Tuesday, October 30, 2012
RESERVE BANK OF INDIA - 2nd QUARTER 2012-13 REVIEW - NO RATE CUT YET AGAIN - DISAPPOINTMENT SHOWS - CRR cut welcome - but insufficient to fuel Growth
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.
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.
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.
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 %.
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
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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