SECOND QUARTER REVIEW OF
Monetary Policy 2012-13 OF RBI
Here
is a summary of the RBI ‘s second quarter review of Monetary Policy for 2012-13,
released today. Stock Market has reacted sharply to the announcement. SENSEX is down by 2o5 points and NIFTY by 68 points. Banking stocks are especially down - but many other stocks are also down.This was predictable. However, Banks are unlikely to be affected much - as they will maintain their margins. The point of concern for the country is that - Credit Demand for capital asset formation will continue to remain muted. Most Banks are therefore concentrating on retail loans, since there is not much demand for production purposes. This is not good for the economic Growth of the country in the long term.
Government also seems disappointed with the Policy.
"Growth is as much a challenge as inflation. If government has to walk
alone to face the challenge of growth then we will walk alone," said the Finance Minister after the monetary policy.
Deputy chairman of planning commission Montek Singh Ahluwalia also seems disappointed that the RBI did not cut rates. "We expected RBI to move to support growth revival," Ahluwalia said.
This blog also had advocated earlier for a RATE CUT at this point of time. The rationale for continuing the HIGH RATE policy does not seem valid, when Growth is of much greater importance. Especially so, when the High Rates have been in existence for such long time, without any effect on Inflation. Government has taken some of the steps indicated by RBI and is moving further in that direction. Therefore, it would have been a welcome measure if RBI had made at least a token RATE CUT immediately
This writer feels that if Growth starts happening, Inflation too, will come down - not the other way. While CRR cut is welcome, RATE-CUT is more urgent as a policy measure. One hopes that RBI will consider this too - quickly.
Now, the Summary of RBI Announcement :
RBI DECISIONS :
Ø Cut
cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.5 % to
4.25 % of their net demand and time liabilities (NDTL) effective the fortnight beginning
November 3, 2012.
Ø The
reduction in CRR, will inject around Rs.175 billion of primary liquidity into
the banking system.
Ø There
is no change in policy interest rate. Accordingly, the repo rate under liquidity
adjustment facility remains at 8.0 %.
Ø Consequently,
reverse repo rate under liquidity adjustment facility (LAF), determined with a
spread of 100 basis points below the repo rate, will continue at 7.0 %, and the
marginal standing facility (MSF) rate, determined with a spread of 100 bps
above the repo rate, at 9.0 %.
Considerations Behind the
Policy Move
The
decision to cut the CRR and keep the policy interest rate unchanged draws from RBI’s
assessment of the evolving liquidity situation and the growth-inflation
dynamic.
First
on liquidity. Systemic liquidity deficit has been high because of several
factors: the wedge between deposit and credit growth, the build-up of
Government’s cash balances from mid-September and the drainage of liquidity on
account of festival-related step-up in currency demand. This high systemic
deficit will have adverse implications for the flow of credit to productive
sectors and for the overall growth of the economy going forward.
As
regards the growth-inflation balance, headline WPI inflation moderated from its
peak of 10.9 % in April 2010 to an average rate of 7.5 % over the period
January-August 2012. During this time, growth has slowed and is currently below
trend. This slowdown is due to a host of factors, including monetary
tightening.
Since
April 2012, RBI’s monetary policy stance has sought to balance growth–inflation
dynamic through calibrated easing. Transmission of these policy impulses
through the economy is still underway. In conjunction with the fiscal and other
measures recently announced by Government, RBI’s monetary policy stance should
work towards arresting the loss of growth momentum over the next few months.
Yesterday’s statement by the Finance Minister reaffirming commitment to fiscal
consolidation will open up space for monetary policy to restrain inflation and
support growth.
Now
coming to inflation. It turned up again in September, reflecting the partial
pass-through of adjustment of diesel and electricity prices, and elevated
inflation in non-food manufactured products. It is, therefore, critical that
even as the monetary policy stance shifts further towards addressing growth
risks, the objective of containing inflation and anchoring inflation
expectations is not de-emphasized.
Monetary Policy Stance
The
policy document spells out three broad contours of our monetary policy stance.
These are:
First,
to manage liquidity to ensure adequate flow of credit to the productive sectors
of the economy;
second,
to reinforce the positive impact of government policy actions on growth as
inflation risks moderate; and
third,
to maintain an interest rate environment to contain inflation and anchor
inflation expectations.
Guidance
In
reducing CRR, RBI intended to pre-empt a prospective tightening of liquidity
conditions, thereby keeping liquidity comfortable and supportive of growth. The
policy stance anticipates the projected inflation trajectory which indicates a
rise in inflation over the next few months before easing in the last quarter.
While there are risks to this trajectory, the baseline scenario suggests a
reasonable likelihood of further policy easing in the fourth quarter of this
fiscal year. This guidance will, however, be conditioned by the evolving
growth-inflation dynamic.
Expected Outcomes
RBI expects that today’s policy actions, and
the guidance that it has given, will result in the following three outcomes:
first,
liquidity conditions will facilitate a turnaround in credit growth to
productive sectors so as to support growth;
second,
as inflation risks moderate, the growth stimulus of the policy actions
announced by the Government will be reinforced;
and,
finally, the policy action will anchor medium-term inflation expectations on
the basis of a credible commitment to low and stable inflation.
Indian Economy
Growth
decelerated over four successive quarters, from 9.2 % year-on-year in the
fourth quarter of 2010-11 to 5.3 % in the fourth quarter of 2011-12. In the
first quarter of this year, growth was marginally higher at 5.5 %. This slight
improvement in GDP growth in the first quarter was mainly driven by growth in
construction, and supported by better than expected growth in agriculture. On
the demand side, the growth of gross fixed capital formation decelerated, while
the slowdown in growth of private consumption expenditure continued. The
external demand conditions and crude oil prices also remained unfavourable,
adversely impacting net exports.
Over
the last quarter, global risks have increased and domestic risks have become
accentuated owing to halted investment demand, moderation in consumption
spending and continuing erosion in export competitiveness accompanied by
weakening business and consumer confidence. The industrial outlook remains uncertain.
Notwithstanding the improvement in rainfall in the months of August and
September, the first advance estimates of the 2012 kharif production are about
10 % lower than last year’s production.
On
the basis of the above considerations, the baseline projection of GDP growth
for 2012-13 is revised downwards from 6.5 % to 5.8 %.
Inflation
Moving
on to inflation. Headline WPI inflation remained sticky, at above 7.5 % on a
y-o-y basis, through the first half of the current year. Furthermore, in
September there was a pick-up in the momentum of headline inflation owing to
the increase in fuel prices and elevated price levels of non-food manufactured
products. This is, in part, attributable to some suppressed inflation in the
form of earlier under-pricing being corrected. However, even after adjusting
for this, the momentum remains firm.
While
WPI primary food articles moderated since July due to the softening of prices
of vegetables, prices of cereal and protein items edged up. WPI food products
inflation increased in September, mainly due to the firming up of the prices of
sugar, edible oils and grain mill products.
Fuel
group inflation registered a significant rise in September, reflecting the
sharp increase in prices of electricity effected from June, the partial impact
of the increase in prices of diesel in mid-September and significant increase
in non-administered fuel prices on account of rising global crude prices.
Non-food
manufactured products inflation was persistent at 5.6 % through July-September.
This upside pressure was a result of firm prices of metal products and other
inputs and intermediates, especially goods with high import content due to a
depreciating rupee.
Consumer
price inflation, as measured by the new CPI, remained elevated, reflecting the
build-up of food price pressures. CPI inflation excluding food and fuel groups
ebbed slightly during June-September, from double digits earlier.
Looking
ahead, the path of inflation will be shaped by two sets of counteracting
forces.
First,
on the downside, slower growth and excess capacity in some sectors will help
moderate core inflation. Stable, or in the best case scenario, declining
commodity prices will reinforce this tendency. An appreciating rupee will also help
to contain inflationary pressures by bringing down the rupee cost of imports,
especially of commodities.
Balancing
those downside forces are some on the upside. Persistent supply constraints may
aggravate as demand revives, resulting in price pressures. Global financial
instability could put downward pressure on the rupee and that will add to
imported inflation. Also, the upsurge in both rural and urban wages will exert
cost-push pressures on inflation.
Finally,
as under-pricing in several products is corrected as part of the fiscal
consolidation process, suppressed inflation is being brought into the open.
This correction is necessary and important. Nevertheless, it will result in
higher inflation readings.
Taking
the above factors into consideration, the baseline projection for headline WPI
inflation for March 2013 is raised to 7.5 % from 7.0 % indicated in July.
Importantly, inflation is expected to rise somewhat in the third quarter before
beginning to ease in the fourth quarter.
Monetary and Liquidity
Conditions
Money supply (M3), deposit
and credit growth have so far trailed below the indicative trajectories of RBI
indicated in the April Policy and reiterated in the July Review.
Deposit growth has decelerated with the
moderation in interest rates, especially term deposits. Credit growth has ebbed
with the slowdown in investment demand, especially with regard to
infrastructure, and lower absorption of credit by industry, in general.
Keeping in view the developments during the year so far and the usual year-end
pick-up, the trajectories of the monetary aggregates for 2012-13 are projected
at 14 % for M3, 15 % for deposit growth and 16 % for growth of non-food credit.
Liquidity
conditions, as reflected in the average net borrowing under the LAF at Rs.486
billion during July-September, remained within the comfort zone of (+/-) one %
of NDTL. However, liquidity conditions tightened in October, mainly on account
of the build-up in the Government’s cash balances and the seasonal increase in
currency demand, taking the average LAF borrowing to Rs.871 billion during
October 15-25, well above the band of (+/-) one % of NDTL
Risk Factors
First,
the downside risks to growth stemming
from the global macroeconomic environment now seem likely to be stronger than
earlier thought. Domestically, a revival in investment activity, which is
key to stimulating growth, depends particularly on the recent policy
announcements by the Government being translated into effective actions;
Second,
despite recent moderation, global commodity prices remain high. Also, under
recoveries in domestic prices of administered petroleum products persist and
will need to be corrected. While corrections are welcome from the viewpoint of
overall macroeconomic stability, we will have to guard against their
second-round effects on inflation.
Third,
the behaviour of food inflation will depend on the supply response in respect
of commodities characterised by structural imbalances, particularly protein
items;
Fourth,
the persistent increase in rural and urban wages, unaccompanied by commensurate
productivity increase, has been and will continue to be a source of inflationary
pressures;
Fifth,
the large twin deficits, i.e., the current account deficit and the fiscal
deficit pose significant risks to both growth and macroeconomic stability; and
Finally,
while liquidity pressures pose risks to
credit availability for productive purposes and could adversely affect
overall investment, excess liquidity could aggravate inflation risks.
The
persistence of inflation pressures, even as growth has moderated, remains a key
challenge. Of particular concern is the stickiness of core inflation, mainly on
account of supply constraints and the cost-push of rupee depreciation.
Consequently, managing inflation and inflation expectations must remain the
primary focus of monetary policy. A central premise of monetary policy is that
low and stable inflation and well-anchored inflation expectations contribute to
a conducive investment climate and consumer confidence, which is key to
sustained growth on a higher trajectory in the medium-term.
Accordingly,
over the past few quarters, monetary policy had to focus on inflation, even as
growth risks have increased. As recent policy initiatives by the Government
start yielding results in terms of revitalising activity, they will open up
space for monetary policy to work in concert to stimulate growth. However, in
doing so, it is important not to lose sight of the primary objective of
managing inflation and inflation expectations.
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