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The Reserve Bank of India (RBI) on Monday said it believes inflation will persist at levels above those indicated by it earlier even as it expects only a “modest recovery” in growth in the second half of the current fiscal. Under the circumstances, “monetary policy will need to aim at anchoring inflation expectations while appropriately addressing growth risks”, the central bank observed in a review of the economy.
The central bank now expects GDP growth in FY14 to come in at levels close to the 5% seen last fiscal. Any formal revision of forecasts, however, will be announced on Tuesday, when the RBI meets to review monetary policy. “In this milieu, monetary and fiscal policies will have to be crafted so as to allow structural policy measures and ground-level actions to shape a sustainable recovery by next year,” the RBI noted, saying it had the unenviable task of anchoring inflation expectations at a time when growth remains tepid.
Economists expect the central bank to hike its key policy repo rate by 25 basis points to 7.75% on Tuesday while lowering the marginal standing facility (MSF) rate by 25 basis points to 8.75%. Banks are currently allowed to borrow 0.5% of their deposit base through the liquidity adjustment facility (LAF) window. For additional requirements, they must access the MSF window.
“The tone of the review remains hawkish, which means inflation and inflationary expectations will be the focus of the policy,” said Shubhada Rao, chief economist at Yes Bank. Rao expects a 25 basis points hike in the repo rate and does not rule out further rate hikes.
“Price stability seems to be the key objective for the RBI,” said Saugata Bhattacharya, chief economist at Axis Bank.
Bhattacharya does not expect the RBI to lift the cap on LAF borrowings though he believes the central bank may allow banks to borrow more through the term repo operations, a move that would help the market develop.
In its annual policy in May, the central bank had put out a baseline GDP growth forecast of 5.7% for FY14, which was lowered to 5.5% in July. Meanwhile, a professional forecasters' survey conducted by the RBI pegs growth for FY14 at 4.8% versus an earlier forecast of 5.7%.
“After a slower H1, a modest recovery is likely in H2 of 2013-14. This is expected to come from a rebound in agricultural growth backed by a better than normal southwest monsoon and a