MUMBAI: The Reserve Bank of India has said that increase in salaries is pushing up prices and that the wage-price spiral needs to be broken to control inflation. This observation by the central bank is seen as one more pointer to higher interest rates since this is its main weapon against rising prices.
In its report, 'Macroeconomic and Monetary Development', for the first quarter of FY12, RBI has said that there a likelihood of growth being lower than expected because inflation would continue to be the top priority. The report said that the government's schemes, such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), has contributed to an increase in wages. "However, the faster increase in wages vis-à-vis inflation poses the risk of wage-price spiral, particularly for food inflation, as the revision in MSPs take into account wage cost escalation," RBI said.
The lower optimism with respect to growth is reflected both in the projections made by forecasters and in the business confidence index as reported by various industry associations. The business confidence index as reported by NCAER for the first quarter of FY12 was down the least with -0.1% decline. The drop was highest according to the survey conducted by Dun & Bradstreet at 21.7%.
According to the report, the latest employment survey result of the NSSO indicates that the real wages of casual labourers have been rising in recent years. "This implies that on an average, the purchasing power of the poor may not have been dented by inflation. Rise in wages in response to inflation could also become faster both on account of MGNREGA wages being indexed to inflation and increase in wage bargaining capacity in the casual labour market. This wage-price inertial movement could add to the structural pressure on food inflation," RBI said.
Giving an indication of the thinking behind the monetary policy, RBI said, "Monetary policy will have to preserve the broad thrust on tight monetary stance till there is credible evidence of inflation trending close to a level within the Reserve Bank's comfort zone."
According to Tushar Poddar, chief India economist, Goldman Sachs, RBI will more than anything focus on taming inflation. "We continue to expect the RBI to hike by another 25 bps after July 26 in the remainder of 2011, with the next hike likely by October. We do not think, as some do, that the RBI will be done with rate hikes on July 26. Inflation and inflation expectations remain at levels so far above the RBI's preferred target that the central bank would want to err on the side of having done too much rather than too little in its fight against inflation."
RBI said that risks to baseline growth and inflation projections may arise from three factors—weaker monsoon, sharp changes in global commodity prices or the Eurozone debt crisis assuming full-blown proportions.
But RBI has said the despite the risk of a slowdown, high inflation calls for an anti inflationary bias.
At an international level, the central bank sees global momentum of recovery to be stalling because of high oil and commodity prices, strife in the Middle East and the Japanese Earthquake.
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