The Reserve Bank of India (RBI) said today that fighting inflation remained the cornerstone of its monetary policy, and urged the government to cut expenditure, indicating it was unlikely to act soon to ease rates despite slowing growth.
The RBI said poor rains had further clouded growth prospects for India but the key was to cut government subsidies and revive capital spending.
"Such an action would also provide some space for monetary policy, but, importantly, lower interest rates alone are unlikely to jumpstart the investment cycle," the RBI said in its annual report.
The report, which is released at the end of the central bank's accounting year, is a review of the previous fiscal year's macroeconomic conditions and outlook for the current year.
India's growth skidded to a nine-year low of 5.3 percent in the March quarter, and many economists have slashed their 2012/13 forecast to around 5.5 percent, lower than the RBI's downwardly revised projection of 6.5 percent.
Inflation, which had stayed well above 7 percent for two and half years, has eased, with both the wholesale price index and the consumer price index slowing, although food prices rose.
But the RBI, which left its key repo rate steady at 8 percent last month, said a close vigil on prices would be necessary for the rest of the year to prevent re-emergence of inflationary pressures.
"Persistence of inflation, even as growth is slowing, has emerged as a major policy challenge," the RBI said.
Complicating the picture further, the central bank said, the government's market borrowing could rise during the fiscal year if revenue receipts fall short of target, which would limit room for monetary policy action to support growth.
The government aims to narrow its fiscal gap to 5.1 percent of GDP in the current fiscal year from 5.76 percent last year, a target seen by many analysts as optimistic.
Tax revenues are under pressure from the economic slowdown, spending on subsidies is on the rise and the government has struggled for support from within the ruling coalition to raise diesel prices or carry out some economic reforms.
"At the current juncture there is no scope for complacency as fiscal slippage is likely during 2012/13 and current account deficit is likely to stay above sustainable level," the RBI said in the report.
It said the current account deficit as part of the overall gross domestic product may not reduce significantly in 2012/13 from the record high of 4.2 percent in the previous year, unless there is substantial improvement in the global economy and domestic policy reforms are initiated.
The current account, the broadest measure of India's trade in goods and services with the rest of the world, ballooned to a record deficit of $21.7 billion or 4.5 percent of GDP in the March quarter.
The Reserve Bank of India further said there is a need for containing risks in housing and gold prices as they are running ahead of inflation.
Pointing out that the housing price inflation had ranged between 16-25% over the last two years, the central bank said that housing price inflation had not moderated in spite of the slowdown in credit to housing and commercial real estate. A close vigil on housing prices was necessary, it said.