike have been in FY11 alone, but still faces inflation above 9 percent, said
becoming resigned to high inflation can push up inflationary expectations in the long term and ultimately lead to a hard landing for Asia's third-largest economy.
Core or wholesale-price inflation rate has stayed over 9% since December last and stood at 9.22% in July, while weekly food inflation numbers have been seeing lots of volatility of late after softening in the first quarter of this fiscal.
Food price numbers inched closer to double-digit mark for the week ended August 13 and rose to 9.80% on the back of dearer vegetables, up from 9.03% in the previous week. However, this is much lower that the number for the corresponding week of last August when it stood at 14.56%.
"On a year-on-year basis, inflation may remain stubborn in the near-term and start falling sometime in the third quarter of 2011-12," said the RBI report, which reiterated the Reserve Bank's inflation forecast of 7% by the end of March 2012.
When asked on the possible impact of a likely third round of quantitative easing (QE3) by the US Fed, (which is meeting tomorrow), Gokarn said, it may boost commodity prices and fan inflation in the country and noted that already crude prices have started going up.
"Given the fiscal limitations and growing signs of weakness in the US, the Fed has already indicated that it will pursue its near-zero rate policy at least till mid-2013. It has also hinted at another dose of quantitative easing. This
policy stance may keep the commodity prices elevated," the RBI said in its annual report.
The upside risks to inflation are more pressing concerns for the short-term, and it is too early to change the central bank's anti-inflationary policy stance, added the report.
On the fiscal measures to contain inflation, Gokarn said the government needs to raise fuel prices further, to contain the burden of subsidies if global oil prices stay at current levels, which if rises further would burden the fiscal target.
Despite the rising threat to GDP growth, the report said, it doesn't not see any major pressure on the current account deficit front, which stood at 2.6 percent of GDP last fiscal.
"The quality of foreign capital inflows into the country this fiscal has vastly improved as the first quarter has seen strong FDI inflows, unlike last year, and so we are of the view that the CAD position should be comfortable. But if the robust exports growth gets impacted very badly due to the slowing global growth, it may pose some challenges," Executive Director Deepak Mohanty said.
The current account deficit(CAD) improved to 2.6% in 2010/11 from 2.8% the previous year and is expected to be within 3% this fiscal.