In its Annual Report for the financial year 2005-06, the RBI has maintained GDP growth forecast for the current financial year at between 7.5 and 8 per cent. The report said the growth momentum over the last few years mainly reflected structural factors, supported by cyclical and seasonal components, and hence is likely to continue this year as well.
The report cautions that several downside risks, which could affect growth rate, remains. Potential escalation and volatility in international crude oil prices, a disorderly unwinding of the macroeconomic imbalances of the major economies, firming up of overall inflationary pressures and expectations and a hardening of international interest rates along with the withdrawal of monetary accommodation have been cited as the major risks emanating from the global economy.
Progress of the monsoon, infrastructural bottlenecks, emerging apprehensions regarding the fiscal outlook and possible hardening of inflation expectations have been identified as potential domestic risks.
The central bank gave itself a pat in the back for the effectiveness of monetary policy measures. "Timely and even pre-emptive monetary measures reinforcing the policy stance paid dividends in terms of low and stable inflation which, in turn, provided conducive conditions for the undisrupted expansion of economic activity while maintaining macroeconomic and financial stability", the report said.
On the monetary policy outlook the RBI said, "While domestic developments continue to dominate the economy, global factors tend to gain more attention now than before. The global outlook for growth is positive but downside risks in regard to inflation and re-pricing of risks in financial markets need to be recognised".
The RBI is very clear that the concept of core inflation, which excludes food and energy prices, does not have much relevance in India as food and energy account for a large share of our inflation index. The RBI believes a large part of the rise in oil prices have a permanent component and hence cannot be considered as a temporary shock.
The RBI is backing the finance ministry on the latest debate on fiscal responsibility vs. supporting economic growth. "Adhering to the FRBM targets in respect of fiscal deficit and revenue deficit is critical for macroeconomic, financial, external sector and budgetary sustainability", the RBI says in the report.
"Any slippage in achieving the FRBM targets could erode the gains achieved in the initial year of the FRBM. It could also generate a chain effect at the state levels to relax targets set out in their fiscal responsibility legislations. Any deviation from the FRBM targets will have both national and international repercussions in terms of credibility", the report adds.
Domestic commercial banks would have to implement Basel II norms on capital adequacy by 31 March 2007. "Banks in India will initially adopt the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk. After adequate skills are developed, both by the banks and also by the supervisors, some of the banks may be allowed to migrate to the Internal Rating Based (IRB) Approach", the RBI said.
Banks may need to raise additional capital to meet the norms by next year. "On current indications, implementation of Basel II will require more capital for banks in India due to the fact that operational risk is not captured under Basel I, and the capital charge for market risk was not prescribed until recently. The cushion available in the system, which at present has a capital to risk assets ratio (CRAR) of over 12 per cent, provides for some comfort but the banks are exploring various avenues for meeting the capital requirements under Basel II", the report said.