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Home > Detail - First Quarter Review of RBI Monetary Policy 2010-11
Detail - First Quarter Review of RBI Monetary Policy 2010-11
Detail - First Quarter Review of RBI Monetary Policy 2010-11
Section I: Overview of Global Economy and domestic macroeconomic development
Section II: Outlook and projections for growth, inflation, money and credit aggregates
Section III: Stance of monetary policy
Section IV: Monetary measures

Section I: Overview of Global Economy and domestic macroeconomic development

Global Economy
An assessment of advanced economies shows increasing pessimism about the sustainability of the current pace of recovery. The International Monetary Fund (IMF) raised its global growth projection for 2010 to 4.6 percent from its April projection of 4.2 percent on the strength of Q1 growth rates. However, the IMF's expectation of slightly faster global growth is largely driven by somewhat greater optimism about emerging market economies (EMEs).

In the US, recovery remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit. In Europe, economic activity is weak, though more resilient than expected in the face of the recent turbulence. In many EMEs, especially in Asia, growth is fast approaching the trend.

Domestic Economy
As per First Quarter Review of July 2010, the Indian economy grew by 7.4 per cent in 2009-10. The momentum was particularly pronounced in Q4 of 2009-10 with growth at 8.6 percent as compared with 6.5 percent in the previous quarter.

The growth in the Index of Industrial Production (IIP) continued during the current financial year although there was modest deceleration in May 2010. In the first two months of this fiscal year, the IIP recorded a year-on-year growth of 14 percent with as many as fifteen out of the seventeen industry groups (two digits NIC classification) showing positive growth.

Money supply (M3) growth on a year-on-year basis moderated from 16.8 percent at end of March 2010 to 15.3 percent as on July 2, 2010 reflecting a slowdown in the growth in bank deposits. Time deposits decelerated mainly because of withdrawal of deposits by public sector undertakings and mutual funds.

The non-food credit growth accelerated from 17.1 percent in March 2010 to 22.3 percent as on July 2, 2010. This reflects the combined impact of a pick-up in industrial activity and financing of the 3G and broadband wireless access (BWA) spectrum auctions. The increase in bank credit to the commercial sector has also been supplemented by higher flow of funds from other sources.

The foreign exchange market saw a relative increase in volatility to the previous quarter, with the rupee showing two-way movements in the range of Rs.44.33-Rs.47.57 per US dollar.

During the first two months, both exports and imports continued to expand in comparison to the figures during the corresponding period of last year. The trade deficit has increased to US $21.7 billion during April - May 2010, from US $14.4 billion in the corresponding period of the previous year, reflecting the sustained increase in domestic activity.

Equity markets also exhibited volatile conditions during the current financial year, although they have firmed up in recent weeks. Resource mobilization by the corporates through public issues in the primary segment of the capital market continued its uptrend.

India's improving growth prospects, combined with persistently high levels of global liquidity, may result in a significant increase in net inflows over the coming months.

Section II: Outlook and Projection

Global Growth and Inflation
The IMF revised the growth projection for the global economy for the year 2010 to 4.6 percent from 4.2 percent in April 2010.

The inflation situation in advanced economies has been shaped by

  • high unemployment,
  • low capacity utilization, and
  • renewed uncertainties about the financial sector
In contrast, the relatively rapid recovery in EMEs has also been accompanied by faster growth in prices.

Significantly, with increasing uncertainty about the pace of global recovery, global energy and commodity prices have softened.

This trend has been reinforced by the slowdown of the Chinese economy. Consequently, global inflationary pressures are expected to be subdued over the next few months.

Domestic Growth and Inflation
The growth prospects of the Indian economy have improved since April 2010.

Growth in exports, which turned positive in October 2009, picked up further in subsequent months despite concerns over the external demand outlook due to the sovereign debt problem in euro area. Service sector activities have also shown buoyancy since the latter half of 2009-10. The leading indicators of various services have shown significant improvements.

The strength of the recovery is also reflected in the sales and profitability growth of the corporate sector.

Increase in resource mobilization by the commercial sector from both banking and non-banking segments and the widening of the current account deficit also suggest strong underlying growth momentum.

In its policy statement of April 2010, the Reserve Bank had placed the baseline projection for WPI inflation for March 2011 at 5.5 percent.

There has been an increase in prices of many administered/ regulated items such as petroleum products, iron ore and electricity. The recent partial deregulation and increase in administered prices of petroleum products is welcome from the long-term fiscal consolidation and energy conservation perspective. Nevertheless, it will have an inflationary impact in the short term. Assuming that global crude oil prices remain stable, the immediate impact on inflation will be about one percentage point on WPI inflation, with second round effects coming through in the months ahead.

The emerging domestic and external scenario, the baseline projection for WPI inflation for March 2011 has been raised to 6.0 percent from 5.5 percent as indicated in the April policy statement.

The inflation has been raised due to following reasons:

  • The spatial and temporal distribution of rainfall in the remaining period of South-West monsoon 2010 is critical.
  • Global energy and commodity prices have been showing distinct signs of softening over the past few weeks as expectations of global growth have moderated. If energy prices continue to decline, this will offset the inflationary impact of the recent fuel price hike. Further, idle global capacity in a range of sectors will allow competitive imports to reduce the momentum in domestic prices.
  • The strengthening of domestic growth drivers, demand-side pressures are building up.
Money and Credit Aggregates
The current year-on-year money supply (M3) growth at 15.3 percent is below the indicative projection of 17.0 percent, non-food credit growth at 22.3 percent was marginally higher than the indicative projection of 20.0 percent.

Risk Factor
The main risk emanates from the global scenario. The global recovery falters, the risk of which has increased since the April 2010 policy announcement, the performance of EMEs is likely to be adversely affected. While India's trade linkages with the advanced economies are appreciably smaller than those of other major EMEs, a widespread slowdown in global trade will have an impact on important manufacturing and service sectors.

A more significant risk, though, is from a potential slowdown in capital inflows. India's rapid recovery has resulted in a widening of the current account deficit as imports have grown faster than exports.

Section III: Stance of Monetary Policy

The policy stance for 2010-11 has been conditioned by three major considerations:

  • Domestic economic recovery is firmly in place and is strengthening. The 7.4 percent growth in 2009-10 despite weak global growth and the insignificant contribution of the agriculture sector is a testimony of the resilience of the Indian economy. The Reserve Bank's upward revision of the GDP growth projection for 2010-11 to 8.5 percent (from 8.0 percent with an upside bias in April 2010) indicates that the economy is steadily reverting to its pre-crisis growth trajectory. However, even as this is happening, prospects of a sustained global recovery appear to be increasingly uncertain, with possible adverse consequences for the EMEs, including India.
  • Inflationary pressures have exacerbated and become generalized with demand-side pressures clearly evident. Capacity constraints are visible in several sectors and pricing power is returning to producers. Inflationary expectations also remain at an elevated level. Given the spread and persistence of inflation, demand-side inflationary pressures need to be contained.
  • Despite the increase in the policy rates by 75 basis points cumulatively, real policy rates are not consistent with the strong growth that the economy is now witnessing. As articulated in previous policy statements/ reviews, lower policy rates can complicate the inflation outlook and impair inflationary expectations, particularly given the increased generalization of inflation. It is, therefore, imperative that we continue in the direction of normalizing our policy instruments to a level consistent with the evolving growth and inflation scenario, while taking care not to disrupt the recovery.
Against the above stated backdrop, the stance of monetary policy is intended to:

  • Contain inflation and anchor inflationary expectations while being prepared to respond to any further build-up of inflationary pressures.
  • Maintain an interest-rate regime consistent with price, output and financial stability.
  • Actively manage liquidity to ensure that it remains broadly in balance so that excess liquidity does not dilute the effectiveness of policy rate actions.

Section IV: Monetary Measures

Bank Rate: The Bank Rate has been retained at 6.0 percent.

Repo Rate: Increased repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points from 5.5 percent to 5.75 percent with immediate effect.

Reverse Repo Rate: Increased reverse repo rate under the LAF by 50 basis points from 4.0 percent to 4.50 percent with immediate effect.

Cash Reserve Ratio (CRR): The cash reserve ratio (CRR) of scheduled banks has been retained at 6.0 percent of their net demand and time liabilities (NDTL).

Expected Outcomes
Monetary policy actions are expected to:

  • Moderate inflation by reining in demand pressures and inflationary expectations.
  • Maintain financial conditions conducive to sustaining growth.
  • Generate liquidity conditions consistent with more effective transmission of policy actions.
  • Reduce the volatility of short-term rates in a narrower corridor.
The second quarter review of Monetary Policy 2010-11, including developmental and regulatory policies, is scheduled on November 2, 2010.
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