Tuesday, April 17, 2012


RBI's Monetary Policy
Statement for 2012-13


RBI has finally responded to the call for Growth. In its annual Monetary Policy Statement released today by the RBI Governor, D.Subbarao, RBI has surprised and pleased many by cutting REPO Rates by 50 basis points. RBI richly deserves the praise of all, for this far-sighted and timely action. The other measures for Banking regulation are also detailed here, which deserve EQUAL PRAISE – since the health of Indian Banking system is uniquely ensured by the efficiency of RBI’s supervisory Role on them. Government should now respond equally well with measures to control Inflation - from its side.

Here are the details from the RBI Governor’s statement:

Ø  Based on an assessment of the current macroeconomic situation, RBI has decided to:   reduce the repo rate under the liquidity adjustment facility (LAF) by 50 basis points. The repo rate will accordingly drop from 8.5 to 8.0 per cent.

Ø  Consequent to this, the reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, gets calibrated to 7.0 per cent. Similarly, the marginal standing facility (MSF) rate, which has a spread of 100 bps above the repo rate, stands adjusted to 9.0 per cent.

Ø  In order to provide greater liquidity cushion, RBI has also decided to raise the borrowing limit of scheduled commercial banks under the marginal standing facility (MSF) from one per cent to two per cent of their net demand and time liabilities (NDTL).

Ø  These changes have come into effect immediately after the announcement.

2 Broad Considerations Behind the Policy Move

Ø  First, growth decelerated significantly to 6.1 % in the 3rd quarter of last year, although it is expected to have recovered moderately in the 4th quarter. Based on current assessment, the economy is clearly operating below its post-crisis trend.

Ø  Headline WPI inflation which remained above 9 % for nearly two years has moderated significantly to below 7 % by March 2012. More importantly, non-food manufactured products inflation has dropped from a high of 8.4 % in November 2011 to 4.7 % in March 2012, actually coming below 5 % for the first time in two years.

3 Contours of Monetary Policy Stance

Ø  to adjust the policy rates to levels consistent with the current  growth moderation;

Ø  to guard against risks of demand-led inflationary pressures re-emerging;

Ø  to provide greater liquidity cushion to the financial system.

Guidance for the period forward :

Ø  The reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.

Ø  Moreover, if subsidies are not contained as indicated in the Union Budget last month, demand pressures will persist, and will further reduce whatever space there is for monetary easing. Revisions in administered prices may adversely impact headline inflation. But the appropriate monetary policy response to this should be based on whether the higher prices translate into generalized inflationary pressures. The likelihood of a pass-through of higher administered prices to generalised inflation depends on the strength of the pricing power in the economy. The pricing power is currently abating, but the risk of a pass-through cannot be ignored altogether. Overall, from the perspective of vulnerabilities emerging from the fiscal and current account deficits, it is imperative for macroeconomic stability that administered prices of petroleum products are increased to reflect their true costs of production.

Ø  Liquidity management posed a major challenge for much of last year. However, liquidity conditions have eased in recent weeks, and are now steadily moving towards the comfort zone of the Reserve Bank. This is reflected in the decline in banks’ borrowings from the LAF and the behaviour of money market rates. The increase in the MSF limit to banks that we just announced should provide additional liquidity comfort. However, should the situation change, appropriate and proactive steps will be taken with the objective of restoring comfort zone conditions.

3 Expected Outcomes

Ø  growth will stabilise around its current post-crisis trend.

Ø  risks of inflation and inflation expectations re-surging will be contained.

Ø  the liquidity cushion available to the system will be enhanced.

Indian Economy

Ø  Turning to the domestic macroeconomic situation, economic growth decelerated last year, dropping from 7.7 % in the 1st quarter to 6.9 % in the second quarter and further down to 6.1 % in the 3rd quarter. This was mainly due to deceleration in industrial growth. Growth in the services sector held up relatively well. On the demand side, gross fixed capital formation contracted both in the second and third quarters of last year.

Ø  The Central Statistics Office (CSO) put out an advance estimate of GDP growth for last year of 6.9 %. More recent data on industrial production suggest that activity may have expanded at a slower pace last year.

Ø  Looking ahead, the overall growth outlook for the current year looks a little better than it was last year. Accordingly, the Reserve Bank’s baseline projection of GDP growth for the current year is 7.3 %.


headline WPI inflation, which remained above 9 % during April-November 2011, moderated to 6.9 % by end-March 2012. This moderation was consistent with the Reserve Bank’s indicative projection of 7 %.

Food articles inflation continues to be high. Significantly.  inflation in protein items is in double digits, reflecting persistent structural demand-supply imbalances in protein foods.

Fuel inflation, on the other hand, moderated from over 15 % in Nov-Dec 2011 to 10.4  % in March 2012 even  as global crude oil prices rose sharply. This reflects the absence of a commensurate pass-through to domestic consumers.

Non-food manufactured products inflation decelerated significantly from 8.4 % in November 2011 to 4.7 % in March 2012, on the back of a slowdown in domestic demand and softening of global non-oil commodity prices.

Even as WPI inflation has softened, inflation as measured by the new series of consumer price index (CPI) suggests that price pressures are still high at the retail level.

Looking ahead, based on an assessment of the domestic demand-supply balance, global trends in commodity prices and the likely demand scenario, the Reserve Bank’s projection of inflation for March 2013 is 6.5 %.

Risk Factors

Ø  a major risk to our growth and inflation projections stems from the outlook for global commodity prices, especially of crude oil. Although upside risks to oil prices from the demand side are limited, geo-political tensions are a concern. Any disruption in supplies is likely to lead to further increase in crude oil prices.

Ø  Even though the Budget has proposed a reduction in the fiscal deficit in the current year, there are several upside risks. Any slippage in the fiscal deficit will have implications for inflation.

Ø  large Government borrowing budgeted for 2012-13 has the potential to crowd out credit to the private sector. If that happens, the supply response required to accelerate growth could be inhibited.

Ø  financing of the current account deficit will continue to pose a major challenge.

Ø  structural imbalances in protein-rich foods persist, and consequently, food inflation is likely to remain under pressure.

Financial inclusion :

There has been significant progress in providing banking services to villages with population above 2,000. The challenge now is to extend coverage to all the unbanked villages of the country. Accordingly, it is proposed to mandate state level bankers’ committees (SLBCs) to prepare roadmaps covering all unbanked villages of population of less than 2,000, and notionally allot these villages to banks for providing banking services in a time bound manner.

Measures  on Customer service in banks :

Ø  banks are being advised to offer a ‘basic savings bank deposit account’ with certain minimum common facilities and without the requirement of a minimum balance to all their customers.

Ø  banks will be mandated not to levy foreclosure charges or pre-payment penalties on home loans extended on a floating interest rate basis.

Ø  banks are being advised to initiate steps to allot a unique customer identification code (UCIC) number to all their customers.

Regulation and supervision:

On Basel III, final guidelines on the implementation of capital regulations will be issued by end-April 2012, and final guidelines on liquidity risk management and liquidity standards by end-May 2012.

There has been a significant increase in loans against gold by non-banking financial companies in the recent period, which has raised several concerns. This policy contains three measures to regulate this further:

Ø  banks should reduce their regulatory exposure ceiling to a single NBFC, having gold loans to the extent of 50 per cent or more of its total financial assets, from the existing 10 % to 7.5 % of bank’s capital funds.

Ø  banks should have an internal sub-limit on their aggregate exposure to all such NBFCs, having gold loans to the extent of 50 per cent or more of their total financial assets, taken together.

Ø  Reserve Bank has constituted a Working Group to undertake a detailed study of gold demand, trends in gold prices and lending by NBFCs against gold.

2 measures relating to NBFCs.

Ø  the draft guidelines on overseas investment by core investment companies (CICs) will be placed on the Reserve Bank’s website for public comments by end-April  2012.

Ø  it has been decided to issue the draft guidelines on the regulatory framework for NBFCs by end-June 2012 based on the recommendations of the Usha Thorat Working Group.

Non-performing assets of banks : We are mandating banks to put in place a robust mechanism for early detection of signs of distress and take remedial measures.

Guidelines on securitisation will be issued by end-April 2012.

2 measures concerning currency management.

Ø  with a view to address the issue of counterfeit notes in circulation, banks are advised to ensure that notes received over the counters are re-circulated only after ensuring their proper authentication through machines.

Ø  keeping in view the extended geographical spread of bank branch network and leveraging on technology, RBI has decided to channelize the distribution of currency and coins only through currency chests and bank branches.

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