Signaling interest rate cut to boost economy at its annual credit policy on Tuesday, the Reserve Bank said it would shift the focus to arresting declining growth while keeping inflation under control.
"Inflation expectations moderated in the fourth quarter of 2012-13 but remain high. With significant upside risks to inflation, monetary policy needs to keep them anchored, while shifting the balance of policy to arrest the declaration in growth momentum," RBI said on the eve of annual monetary policy.
RBI in its Macroeconomic and Monetary Development Report also cautioned that inflation is likely to remain "sticky" at the current level through out the fiscal (2012-13). Finance minister Pranab Mukherjee too described the rising food inflation as "disturbing".
The inflation, according to latest data, was 6.89% during March. As regards growth, it declined to three year low of 6.9% during 2011-12.
"Monetary policy needs to support growth without risking external balance or inflation by excessive fueling demand," it said.
So far RBI's stance was checking inflation and it raised interest rates 13 times since March 2010 which impacted industrial output due to costly credit. During April-February period 2011-12, the IIP fell to 3.5%, as against 8.1% in same period in 2010-11.
Therefore, it is widely expected that the central bank would cut interest rate in the annual policy to be announced on Tuesday.
The Reserve Bank, in its review in March gave indications of peaking of the interest rates cycle in line with the evolving growth inflation dynamics.
In view of declining industrial output, Mukherjee had said that "the government along with RBI will take required steps to revive activity in the economy."
Experts believe the decline in inflation in manufactured items category as per recent data would prompt RBI to ease interest rate.
Inflation in manufactured items declined to 4.87% in March, from 5.75% in February. However, food inflation rose sharply to 9.94%, from 6.07% in February.
"...food inflation in the month of March has increased, which is disturbing factor. I do hope in course of time it will moderate," Mukherjee said.
Commenting on inflation, RBI said, "Inflation is likely to remain sticky at about current level during the year with the probability of further significant moderation being small".
On growth, RBI said that it expects only a moderate increase in economic growth during the current fiscal in view of global uncertainties and upside risks to inflation.
"Growth is likely to improve moderately in 2012-13. While inflation has moderated, risks to inflation are still on the upside," the RBI said.
It also highlighted the need to raise prices of petroleum products and deregulate diesel prices to contain fiscal slippages and arrest decline in growth.
The RBI further said that "major concern on the inflation front continues to be high fuel prices driven by the increase in international oil prices," the report added.
Since October 2011, the repo rate of RBI has stood at 8.5%. Repo rate is the signaling rate at which it lends to other banks. Other policy rates like reverse repo and bank rate adjust automatically with change in the repo rate.