Ahead of the Reserve Bank's credit policy review tomorrow, chief economic advisor Arvind Virmani has said the impact of weak monsoon on food supply will make it a bit difficult for the RBI to strike a balance between promoting growth and controlling inflationary expectations.
"In India's case there is a new concern, that is agriculture, monsoon related supply effects. Domestic supply side issue (of food products) has to be accounted for. That makes this judgement (of striking a balance between growth and inflationary expectations) a little more complicated," Virmani told PTI.
Monetary policies worldwide has to deal with issues like controlling inflation, promoting growth and financial stability.
However, financial stability is not such a big concern any longer, Virmani said.
In case of inflation, the CEA said, the monetary policy has to deal with two issues -- excess demand and inflationary expectations that is the perception about price rise in the future.
However, at present the issue of excess demand does not exist in India, and hence monetary policy has to deal with inflationary expectations, he added.
"Monetary policy has to deal with two issues, one is excess demand, which is not such a big issue as far as I can see right now, but you also have to be concerned about inflation expectations," Virmani said.
When RBI talks of inflation, it does not take into account only wholesale prices inflation, which is above 1 per cent, but consumer price indices as well, which are in double digits.
Many experts, including Virmani, expect inflation to reach 6 per cent by this fiscal end.
He said when WPI rises to 6, it is quite possible that the gap is narrowed between wholesale price inflation and those based on retail prices.
The CEA said when supply shocks are there, role of the monetary policy becomes important to control inflationary expectations because it cannot control supply.
"Until demand is a problem, monetary policy will not be able to solve the inflation problem. So, it is really the issue of inflation expectations," he said.
Inflationary expectations to some extent depends upon market judgement, Virmani said.
"In some sense it depends on the markets. As long as markets are comfortable and there is no inflationary expectation then focus could remain on ensuring that growth returns to the (high) path," he said.
According to Virmani, growth process would follow a U-shape recovery in India, which means that growth would start picking up from later part of the fiscal.
However, RBI could have a different take, he said.
"So far as growth is concerned my forecast is U-shape recovery. It is not me who has to make this judgement, I may be confident about my judgement, they (RBI) have to make their own judgement," he said.
In the previous monetary review, the RBI had projected the economy to grow by 6 per cent with upward bias.
The economy grew by 6.7 per cent last fiscal, down 2.1 per cent from the average growth of 8.8 per cent during the previous five years. In the first half of this fiscal, it grew by 6.1 per cent.
The RBI is widely expected to keep short term lending rate (repo) and short term borrowing rate (reverse repo) unchanged as economic recovery is still on a weak footing.
However, many believes that the central bank might tinker with cash reserve ratio, the amount of money that banks have to keep with RBI, to check inflationary expectations.
