Raises expectations of rise in policy rates.
Reserve Bank of India (RBI) Deputy Governor Subir Gokarn on Tuesday warned of persistent inflationary pressures on the economy from rising food prices, heightening expectations that the central bank will raise policy rates at its second quarter monetary policy review due on November 2.
“Persistent price increases in commodities for which there are less effective substitutes, with other things remaining equal, will raise the potential rate of inflation over a period of time,” Gokarn said at a conference speech in Mumbai on Tuesday. He added that structural changes in the emerging economy could have an adverse impact on inflation and inflation expectations.
The yield on the benchmark 7.8 per cent government bonds due in 2020 moved up five basis points (bps) to 8.18 per cent in response to the deputy governor’s comments. The bonds were trading at the same level at the close.
In its last quarterly policy review in July, RBI had forecast inflation would fall to six per cent by the end of the current financial year.
The wholesale price index (WPI) inflation for September was at 8.62 per cent compared to a year ago while food inflation was 15.53 per cent in early October.
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It is widely believed that RBI will raise policy rates by 25 bps in the second quarter monetary policy review while leaving other monetary tools such as the cash reserve ratio and the statutory liquidity ratio unchanged.
RBI has raised policy rates five times this year to normalise interest rates and rein in inflation.
Gokarn said structural changes in the emerging economy could have an adverse impact on inflation and inflation expectations. “This means that actual inflation or interest rates will be higher than they would be in the absence of such increases,” he said.
“When we take into consideration the impact of structural food price shocks such as the ones India is experiencing, the policy implications become complex,” Gokarn said.
Citing the example of pulses, whose price has roughly doubled in the past three years, Gokarn said rising incomes had increased the share of proteins in people’s diet.
“Rising affluence has also led to an increase in demand for proteins and nutrition,” Gokarn added.
He said the conventional view suggested that monetary tools would have no impact in combating a rise in food prices due to a temporary supply disruption. Indeed, it could hurt the economic growth prospects. “However, if the economy is at or close to capacity utilisation, even temporary price shocks can aggravate inflation expectations, which may justify a monetary response even though the shock is temporary and will die out before the actions take effect," he said.