Thursday, June 16, 2011

RBI Mid-Quarter Monetary Policy Review: dated 16th,June 2011 = An appraisal of its likely Impact =

RBI   Mid-Quarter Monetary Policy Review:

16th,June 2011

An appraisal

The following are the major highlights of the RBI’s mid-quarter review of the credit policy dated 16th, June 2011.

Ø  REPO RATE  (under the Liquidity adjustment Facility) is increased by 25 Basis points to 7.5% (from 7.25%) 

Ø  REVERSE REPO RATE under the LAF  (short term Borrowing Rate) will stand automatically adjusted to 6.5 per cent.

Ø  MARGINAL STANDING FACILITY (MSF) rate becomes 8.5 per cent.
Other Perspectives emerging from the Policy review statement are as below :

·         Global commodity prices still remain the key external risk though some signs of moderation are becoming visible.
·         Headline numbers understate the pressures because fuel prices have yet to reflect global crude oil prices.
·         2010-11 fourth quarter profit growth and margins and credit growth do not suggest a sharp or broad-based deceleration.
·         Domestic inflation risks remain high.
·         The monetary policy stance remains firmly anti-inflationary.
·         In the current circumstances, some short-run deceleration in growth may be unavoidable in bringing inflation under control.

Global economy

Ø  Global Economy Weakened in Q2 of 2011.
Ø  Growth moderated in both advanced economies and emerging market economies (EMEs) under the impact of high oil and other commodity prices, the spillover from the Japanese natural disasters and monetary tightening in EMEs to contain inflationary pressures.
Ø  Uncertainty about the resolution of the sovereign debt problem in the euro area has increased.
Ø  These developments increase downside risks to global growth prospects.
Ø  As inflation in EMEs remained elevated due both to high commodity prices and strong domestic demand, many EMEs persisted with monetary tightening during Q2 of 2011 to contain inflation.


·         GDP growth decelerated to 7.8 per cent in Q4 of 2010-11 from 8.3 per cent in the previous quarter and 9.4 per cent in the corresponding quarter a year ago.
·         For the year 2011 as a whole, GDP growth was 8.5 per cent.
·         Private consumption was robust.
·         Investment activity moderated in Q4 of 2010-11.


·         The Central Statistical Organisation (CSO) released the new series of industrial production with 2004-05 as the base.
·         The new series represents a better coverage of the industrial structure in the country.
·         The trend in industrial production as revealed by the new series is significantly different from that indicated by the old series (base: 1993-94).
·         While the old series suggested a sharp deceleration from 10.4 per cent in the first half of 2010-11 to 5.5 per cent in the second half, the new series suggested broadly the same growth of a little over 8 per cent in both halves of the year.
·         While the y-o-y IIP growth moderated to 6.3 per cent in April 2011, growth in capital goods production at 14.5 per cent was buoyant.
·         During April-May 2011, both exports and imports increased sharply and the trade deficit widened.
·         The progress of south west monsoon 2011 has so far been satisfactory, which augurs well for agricultural production.


v  The headline WPI inflation rate was 9.7 per cent in March 2011.
v  In April 2011, it was 8.7 per cent and rose to 9.1 per cent in May 2011.
v  The numbers for April and May 2011 are as yet provisional and, given the recent pattern, these numbers are likely to be revised upwards.
v  The main drivers of WPI inflation in April-May 2011 were non-food primary articles, fuel group and non-food manufactured products.
v  The consumer price inflation for  industrial workers (CPI - IW) rose from 8.8 per cent in March 2011 to 9.4 per cent in April 2011.
v  Non-food manufactured products inflation was 8.5 per cent in March 2011.
v  Provisional data indicate that it increased from 6.3 per cent in April to 7.3 per cent in May 2011, numbers much above its medium-term trend of 4.0 per cent.
v  This pattern in non-food manufactured products inflation is a matter of particular concern.
v  Besides reflecting high commodity prices, it also suggests more generalised inflationary pressures; rising wages and costs of service inputs are apparently being passed on by producers along the entire supply chain.


v  Year-on-year non-food credit growth moderated from 21.3 per cent in March 2011 to 20.6 per cent in early June 2011, but remained above the indicative projection of 19 per cent.
v  The y-o-y deposit growth increased to 18.2 per cent in early June 2011 from 17.0 per cent in March 2011.
v  Consequently, the incremental non-food credit-deposit ratio moderated to 80.5 per cent (y-o-y) in early June 2011 from 95.3 per cent in March 2011.
v  The y-o-y increase in money supply (M3) was at 17.3 per cent in early June 2011 as compared with 16.0 per cent in March 2011.
v  Monetary transmission has been quite strong with 45 scheduled commercial banks raising their Base Rates by 25-100 basis points after the May 3 Policy Statement.
v  Cumulatively, 47 banks raised their Base Rates by 150-300 basis points during July 2010-May 2011.
v  The higher cost of credit is restraining credit growth, but it still remains fairly high, suggesting that economic activity is holding course.


v  The Government’s cash balances moved from a surplus of  Rs.89,000 crore on an average during Q4 of 2010-11 to a deficit of  Rs.29,000 crore during Q1 of 2011-12 (up to June 15, 2011).
v  Consequently, net injection of liquidity through LAF repos declined from an average of  Rs.84,000 crore during Q4 of 2010-11 to Rs.41,000 crore in 2011-12 (up to June 15, 2011).
v  The net liquidity injection by the Reserve Bank was higher at  Rs.60,000 crore as on June 15, 2011.
v  As articulated in the May 3 Policy Statement, the Reserve Bank will continue to maintain liquidity conditions such that neither surplus liquidity dilutes the monetary policy stance nor large deficit chokes off fund flows to productive sectors of the economy.


The policy action in this Review is expected to:
• contain inflation and anchor inflationary expectations by reining in demand side pressures; and
• mitigate the risk to growth from potentially adverse global developments.


The RBI’s monetary Policy reviews are always highly logical, consistent and well reasoned. As we can see from the above Points from the RBI Review dated 16th,June,2011 – RBI has taken into account Global developments, local developments, money supply, inflation, growth conditions etc – and with them, supports its Policy prescription.
In the circumstances stated by RBI, the hiking of the repo rates is perhaps unavoidable.
But then – what are the other salient aspects we need to take note of from the review?

1.   Global economic conditions : There is an implicit assumption – that global inflation will reflect in India too – automatically. This is not necessarily true. Even in respect of Oil and its related products – India has a system of absorbing the additional expenditure at the central level (to some extent) and passing on a part of the additional expenditure on account of oil price hikes into the Indian markets. This, in my view, is quite healthy. Central funding of the additional Oil Bill – is any way coming from taxes, and is indirectly borne by the people only. But, the inflation on this account is not spread to all commodities with huge spiraling effect. Which Global Products will affect Indian purchases? Capital Goods, computers and the like – whose share in Inflation is pretty little.
2.   Indian Conditions – Food Inflation : Food articles are in  Inflation spiral – more because of logistical, warehousing and other inefficiencies and not much due to shortages compared to Demand. Where shortages appear periodically like in edible oils, long term measures like increasing acreage and short term measures like Imports are called for.
Now Tamilnadu has started supplying food grains  FREE at its PDS outlets – which is laudable. The effect of such measures will be effective control on Food Inflation. Other states also can adopt the same – instead of allowing the food grains to rot in FCI Godowns. If supply mechanism is streamlined, even other food articles prices in the markets will come down significantly.
There are many items like Sugar and a few other food items – where there is no shortage. In such cases, the respective Ministries need to move in quickly to control prices.
3.   Indian Conditions – Non-Food Inflation : Oil Price hikes are bound to result in an all-round inflation spiral in many products and services. Inflation will not be limited to the percentage increase in Oil prices.
Increase in iron Ore prices, rubber prices and such other raw material prices – have their cascading effect on steel prices, manufactured article prices etc. If raw material prices are controlled – by stopping exports, improving imports, bringing in additional acreage (for rubber, Cotton,  other plantations etc), Non-food inflation will come down.
4.   CSO Statistics : It is heartening that CSO has updated its statistical Indices. While this is a matter for satisfaction - there is also need to improve the statistical collection methodologies and machinery,  and further improve collation and computational methods, using latest software programs - as the monthly variations in manufacturing indices do not seem to be logical – even now.
5.   Credit Growth : Credit Growth is bound to be there, in a growing economy – even in the face of high interest rate regime.
But, sectors like automobiles, consumer durables are showing slower growth.
Several manufacturers have not fully passed on  their increasing raw material costs, as we can see from their decreasing profitability curves (Like Maruti, TATA Motors etc).So, prices of manufactured products are not going up at the speed suggested by Inflation numbers.
Banks have of course responded well to all RBI rate increases – by increasing their own lending rates – and they have also kept their borrowing rates rising steadily, keeping their own profit margins steady.
Credit today is considerably dearer compared to the beginning of FY 2011 – and is likely to affect small and medium scale industries; loans on automobiles, house-purchases, consumer goods and a few other sectors.
6.   Liquidity Conditions : While this is RBI numbers – the invisible money in circulation distorts all sorts of calculations.

All in all – the RBI Policy prescription is in expected direction only. It is however essential that the state and central Ministries must also come out with strong Policy measures to counter Inflation – and support these RBI measures to become effective.

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