RBI sees increase in interest rates

Inflation may move upwards, growth may slow.

The Reserve Bank of India's (RBI) annual report for 2003-04, released today, drops broad hints that interest rates may go up, inflation may inch upwards and gross domestic product (GDP) growth may slow down in 2004-05. The RBI cites, in this connection, the uncertain monsoon and rising global crude oil prices.

Making it clear that the central bank's position on interest rates had shifted from soft to neutral, the report said: "With the return of inflation worldwide and the raising of policy rates by several central banks, reversal of the existing ample international liquidity conditions will impact domestic financial markets." It warns market players on the need for "re-balancing portfolios" as interest rates move to a more neutral level.

Coming close on the heels of Finance Minister P Chidambaram's assurance last week that interest rates would remain stable, the RBI annual report's interest rate outlook is significant. Government bond prices fell on the RBI comment. The yield on the 10-year benchmark paper rose to 6.16 per cent today from 6.02 per cent on Saturday.

"While the prospects for gross domestic product growth continue to be bright, in particular, due to a possible acceleration in the growth of world output and enhanced domestic investment activity, there are also downside risks emanating from (the) uncertain monsoon as well as the possible persistence of high and uncertain oil prices," the report says.

Based on these risks, the RBI said there would be a downward bias to the estimates of GDP growth made in the beginning of the year but refused to quantify it. The GDP grew by 8.2 per cent during 2003-04.

In its annual policy statement in May, the central bank had forecast that India would grow by 6.5-7 per cent on the back of a normal monsoon and a pick-up in industrial activity and exports. The annual report, however, made it clear that "India will continue to be among the top performers globally".

The RBI has also not changed its monetary policy position for 2004-05. The objective will continue to be higher growth and consolidation of the recent gains from reining in inflationary expectations.

According to the RBI, barring the emergence of adverse and unexpected developments, the stance will continue to provide adequate liquidity to meet credit growth and support investment and export demand in the economy, while keeping a very close watch on price movements.

The annual report could not assess the full impact of the monsoon on growth prospects but said "the medium-term outlook remains favourable".

This is based on industrial recovery and the sustained growth of the services sector. It also mentioned that the industrial recovery had been broad-based and robust.

Adequate stocks of foodgrain and foreign exchange reserves would provide a sufficient cushion to the economy against possible adverse developments, it pointed out.

Referring to the "modest depreciation" of the rupee against the dollar in the first quarter, the annual report said expectations relating to the near-term was indicative of stable conditions in the foreign exchange market. It also said net capital flows were likely to remain positive.

"While the economy may not have to deal with surges in capital inflows of the order of the preceding year, especially in the context of churning of portfolio investment flows in Asia, domestic financial markets must nonetheless be prepared for significant capital flows for the year as a whole," the annual report said.

Looking forward, the RBI sees the current account remaining in surplus as net capital flows are likely to be positive, and with the balance of payments surplus at $7.5 billion in the first quarter of the 2004-05, the outlook for the year continues to look strong.

Click here for the RBI report