The UPA government and the Reserve Bank of India (RBI) are facing a dilemma: the string of measures to snuff out inflation have hurt growth raising the risk of plunging the economy into slowdown.
The RBI on Friday acknowledged that underlying inflationary pressures remain strong, even as risks to growth are emerging.
Clocking a gross domestic product (GDP) growth rate of 8% for 2011-12 that the central bank had projected earlier, appears slim.
Raising interest rates still remains the most potent tool with RBI to tame prices, but it has hurt industrial growth.
Besides, inflationary expectations—or the view among consumers and businesses of where prices are heading— are above 12%.
Economists cautioned that high inflationary expectations for a prolonged period of time alters people’s consumption patterns promoting them to spend their money quickly, because they believe prices will keep rising.
The rise in spending itself pushes up inflation further, resulting in a cycle that can only halted by a slowdown.
"A premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is, therefore, imperative to persist with the current anti-inflationary stance," the RBI said.
Economists said it is unlikely that the central bank will start slashing rates anytime soon.
"Market expectations for aggressive policy easing look misplaced," said Mole Hau of BNP Paribas.
"Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory," RBI said.