First Quarter Review of Monetary Policy 2012-13


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First Quarter Review of Monetary Policy 2012-13

  1. 1. RESERVE BANK OF INDIAFirst Quarter Review ofMonetary Policy 2012-13 Dr. D. Subbarao Governor July 31, 2012 Mumbai i
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  3. 3. CONTENTS Page No.I. The State of the Economy Global Economy..........................................................................2 Domestic Economy......................................................................3II. Domestic Outlook and Projections Growth.........................................................................................6 Inflation........................................................................................7 Monetary Aggregates...................................................................8 Risk Factors.................................................................................9III. The Policy Stance............................................................................9IV. Monetary and Liquidity Measures......................................... 11 iii
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  5. 5. ABBREVIATIONSbps - Basis PointsBRICS - Brazil, Russia, India, China and South AfricaCAD - Current Account DeficitCI - Confidence IntervalCPI - Consumer Price IndexCRR - Cash Reserve RatioEC - European CommissionEDEs - Emerging and Developing EconomiesGDP - Gross Domestic ProductIIP - Index of Industrial ProductionIMF - International Monetary FundIOS - Industrial Outlook SurveyLAF - Liquidity Adjustment FacilityLPA - Long Period AverageM 3 - Broad MoneyMQR - Mid-Quarter ReviewMSF - Marginal Standing FacilityNDTL - Net Demand and Time LiabilitiesOBICUS - Order Books, Inventories and Capacity Utilisation SurveyOMO - Open Market OperationPMI - Purchasing Managers’ IndexPOL - Petroleum, Oil and LubricantsPWRI - Production Weighted Rainfall IndexQ - QuarterREER - Real Effective Exchange RateSCBs - Scheduled Commercial BanksSLR - Statutory Liquidity RatioUK - United KingdomUS - United States of AmericaWALR - Weighted Average Lending RateWEO - World Economic OutlookWPI - Wholesale Price IndexY-o-Y - Year-on-Year v i
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  7. 7. Reserve Bank of India First Quarter Review of Monetary Policy 2012-13 By Dr. D. Subbarao GovernorIntroduction account deficit (CAD) and fiscal deficit, Since the Monetary Policy pose significant risks to macroeconomicStatement for 2012-13 in April 2012, stability. Against this backdrop ofmacroeconomic conditions have heightened global uncertainty anddeteriorated. Much of the global economy domestic macroeconomic pressures, theis in a synchronised slowdown, having challenge for monetary policy is tolost the upward momentum seen in the maintain its priority of containingearly months of the year. Despite the inflation and lowering inflationslowing global economy, the outlook for expectations. At the same time, monetarycommodity prices is uncertain. The policy has also to be sensitive to risks tosituation in the euro area continues to growth and financial stability.cause concern even as the prospects of 3. In the above context, thisimmediate default have been averted. Statement should be read and understoodWhile exports of emerging and together with the detailed review indeveloping economies (EDEs) have been M a c ro e c o n o m i c a n d M o n e t a r ydented by the weak global economic Developments released yesterday by theactivity, capital flows into them have Reserve Bank.declined markedly because of the strains 4. This Statement is organised inin the euro area financial market four Sections: Section I provides anconditions. overview of global and domestic2. Domestically, the macroeconomic macroeconomic developments. Sectionsituation continues to raise concerns. II sets out the outlook and projections forWhile growth has slowed down growth, inflation and monetarysignificantly, inflation remains well aggregates. Section III explains the stanceabove the comfort zone of the Reserve of monetary policy. Section IV specifiesBank. The large twin deficits, viz. current the monetary and liquidity measures. 1
  8. 8. I. The State of the EconomyGlobal Economy inter-linked, fiscal and financial stability5. The global economy is slowing pressures in the euro area remain thedown. In its latest update of the World most significant source of systemicEconomic Outlook (WEO), the global risk. In recent weeks, renewedInternational Monetary Fund (IMF) has concerns about Greece and the need forrevised its projection for global growth greater collective support to Spain andin 2012 marginally downwards to 3.5 per Italy have amplified these risks.cent, but has emphasised further Consequently, the potential for negativedownside risks to growth. In the US, spillovers to the euro area core countriesoutput growth decelerated to 1.5 per cent and to the rest of the world have also(seasonally adjusted annualised rate) in increased.Q2 from 2.0 per cent in Q1 of 2012. In 7. Importantly, risks to globalthe euro area, growth was flat in Q1 after growth, which stem from persistenta contraction by 1.2 per cent in the weakness in advanced economies, haveprevious quarter. In the UK, growth increased with EDEs also exhibitingcontracted by 2.8 per cent in Q2 of 2012 moderation in growth. Among theand 1.3 per cent in Q1. Output in Japan BRICS countries, growth in China fellexpanded by 4.7 per cent in Q1 after a from 8.1 per cent in Q1 of 2012 to 7.6low growth of 0.1 per cent in the previous per cent in Q2. Growth also moderatedquarter, supported by reconstruction significantly in Brazil and South Africarelated demand. The global manufacturingpurchasing managers’ index (PMI) fell in Q1. According to the IMF, growth inbelow the neutral level of 50.0 to 48.9 in a number of major EDEs turned out toJune 2012 - the lowest in 3 years - be lower than forecast by it earlier.suggesting contraction in manufacturing 8. Inflationary pressures softeneda c t i v i t y. T h e g l o b a l c o m p o s i t e a c r o s s a d v a n c e d a n d e m e rg i n g(manufacturing and services) PMI at economies, reflecting both weaker50.3 in June 2012 suggests near growth prospects and moderation instagnation. commodity prices. International (Brent)6. The decisions by the European crude oil prices declined from an averageCommission (EC) Summit on July 2, of about US$ 125 per barrel in March2012 improved market confidence, but 2012 to an average of about US$ 95only temporarily. Without a sustained per barrel in June 2012. In July, however,recovery in growth or moderation in the average price increased to abovesovereign debt stress, which are highly US$ 100 per barrel. In advanced 2
  9. 9. economies, spare capacity in both significantly lower than the expansion ofproduct and labour markets limits risks 5.7 per cent registered in theto core inflation. Among the BRICS corresponding period of last year. Thecountries, inflation fell significantly in PMI rose marginally to 55.0 in June 2012China and Russia. It also eased in Brazil from 54.8 in May. The compositeand South Africa. Even as growth in (manufacturing and services) PMI alsoIndia is slowing, it is clearly an outlier rose to 55.7 in June from 55.3 in May.insofar as inflation is concerned. 12. During the ongoing monsoonDomestic Economy season, rainfall up to July 25, 2012 was9. Gross Domestic Product (GDP) 22 per cent below its long period averagegrowth decelerated over four successive (LPA). The Reserve Bank’s productionquarters from 9.2 per cent in Q4 of weighted rainfall index (PWRI) showed2010-11 to 5.3 per cent in Q4 of an even higher deficit of 24 per cent.2011-12. Significant slowdown in Further, the distribution of rainfall wasindustrial growth as well as deceleration very uneven, with the North-West regionin services sector activity pulled down registering the highest deficit of about 39the overall GDP growth to 6.5 per cent per cent of LPA. If the rainfall deficiencyfor 2011-12, below the Reserve Bank’s persists, agricultural production could bebaseline projection of 7 per cent. adversely impacted.10. O n t h e e x p e n d i t u r e s i d e , 13. Capacity utilisation levels in Q4significant weakness in investment of 2011-12 as reflected in the results ofactivity was the main cause of the the Reserve Bank’s order book,slowdown. Gross fixed capital formation, inventories and capacity utilisationwhich grew by 14.7 per cent in Q1 of survey (OBICUS) revealed the usual2011-12, moderated to 5.0 per cent in Q2 seasonal improvement over the previousand then contracted by 0.3 per cent in Q3before recovering to a growth of 3.6 per quarter. However, lead information fromcent in Q4. Growth in private consumption the Reserve Bank’s industrial outlookalso decelerated in 2011-12, even as it survey (IOS) indicates that capacityremained the key driver of growth. The utilisation dropped in Q1 and Q2 ofpositive impact of the rupee depreciation 2012-13. Moreover, overall businesson exports is yet to be seen. sentiment also moderated in both the quarters.11. Growth in the index of industrialproduction (IIP) decelerated from 8.2 per 14. Headline Wholesale Price Indexcent in 2010-11 to 2.9 per cent in (WPI) inflation increased from 7.5 per2011-12. Further, IIP growth during cent in April to 7.6 per cent in May beforeApril-May 2012, at 0.8 per cent, was moderating to 7.3 per cent in June 2012. 3
  10. 10. The stickiness in inflation, despite the weights of commodities, especially ofsignificant growth slowdown, was food items in the two indices. Second,largely on account of high primary food even in respect of similar items, inflationinflation, which was in double-digits was higher in CPI than in WPI, suggestingduring Q1 of 2012-13 due to an unusual that besides the incidence of higherspike in vegetable prices and sustained service taxes, moderation in non-foodhigh inflation in protein items. manufactured products prices has not yet been transmitted to the retail level. The15. Fuel group inflation moderated rate of increase in the prices of services,from 12.1 per cent in April 2012 to 11.5 which is included in CPI but not in WPI,per cent in May and further to 10.3 per was also high.cent in June on account of decrease innon-administered fuel prices, which in 18. Among other factors, urbanturn was due to decline in global crude households’ inflation expectations, as peroil prices. However, the reversal in crude the latest survey conducted by the Reserve Bank, increased slightly in Q1oil prices in recent weeks may add to of 2012-13 after a decline in the previousdomestic inflationary pressure. q u a r t e r. N o t w i t h s t a n d i n g s o m e16. Non-food manufactured products moderation, wage inflation in rural andinflation was at 4.8 per cent in May and urban areas remains relatively high.June 2012. The momentum indicator of 19. A n a n a l y s i s o f c o r p o r a t enon-food manufactured products performance in 2011-12, based on ainflation (seasonally adjusted 3-month common sample of 2,273 non-moving average annualised inflation government non-financial companies,rate), however, showed an upturn. indicates that the sales growth remainedMoreover, input price pressures persist positive for the year even after adjustingdue to both exchange rate movements for inflation. However, earningsand supply side constraints. Going decelerated due to an increase inforward, further pressure on non-food expenditure, indicating decline in pricingmanufactured products inflation cannot power. Early results for Q1 of 2012-13be ruled out. suggest that pricing power remained17. The Consumer Price Index (CPI series) inflation remained in double- 20. While the money supply (M3)digits in Q1 of 2012-13, driven by both growth, at 14.3 per cent in mid-July, wasfood and non-food prices. The divergence marginally lower than the indicativebetween WPI and CPI inflation was on trajectory of 15 per cent, non-food creditaccount of two factors. First, there are growth at 17.4 per cent was slightlydifferences in the composition and above the indicative projection of 17 per 4
  11. 11. cent. If we include banks’ investment in conditions was due to a decline incommercial paper and other instruments, government cash balances with thenon-food credit growth was even higher Reserve Bank, injection of liquidity ofat 17.7 per cent. about `860 billion by way of open21. The flow of resources to the market operation (OMO) purchases ofcommercial sector, from both bank and securities and increased use of the exportnon-bank sources, increased to `1.9 credit refinance facility by banks aftertrillion in 2012-13 so far (up to July 13, the increase in the limit effected in the2012) as compared with `1.4 trillion June Mid-Quarter Review. Reflecting theduring the corresponding period of last improvement in the liquidity situation,year. Amongst non-bank sources, the weighted average call money rate,resources raised through commercial which is the operating target of thepaper increased significantly. Reserve Bank, stayed close to the policy repo rate.22. Following the reduction in therepo rate in April, several commercial 24. During Q1 of 2012-13, yields onbanks reduced their lending rates. The government securities softened reflectingmodal base rate of scheduled commercial an improvement in liquidity, moderationbanks (SCBs) declined by 25 bps to in inflation and concerns about weakening10.50 per cent during April-June 2012. of domestic and global growth. TheSignificantly, on the basis of the weighted 10-year benchmark yield wasaverage lending rate (WALR) of significantly lower at 8.11 per cent oncommercial banks, adjusted for inflation, July 26, 2012 as compared with 8.63 perreal rates are now lower than they were cent at end-March 2012.during the high growth five-year period 25. Housing prices continued to riseof 2003-08. Banks’ actions on deposit despite the decline in volume ofrates, however, were muted due to the transactions. The Reserve Bank’sslowdown in deposit growth. quarterly housing price index suggests that prices increased in Q4 of 2011-12 in23. Liquidity conditions have eased most of the 9 cities for which the indexconsiderably since the April Policy. The is compiled.average daily net borrowing under theliquidity adjustment facility (LAF), 26. During April-May 2012, whilewhich was 2.2 per cent of average net food subsidies were lower, fertiliserdemand and time liabilities (NDTL) in subsidies were more than twice theQ4 of 2011-12, declined sharply to 1.3 previous year’s level. Clearly, if theper cent in Q1 of 2012-13 and further to target of restricting the expenditure on0.7 per cent in July 2012 (up to July 26, subsidies to under 2 per cent of GDP in2012). The turnaround in liquidity 2012-13, as set out in the Union Budget, 5
  12. 12. is to be achieved, immediate action on previous year. Based on preliminaryfuel and fertiliser subsidies will be data, services exports rose moderately byrequired. 3 per cent to US$ 35 billion, while27. In 2011-12, the CAD rose to services imports surged by 19 per centUS$ 78 billion (4.2 per cent of GDP) to US$ 21 billion in Q1. Accordingly, netfrom US$ 46 billion (2.7 per cent of services exports of US$ 14 billion in Q1GDP) in the previous year, largely of 2012-13 were lower by 12 per cent asreflecting a higher trade deficit on compared with Q1 of 2011-12.account of subdued external demand and 29. During 2012-13 so far (July 20,relatively inelastic imports of petroleum, 2012), the 6-, 30- and 36-currency tradeoil and lubricants (POL) as well as gold weighted real effective exchange ratesand silver. As capital inflows fell short (REER) depreciated in the range of 7-10of the CAD, there was a net drawdown per cent, primarily reflecting the nominalof reserves (on a BoP basis) to the extent depreciation of the rupee against the USof US$ 13 billion in contrast to a net dollar by around 9 per cent. Theaccretion to reserves of more or less of depreciation was mainly on account ofthe same order in the previous year. the slowdown in capital inflows, the large28. Reflecting the fragile global current account deficit, domesticsituation, India’s merchandise exports economic uncertainty and growingdeclined by 1.7 per cent to US$ 75 billion apprehensions about the euro areaduring Q1 of 2012-13. However, imports problem.declined even more sharply, by 6.1 per 30. Exchange rate depreciation in Q1cent, to US$ 115 billions led by a decline of 2012-13 was not specific to India;in imports of non-oil non-gold most EDE currencies also depreciated.commodities. As a result, the trade deficit However, among the EDEs with largewas lower at US$ 40 billion in Q1 of current account deficits, the depreciation2012-13 as compared with US$ 46 of the Indian rupee was relatively large,billion in the corresponding period of the reflecting moderation in capital inflows. II. Domestic Outlook and ProjectionsGrowth in industrial activity. Both theses31. In the April Policy, the Reserve assumptions did not hold. The monsoonBank had projected GDP growth for has been deficient and uneven so far.2012-13 at 7.3 per cent on the assumption Also, data on industrial production forof a normal monsoon and improvement April-May suggest that industrial 6
  13. 13. activity, despite some recovery, remains On the basis of the above considerations,weak. In addition, several risks to the growth projection for 2012-13 isdomestic growth have intensified. First, revised downwards from 7.3 per cent toglobal growth and trade volume are now 6.5 per cent (Chart 1).expected to be lower than projected Inflationearlier. Given the greater integration of 32. In the April Policy, the Reservethe Indian economy with the global Bank made a baseline projection of WPIeconomy, this will have an adverse inflation for March 2013 of 6.5 per cent.impact on growth, particularly in industry This was based, in part, on an assumptionand the services sector. However, the of normal monsoon. The deficient andlagged impact of depreciation of the uneven monsoon performance so farexchange rate could partly offset this. will have an adverse impact on foodThe impending “fiscal cliff” in the US in inflation. Notwithstanding some2013, when temporary tax concessions moderation, international crude oilexpire and automatic spending cuts take prices remain elevated. This, coupledeffect, also entails additional risks to the with the pass- thr ough of r upeegrowth outlook. Second, reflecting the depreciation to import prices, continueslagged impact of weak industrial activity to put upward pressure on domestic fueland global slowdown, the services sector price inflation. In addition, with thegrowth is also expected to slow down. adjustment of domestic prices of 7
  14. 14. petroleum products to international price 34. Although inflation has remainedchanges still incomplete, embedded risks persistently high over the past two years,of suppressed inflation could also impact it averaged around 5.5 per cent duringfuel prices in India going forward. The the 2000s, both in terms of WPI and CPI,decline in non-food manufactured down from its earlier trend rate of aboutproducts inflation has not been 7.5 per cent. Given this record, thecommensurate with the moderation in conduct of monetary policy will continuegrowth. Input price pressures on account to condition and contain perception ofof exchange rate movements and inflation in the range of 4.0-4.5 per cent.infrastructural bottlenecks in coal, This is in line with the medium-termminerals and power may exert upside objective of 3.0 per cent inflationpressure on non-food manufactured consistent with India’s broader integrationproducts inflation. into the global economy.33. Keeping in view the recent trends Monetary Aggregatesin food inflation, trends in globalcommodity prices and the likely demand 35. With nominal growth remainingscenario, the baseline projection for WPI broadly at the level envisaged in theinflation for March 2013 is now raised April Policy, monetary aggregates arefrom 6.5 per cent, as set out in the April expected to move along the trajectoriesPolicy, to 7.0 per cent (Chart 2). projected in the Monetary Policy 8
  15. 15. Statement 2012-13. Accordingly, M3 adversities in several parts of thegrowth projection for 2012-13 has been world, the outlook for food andretained at 15 per cent and the growth commodity prices, especially crudein non-food credit of SCBs at 17 per oil, has turned uncertain. Thesecent. As always, these numbers are developments have adverseindicative projections and not targets. implications for domestic growth and inflation.Risk Factors36. The projections of growth and iii) While inflation in protein itemsinflation for 2012-13 are subject to a remains elevated due to structuralnumber of risks as indicated below: demand supply imbalances, additional risks to food inflationi) External risks to the outlook for the have emerged from the deficient and Indian economy are intensifying. uneven monsoon. This has the Adverse feedback loops between potential of aggravating inflation sovereign and financial market and inflation expectations. stress in the euro area are resulting iv) At current levels of the CAD and in increased risk aversion, financial the fiscal deficit, the Indian economy market volatility, and perverse faces the “twin deficit” risk. movements in capital flows. With Financing the latter from domestic the deteriorating macroeconomic saving crowds out private situation in the euro area interacting investment, thus lowering growth with a loss of growth momentum prospects. This, in turn, deters in the US and in EDEs, the risks of capital inflows, making it more potentially large negative spillovers difficult to finance the former. have increased. India’s growth Failure to narrow twin deficits with prospects too will be hurt by this. appropriate policy actions threatensii) Reflecting the setback to the global both macroeconomic stability and recovery as also weather-related growth sustainability. III. The Policy Stance37. Keeping in view the slowdown developments suggested that even asin growth, the Reserve Bank front- growth moderated, inflation remainedloaded the policy rate reduction in April sticky. Keeping in view the heighteningwith a cut of 50 basis points. Subsequent risks to inflation, the Reserve Bank 9
  16. 16. decided to pause in the Mid-Quarter implications. In this context, investmentReview (MQR) of June 2012, even in activity has remained subdued over thethe face of slowing growth. last two years. External demand has also38. Against the backdrop of global remained weak due to the slowdown inand domestic macroeconomic conditions, global growth. Consequently, the postoutlook and risks, the policy stance in crisis trend rate of growth, which wasthis review is shaped by three major earlier estimated at 8.0 per cent, hasconsiderations. dropped to 7.5 per cent. While the current rate of growth is clearly lower than trend,39. First, after moderating for a short the output gap will remain relativelyperiod during December-January, small. Under these conditions, demandheadline WPI inflation edged up again pressures on inflation can re-emergebeginning February 2012 and has quite quickly, exacerbating the existingremained sticky, above 7 per cent, onaccount of increase in food prices, supply pressures.increase in input costs, and upward 41. Third, liquidity conditions playrevision in prices of some administered an important role in the transmission ofitems such as coal. Headline inflation has monetary policy signals. Although thepersisted even as demand has moderated situation has eased significantly in theand the pricing power of corporates recent period, it is necessary to ensureweakened. Non-food manufactured that liquidity pressures do not constrainproducts inflation has also not declined the flow of credit to productive sectorsto the extent warranted by the growth of the economy.moderation. This reflects severe supplyconstraints and entrenchment of inflation 42. Against this backdrop, the stanceexpectations. of monetary policy is intended to:40. Second, growth decelerated • contain inflation and anchor inflationsignificantly to 6.5 per cent in 2011-12. expectations;Although more recent data suggest some • support a sustainable growth pathpick up, overall economic activity over the medium-term; andremains subdued. Importantly, thecurrent growth performance has to be • continue to provide liquidity toseen in reference to the trend rate of facilitate credit availability togrowth in order to assess its inflationary productive sectors. 10
  17. 17. IV. Monetary and Liquidity Measures43. On the basis of the current Guidanceassessment and in line with the policystance outlined in Section III, the 50. The primary focus of monetaryReserve Bank announces the following policy remains inflation control in orderpolicy measures. to secure a sustainable growth path overRepo Rate the medium-term. While monetary actions over the past two years may have44. It has been decided to retain therepo rate under the liquidity adjustment contributed to the growth slowdown – anfacility (LAF) at 8.0 per cent. unavoidable consequence – several otherReverse Repo Rate factors have played a significant role. In the current circumstances, lowering45. The reverse repo rate under the policy rates will only aggravateLAF, determined with a spread of 100basis points below the repo rate, stands inflationary impulses without necessarilyat 7.0 per cent. stimulating growth. As the multipleMarginal Standing Facility (MSF) constraints to growth are addressed, theRate Reserve Bank will stand ready to act46. The MSF rate, determined with a appropriately.spread of 100 basis points above the repo 51. Meanwhile, managing liquidityrate, stands at 9.0 per cent. within the comfort zone remains anBank Rate objective and the Reserve Bank will47. The Bank Rate stands at 9.0 respond to liquidity pressures, includingper cent. by way of OMOs.Cash Reserve Ratio 52. In a turbulent global environment,48. The cash reserve ratio (CRR) of the risks of external shocks are high andscheduled banks has been retained at the Reserve Bank stands ready to respond4.75 per cent of their net demand and to any such shocks swiftly, using alltime liabilities (NDTL). available instruments.Statutory Liquidity Ratio49. It has been decided to: Expected Outcomes• reduce the statutory liquidity ratio 53. The policy actions taken are (SLR) of scheduled commercial expected to: banks from 24.0 per cent to 23.0 per cent of their NDTL with effect from • anchor inflation expectations based the fortnight beginning August on the commitment of monetary 11, 2012. policy to inflation control; and 11
  18. 18. • maintain liquidity to facilitate out through a press release on Monday, smooth flow of credit to productive September 17, 2012. sectors to support growth. Second Quarter Review of MonetaryMid-Quarter Review of Monetary Policy 2012-13Policy 2012-13 55. The Second Quarter Review of54. The next Mid-Quarter Review of Monetary Policy for 2012-13 is scheduledMonetary Policy for 2012-13 will be put for Tuesday, October 30, 2012.MumbaiJuly 31, 2012 12