Friday, September 16, 2011



Mid-Quarter Monetary Policy Review  Dated 16th, September 2011


RBI has announced its Mid-quarter Monetary Policy review today, along with its monetary measures to control Inflation. According to its Press release, RBI has decided to :

increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 % to 8.25 % with immediate effect.

Consequent to the above increase in the repo rate, the reverse repo rate under the LAF will stand automatically adjusted to 7.25 % and the marginal standing facility (MSF) rate to 9.25 % with immediate effect.”

As always, RBI monetary Policy measures are supported by its review of national and international macro economic situation, reasons there for, factors underlying it and allied matters. This is summarized below :


Since RBI’s 1st Quarter Review of July 26, global macroeconomic outlook has worsened. Sluggishness will persist longer than earlier expected. Concerns over  sovereign debt problem in euro area have added further uncertainty to the prospects of recovery.

Domestically, even as many indicators point to moderating growth, both headline and non-food manufactured products inflation are at uncomfortably high levels. Crude oil prices remain high. Food price inflation persists notwithstanding a normal monsoon.

Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilization of energy prices and moderating domestic demand should facilitate this process.  However, in current scenario, with the likelihood of inflation remaining high for next few months, rising inflationary expectations remain a key risk. This makes it imperative to persevere with the current anti-inflationary stance.
Global Economy

Global economy slowed in Q2 (April-June) of 2011.  Lead indicators such as purchasing managers’ indices (PMIs) suggest a further moderation in economic activity in Q3, with global manufacturing PMI approaching neutral level of 50. In recent weeks, global financial markets have been rattled by perceptions of  inadequate solutions to the euro area sovereign debt problem, exposure of banks to euro area sovereign debt and renewed fears of recession. Global recovery will also be affected by fiscal consolidation measures in some of the advanced economies.

In the US, apart from fiscal concerns, stubbornly high unemployment and weak housing markets continued to weigh on consumer confidence and private consumption. In response to the weakening of economic activity, the US Federal Open Market Committee, in its 9th August meeting, indicated that it would keep the federal funds rate near zero at least through mid-2013.

Economic activity in the euro area decelerated significantly during Q2 of 2011 reflecting decline in both private and government consumption expenditures as well as deceleration in capital formation. Economic activity contracted in Japan reflecting the impact of the earthquake/tsunami.

In contrast to advanced economies, growth remained relatively resilient in emerging and developing economies, notwithstanding some moderation in response to monetary tightening to contain inflation.

Domestic Economy

GDP growth decelerated to 7.7 % in Q1 of 2011-12 from 7.8 % in the previous quarter and 8.8 % in the corresponding quarter a year ago. Agricultural growth has accelerated, but industry and services have decelerated. The index of industrial production (IIP) slowed from 8.8 % year-on-year in June  to 3.3 % in July. However, excluding capital goods, the growth of IIP was higher at 6.7 % in July  as  compared with 4.4 % in June. Cumulatively, the IIP increased by 5.8 % during April-July 2011, compared with an increase of 9.7 % in the corresponding period of the previous year.

The HSBC Purchasing Managers' Index for the manufacturing sector also suggested moderation.  Corporate margins in Q1 of 2011-12 moderated across several sectors compared to their levels in Q4 of 2010-11. However, barring a few sectors, significant pass-through of rising input costs is still visible.

Monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline.


Headline year-on-year wholesale price index (WPI) inflation rose from 9.2 % in July to 9.8 % in August 2011.  Inflation in respect of primary articles and fuel groups edged up in August. Year-on-year non-food manufactured products inflation rose from  7.5 % in July  to 7.7 % in August 2011 suggesting as yet persistent demand pressures. The oil marketing companies raised the price of petrol by ` 3.14 per litre with effect from September 16, 2011. This will have a direct impact of  7 basis points to WPI inflation, in addition to indirect impact with a lag. The new combined (rural and urban) consumer price index (base: 2010=100) rose to 110.4 in July from 108.8 in June. Other consumer price indices registered inflation rates in the range of 8.4 to 9.0 % in July.

Monetary, Credit and Liquidity Conditions

Year-on-year money supply (M3) growth at 16.7 % in August was higher than the projection of 15.5 % for the year reflecting higher growth in term deposits and moderation in currency growth.  Similarly, year-on-year non-food credit growth at 20.1 % in August 2011 was above the indicative projection of 18 % set out in the July Review.

Liquidity has remained in deficit, consistent with the stance of monetary policy. The daily average borrowings under the liquidity adjustment facility (LAF) were around ` 40,000 crore in September (up to September 15, 2011). Money and the government securities markets have remained orderly. In recent weeks, as a result of global risk aversion, the rupee has depreciated, which may have adverse implications for inflation.

Monetary transmission strengthened further with 45 scheduled commercial banks raising their Base Rates by 25-100 basis points after the July Review. Consequently, the modal base rate of banks rose to 10.75 % in August from 10.25 % in July.
Fiscal Conditions

The central government’s fiscal imbalances widened during April-July of 2011 reflecting, primarily, the impact of decline in revenue receipts coupled with pressures from non-plan revenue expenditures on account of higher petroleum and fertiliser subsidies. Fiscal deficit at 55.4 % of the budget estimates in the first four months of the current fiscal was significantly higher than that of 42.5 % during the corresponding period last year (when adjusted for the more than budgeted spectrum proceeds).

Summing Up

To sum up, developments in the global economy over the past few weeks are a matter of serious concern. Growth momentum is weakening in the advanced economies amidst heightened concerns that recovery may take longer than expected earlier. Although India's exports have performed extremely well in the recent period, this trend is unlikely to be sustained in the face of weakening global demand. This, combined with the slowing down of domestic demand, to which the monetary policy stance is also contributing, suggests that risks to the growth projection for 2011-12 made in the July Review are on the downside.

Meanwhile, inflation remains high, generalized and much above the comfort zone of the Reserve Bank. After slight moderation in July, non-food manufactured products inflation rose again in August, suggesting continuing demand pressures.  Global crude oil prices have remained elevated despite weakening of global recovery. Moreover, there is still an element of suppressed inflation. Though global oil prices have moderated, the pass-through to domestic prices remains incomplete. Also, current administered electricity prices are yet to reflect increase in input prices, even as many states have initiated increases. Food inflation is at near-double digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon. The inflation momentum, reflected in the de-seasonalised sequential monthly data, persists.

Expected Outcome

The policy action in this Review is expected to:

reinforce the impact of past policy actions to contain inflation and anchor inflationary expectations.


The monetary tightening effected so far by the Reserve Bank has helped in containing inflation and anchoring inflationary expectations, though both remain at levels beyond the Reserve Bank’s comfort zone.  As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12.  As such, a premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is, therefore, imperative to persist with the current anti-inflationary stance. Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory, to which the moderation in demand is expected to contribute, and the implications of global developments.


While all the above analysis is broadly correct, the final remedy does not appear to be correct.

If there has been normal monsoon now and earlier, why does food Inflation persist? This is mainly due to mismatch between supply and the demand for food products. – and not due to excess liquidity in the system.

It would be an incorrect method to try to depress demand for food articles by artificially reducing the money supply going into their purchase. In India, there is a huge undernourished population even now – and food supply must reach them in adequate quantities. NREGA and other such schemes are intended for it. So, these schemes are bound to create money supply precisely for Food articles. It is Government’s duty to augment supply of food articles also to these sections of society – so that no Inflation results in food articles’ prices.

There must be central and State Government action – to ensure that there is no hoarding in food articles and that there are adequate transportational and other logistical arrangements for food supplies to reach the locations where we find pricing pressures. Also, Governments must take effective steps to increase the acreage under agriculture very quickly and see that products in shortage are cultivated more.

India has floods in many places but where water is needed for agriculture, there, we find shortage of water. Governments must take steps to ensure that the flood waters are diverted to draught prone places – so that floods are averted and adequate water supply  in draught prone places is  ensured. In India, most water storage facilities, we find, were created hundreds of years ago, by our ancient Kings. Today, due to faulty planning, many of these have disappeared.

The central and State food and agriculture Ministers / secretaries must meet at least once in a quarter and draw up plans for a national water Grid, which ensures adequate, clean water to all places in India. They must also ensure the creation of adequate storage and distribution facilities. Hoarding and creation of artificial scarcities occurs in certain articles. This must be prevented by the Government.

Thus, there are short term and long term measures that each Government must take – to increase food supplies and arrest food inflation.

In regard to manufactured articles, India must promote greater demand and greater supply both – at this point of time. Manufacturers and entrepreneurs in India need further encouragement to enhance supplies. While supply chain can be created by them – demand must not be stifled by RBI or Government – by Rate Hikes etc. The last 2 years have seen Rate Hikes that were not seen in last several years. But, this did not arrest Inflation. On the other hand, now, it is adversely affecting Growth in several sectors – like housing and Auto sectors.

USA is deeply concerned on how to increase demand in these sectors – where as India is stifling even the natural growth of demand in these sectors.

Government’s policies are also not helping the growth or control of Inflation. For instance, huge taxation is one of the main causes of the sluggishness in the Airlines sector. Both Public and Private carriers are slipping into the Red despite higher fares. If Air line carriers slip into red – Governments taxes also will be affected adversely. On the other hand, reducing the taxes on airline fuel etc – and helping them balance their Balance sheets – will help them and also the Government eventually.

Increasing Petrol, diesel and LPG prices is directly and indirectly inflationary. Government must absorb these additional costs. Its taxation policies will generate enough resources – if Inflation is not spiraling out of bounds and incomes are increasing.

I do not know if the repo and reverse repo rates in India have already touched current world highs – or we are headed in that direction. But, it is definitely time to reverse them. Rate Hike, in my view, is the wrong medicine by the wrong Doctor at the wrong time. But, to be fair to RBI, if it must act to control Inflation, this is the only medicine in its Kit. Hence, this is not intended to be a criticism of RBI Policies.

But, it is the Government which must take serious measures on supply side especially – and ensure adequate supplies to meet the demand. Prices will come down. Inflation will come down.

India is not at a stage where it can afford to stall Growth. It must  PLAN FOR ABUNDANCE – and not for scarcities. It must not stifle demand – especially for food products and other essential products. If necessary, it must control the prices by other means available to Government.

It looks as though – Mr. Kaushik Basu and Mr. Pranab Mukherjee are both thinking of such “out-of-the-box” measures only presently.

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