"At this juncture, rising and volatile international crude prices and the heightened levels of food prices pose risks to the inflation outlook," RBI said in its mid-term review of monetary policy on Tuesday.
While retaining its forecast for inflation at five per cent this fiscal, RBI has lowered its objective of inflation to three per cent in the "medium term" against 4-4.5 per cent as announced in the last quarterly review in July.
"So far as prices are concerned, inflationary development is on track. We expect inflation will end at the level of five per cent, subject to the caveat that oil prices are ruling high and a pass-through may occur," RBI Governor Y V Reddy said at his post-credit policy press conference.
Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, eased from 6.4 per cent on April 7, 2007 to 3.1 per cent by October 13, 2007. On an average basis, however, annual WPI inflation at 5.2 per cent was higher than 4.6 per cent a year ago, the RBI said.
An analysis of constituent price movements indicates that the rise in prices of edible oils, oilseeds and oil cakes, which together have a weight of 6.9 per cent in the WPI, contributed nearly 40 per cent of the headline inflation.
About 16 per cent came from increases in prices of primary food items especially rice, milk and vegetables. Excluding food, headline WPI inflation was 3.0 per cent as against 5.0 per cent a year ago. Other items that contributed to headline inflation included cement, drugs and medicines, iron and steel and electrical machinery.
Annual inflation of fuel, power, light and lubricants group, which has a weight of 14.2 per cent in WPI, declined to 1.6 per cent as on October 13, 2007 as against 5.0 per cent a year ago. Excluding the fuel group, inflation was at 4.4 per cent compared to 5.6 per cent a year ago.
RBI said the average price of Indian basket of imported international crude was at around $72.1 per barrel during July-September 2007, higher than $66.4 in April-June 2007 and $56.6 in January-March 2007.
India imports nearly three-fourths of its crude oil requirements, and the government has not allowed state-run oil marketing firms to increase prices despite rise in international rates.
Domestic retail prices of petrol and diesel have remained unchanged after two downward revisions in 2006-07, thereby increasing the magnitude of incomplete pass-through.
The issue of oil bonds and burden sharing by upstream oil public sector units (PSUs) in the form of discounts on crude oil and products is expected to mitigate a part of the under-recoveries. Overall, inflation risks on account of oil prices remain incipient and it is possible that some increase in domestic prices of petroleum products would translate into some elevation in WPI inflation.
Although inflation in terms of wholesale prices appears to have eased considerably, it still remains high in terms of consumer prices, particularly those facing agricultural workers and rural labourers, RBI said.