RESERVE BANK
OF INDIA
Mid-Quarter Monetary Policy Review: September 2012
The Reserve Bank of India has
announced its Mid quarter Monetary Policy Review for Spetember,2012. As always,
RBI’s analysis of the Economy and policy guidance provides interesting
insights to all interested readers. They are also of significant implications
for the economy.
Monetary and Liquidity Measures
The RBI, on the basis of an
assessment of the current macroeconomic situation, has decided to:
(i)
reduce the cash reserve ratio (CRR) of scheduled
banks by 25 basis points from 4.75 per cent to 4.50 per cent of their net
demand and time liabilities (NDTL) effective the fortnight beginning September
22, 2012. Consequently, around ` 170 billion of primary liquidity will be
injected into the banking system; and
(ii)
keep the policy repo rate under the liquidity
adjustment facility (LAF) unchanged at 8.0 per cent. Consequently, the reverse
repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal
standing facility (MSF) rate and the Bank Rate at 9.0 per cent
What RBI says in
arriving at these decisions is summarized below :-
2. There have been several
significant developments since RBI’s 1st
Quarter Review of Monetary Policy in July. Globally, as risks have risen, both
the European Central Bank (ECB) and the US Fed have responded with liquidity
measures intended to calm financial markets and provide further stimulus to
economic activity. While these measures have certainly mitigated short-term
growth and financial risks, they will also exert pressure on global asset
prices, and particularly, commodity prices. Domestically, growth continues to
be weak amidst a negative investment
climate; however, the recent reform measures undertaken by Government have
started to reverse sentiments. Government undertook long anticipated measures
towards fiscal consolidation by reducing fuel subsidies and selling stakes in
public enterprises. Further, steps taken to increase FDI should contribute to
both greater capital inflows and, over the long run, higher productivity,
particularly in the food supply chain. Importantly, however, for the moment,
inflationary pressures, both at wholesale and retail levels, are still strong.
3. In April, RBI implemented a
frontloaded policy rate reduction of 50 basis points on the expectations of
fiscal policy support for inflation
management alongside supply-side initiatives for addressing the
deceleration of investment and growth. As these expectations did not materialise and inflation
remained firmly above 7.5 per cent, the RBI decided to pause in its policy
easing in the Mid-Quarter Review (MQR) of June and in the First Quarter Review
(FQR) of July. As inflationary tendencies have persisted, the primary focus of
monetary policy remains containment of inflation and anchoring of inflation
expectations. In this context, the Government’s recent actions have paved the
way for a more favourable growth-inflation dynamic by initiating a shift in
expenditure away from consumption (subsidies) and towards investment (including
through FDI). Of course, several challenges remain, one of which is persistent
inflation. But, as policy actions to stimulate growth materialize, monetary
policy will reinforce the positive impact of these actions while maintaining
its focus on inflation management. Only this will ensure that the economy
derives the maximum benefit from the recent, and anticipated, fiscal and
supply-side policy measures.
Global
Economy
4. Global activity has been
weakening in Q3 of 2012. Merchandise trade slowed considerably with absolute
contractions in major economies. Global purchasing managers’ indices (PMI)
point to contraction in manufacturing and only modest growth in services.
Persistent sovereign debt pressures amidst weakening economic activity in the euro
area pose significant downside risks to the global economy. These concerns have
prompted the announcement of the programme of outright monetary transactions
(OMTs) in the form of sovereign bond purchases by the ECB. The US Fed announced the purchase of additional agency
mortgage-backed securities until labour market conditions improve
substantially, and extended exceptional policy accommodation till mid-2015.
5. Growth in several major
emerging and developing economies (EDEs) is also moderating, with China’s Q2
2012 growth slowing to its lowest rate in the past three years. Slowing global
demand has adversely affected industrial activity and exports in these
economies. Additionally, drought conditions in major grain-producing areas of
the world and the possibility of further hardening of international crude
prices in view of the fresh dose of quantitative easing impart ubiquitous risks
to overall global macroeconomic prospects.
Domestic
Economy
Growth
6. Economic activity picked up
modestly in Q1 of 2012-13 in relation to the preceding quarter; but the
sluggish momentum of value added in Q1 was evident across all sectors of the
economy, and particularly in industry. Lead indicators point to slack activity
in Q2 as well. Industrial production rose by just 0.1 per cent in July. In
August, the manufacturing PMI fell to its lowest level during 2012 so far, as a
result of output disruptions due to power shortages and declining export
orders. The services PMI, however, picked up in August on growth in new orders
and employment. With the progressive reduction in the rainfall deficit, kharif
sowing, though still below normal, has improved. Reassuringly, the late rains
have augmented storage in reservoirs which should improve prospects for the
rabi crop, mitigating to some extent the concerns about agricultural prospects.
Inflation
7. Headline WPI inflation (y-o-y)
has remained sticky at around 7.5 per cent throughout the current financial
year so far. At the disaggregated level, within primary food articles, the
easing of vegetable prices in July-August was to a large extent offset by the
surge in prices of cereals and pulses. Demand-supply imbalances in respect of
protein-rich items persist. Fuel price inflation picked up in August, largely
reflecting the upward revision in electricity prices. As welcome as the recent
hike in diesel prices/rationalisation of LPG subsidy has been, the pass-through
to administered prices remains incomplete. International crude prices are
vulnerable to being driven up further by global liquidity. Core inflation
pressures remained firm with non-food manufactured products inflation inching
up from 5.1 per cent in April to 5.6 per cent in August and the momentum
indicator remaining elevated. Even as demand pressures moderate, supply constraints
and rupee depreciation are imparting pressures on prices, rendering them
sticky.
8. In terms of the new CPI,
inflation (y-o-y) remained broadly unchanged in July from June at close to 10
per cent, held up by rising prices of food items. Notwithstanding some easing in July, core CPI
inflation (CPI excluding food and fuel sub-group) remains elevated.
9. While the recent upward
revision in diesel prices and rationalisation of subsidy for LPG is a
significant achievement, in the short-term, there will be pressures on headline
inflation. Over the medium-term, however, it will strengthen macroeconomic
fundamentals. It is important to note
that these revisions were anticipated at the time of the April policy when a
front-loaded repo rate reduction was undertaken. Over the longer run, holding down subsidies
to under 2 per cent of GDP as indicated in the Union Budget for 2012-13 is
crucial to manage demand-side pressures on inflation. Containing inflationary
pressures and lowering inflation expectations warrant maintaining the momentum
of recent policy actions to step up investment, alleviate supply constraints,
and improve productivity.
Liquidity
Conditions
10. Money supply (M3), bank
credit and deposits have moderated in relation to their indicative
trajectories, reflecting the slowing down of economic activity. Against this
backdrop, liquidity conditions have remained comfortable since the FQR.
However, going forward, the wedge between deposit growth and credit growth
could widen on the back of the seasonal
pick-up in credit demand in the second half of the year. This, combined
with outflows on account of advance tax payments and the onset of
festival-related currency demand, could accentuate pressures on liquidity over
the next few weeks. In these conditions, appropriate liquidity management
assumes importance in order to ensure that drawals under the Liquidity
Adjustment Facility (LAF) broadly remain within the indicative target of +/- 1
percent of NDTL, thereby facilitating monetary policy transmission and enabling
adequate flow of credit to the productive sectors of the economy.
External
sector
11. While the trade deficit
narrowed in the first five months of 2012-13, the relatively large fall of
exports in July-August is indicative of risks to the current account from the
worsening global outlook. As regards external financing, the moderation in FDI
inflows was partly compensated by a surge in non-resident deposits and a
renewal of FIIs flows in recent months. Consequently, the rupee has been
trading in a narrow range since the FQR. Looking ahead, a moderation in the
trade deficit combined with increased inflows in response to domestic policy
developments could ease pressures on the balance of payments. However, risks
from global factors, in terms of both capital movements and oil prices will
persist. Given these external risks, holding down the CAD to sustainable levels
will depend on durable fiscal consolidation and, in particular, switching
public expenditure from subsidies to capital outlay that crowds in private
investment, thus preparing the ground for a revival of growth.
Guidance
12. Since the FQR, while growth
risks have increased, inflation risks remain. Mitigating the growth risks and
taking the economy to a higher sustainable growth trajectory requires concerted
policy action across a range of domains, a process to which last week’s actions
made a significant contribution. Monetary policy also has an important role in
supporting the growth revival. However, in the current situation, persistent
inflationary pressures alongside risks emerging from twin deficits – current
account deficit and fiscal deficit - constrain a stronger response of monetary
policy to growth risks. Accordingly, as this process evolves, the stance of
monetary policy will be conditioned by careful and continuous monitoring of the
evolving growth-inflation dynamic, management of liquidity conditions to ensure
adequate flows of credit to productive sectors and appropriate responses to
shocks emanating from external developments.
MY COMMENTS :-
There can be no denying of the
facts and the strength of arguments coming from the RBI. It is largely true not much action has been taken by the Government, from the supply side - for containing Food
Inflation. Government must address this aspect. It is apparent to one and all –
and it has come from RBI several times in its reports – that until
fiscal and administrative measures are taken – from supply side – there can be
no control over food inflation.
RBI has also done well to point
out the need for supply side measures – and has even pin pointed the inflation
in cereals and pulses – where action is overdue.
With the recent activity seen in
the Government over REFORM MEASURES, we hope that the Government will activate
the Food and Agri Ministries at the Centre and States – so that they will
initiate the necessary supply side measures and other administrative measures –
to control food article supply and their prices.
This said – it still looks not
the correct prescription for RBI to retain the Repo and reverse repo rates at
current HIGH LEVELS.
These rates are a Big factor in
capital Asset formation on one side and in
incentivizing Buying / consumption for many consumer products. We find
deceleration in Buying in all sectors of Automobile Industry. Likewise, in the
Realty sector.
Infra sector is not picking up
because of Governmental bottlenecks on one side – and hesitancy of Infra
Industry to go for implementation of projects in such scenario, given the high
interest rates.
Will Telecom sector bid at the
High licence fees fixed by Govt – and then go for further loans at current
interest rates for expansion? This seems doubtful. Their profitability is
already very LOW – for incentivizing any expansion at such high interest rates.
Capital asset formation happens
only when Return
from capital is good enough compared to Cost of Capital. This, in current
circumstances, is in RBI’s hands,
So, the point is – RBI, I
personally feel, must BAT FOR GROWTH –
at this point of time – even with the current High Inflationary levels, since
FOOD INFLATION is out of its hands and the responsibility now lies on Central
and State Governments (Food and Agri Ministries). Any reduction in Interest
Rates is not going to stoke Inflationary pressures in FOOD ARTICLES.
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