No surprises seen on inflation front

RESERVE BANK OF INDIA'S REPORT ON CURRENCY AND FINANCE 2003-04

The Reserve Bank of India report on Currency and Finance (2004-05) said the worst is over on the inflation front.

The report, released on Thursday, said inflationary pressures are expected to moderate in the coming months as "the balance of risks has tilted downwards" with the recent easing of oil prices, improved rabi prospects, fiscal measures to dampen price rise and measures to impound liquidity.

The RBI has reiterated its forecast of inflation hovering in the range of 6-6.5 per cent for 2004-05.

The report, not an official view of the RBI but that of its executives of the Department of Economic Analysis and Policy, further stated that the pursuit of price stability remains a key objective of monetary policy given the fact that the poor have no hedge against inflation.

In the face of sharp rises in the international commodity prices and the persistence of a large liquidity overhang, price stability remains the continued policy objective, it said.

The report has argued that the concept of inflation targeting is debatable given that monetary policy decisions affect prices with a lag of around two years and more exogenous shocks can occur in this period.

It further stated that divergence of various indicators of headline inflation creates difficulty in conduct of monetary policy and, therefore, core inflation or underlying inflation is worth exploring.

To rein in inflation at lower levels, it suggested that the states should be subjected to fiscal responsibility rules like the Centre.

It also pointed out that inflation trends based on two different indicators such as wholesale price index (WPI) and consumer price index (CPI) have differed in 1990s owing to two key factors such as coverage and weight.

While food group has a larger weight in CPI, services are excluded in WPI. In the sub group, while iron and steel contributes more than one-fifth weight in WPI, their presence is almost negligible in CPI.

According to the report, India has been managing capital inflows through a multi-pronged strategy to ensure domestic economic and financial stability.

These include liberalisation of policies on capital account outflows, encouraging prepayment of external borrowings, alignment of interest rates on non-resident external deposits and greater flexibility in exchange rate.

The report conclude that while year-to-year inflation may vary depending on intensity of supply shocks, monetary policy can stabilise inflationary expectations at low levels. An environment of low and stable inflation is conducive for financial savings, sustained growth and employment.