RBI Governor
Announces Third Quarter Review of Monetary Policy 2012-13
Statement by Dr. D.
Subbarao, Governor, Reserve Bank of India
[RBI
Press Release dated 29th January 2013]
"First of all, on behalf of the Reserve Bank, a
warm welcome to you all to this Third Quarter Review of Monetary Policy for
2012-13.
2. Earlier this
morning, we put out the Policy Review document. Based on an assessment of the
current macroeconomic situation, we have decided to reduce the policy repo rate
under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per
cent to 7.75 per cent.
3. Consequent to
this, the reverse repo rate under the LAF, determined with a spread of 100
basis points below the repo rate, gets calibrated to 6.75 per cent. Similarly,
the marginal standing facility (MSF) rate, determined with a spread of 100
basis points above the repo rate, and also the Bank Rate stand adjusted to 8.75
per cent.
4. These changes
have since come into effect immediately after the announcement.
5. We have also
decided to reduce the cash reserve ratio (CRR) of scheduled banks by 25 basis
points from 4.25 per cent to 4.0 per cent of their net demand and time
liabilities (NDTL) effective the fortnight beginning February 9, 2013.
6. This reduction
in the CRR will inject primary liquidity of around `180 billion into the
banking system.
Considerations Behind the Policy Move
7. Today’s
decision to further ease the monetary policy stance was informed by three
considerations.
8. First, both
headline wholesale price inflation and its core component, non-food
manufactured products inflation, have softened through the third quarter. This
provided some relief from the persistence that dominated the first half of the
year. Several indicators such as the weaker pricing power of corporates, excess
capacity in some sectors, the possibility of international commodity prices
stabilising as well as inflation momentum measures suggest that inflationary
pressures have peaked. However, further moderation in inflation going into the
next fiscal year is likely to be muted as the correction of under-pricing of
administered items is still incomplete and food inflation remains elevated.
Accordingly, the setting of monetary policy has to remain sensitive to these
conflicting pressures and attendant risks.
9. Second, growth
has decelerated significantly below trend through the last fiscal year and
through this year so far, and overall economic activity remains subdued. On the
demand side, investment activity has been way below desired levels and
consumption demand too has started to decelerate. External demand has also
weakened due to languid global growth. On the supply side, constraints in the
availability of key raw materials and intermediates are becoming binding. While
the series of policy measures announced by the Government has boosted market
sentiment, the investment outlook is still lacklustre, especially in terms of
demand for new projects.
10. The third
consideration that informed our decision is that liquidity conditions have
remained tight. Although the Reserve Bank lowered the cash reserve ratio, CRR,
successively in September and October 2012, and carried out open market
operations (OMO) injecting systemic liquidity of `470 billion during December and January to
augment liquidity, the average net LAF borrowings at `910 billion in January
have been above the Reserve Bank’s comfort level. This tightness could
potentially hurt credit flow to productive sectors of the economy. The structural
deficit in the system provided a strong case for injecting permanent primary
liquidity into the system.
Monetary Policy Stance
11. The policy
document also spells out the three broad contours of our monetary policy
stance. These are:
•
first, to provide an appropriate interest
rate environment to support growth as inflation risks moderate;
•
second, to contain inflation and anchor
inflation expectations; and
•
third, to continue to manage liquidity to
ensure adequate flow of credit to the productive sectors of the economy.
Guidance
12. As has become
standard practice by now, we have also given the following guidance for the
period forward:
13. With headline
inflation likely to have peaked and non-food manufactured products inflation
declining steadily over the last few months, there is an increasing likelihood
that going into 2013-14, inflation will remain range-bound around the current
levels. This provides space, albeit limited, for monetary policy to give
greater emphasis to growth risks. This policy guidance will, however, be
conditioned by the evolving growth-inflation dynamic and the management of
risks from the twin deficits.
Expected Outcomes
14. We expect that
today’s policy actions, and the guidance that we have given, will result in the
following three outcomes:
•
first, investment will be encouraged,
thereby supporting growth;
•
second, medium-term inflation expectations
will remain anchored on the basis of a credible commitment to low and stable
inflation;
•
and,
finally, there will be an improvement in liquidity conditions to support credit
flow.
Global and Domestic Developments
15. Our
policy decisions have been based on a detailed assessment of the global and
domestic macroeconomic situation. Let me comment first on the global outlook.
Global Economy
16. Since
the Reserve Bank’s last quarterly Policy Review in October 2012, headwinds
holding back the global economy have begun to abate gradually, although
sluggish conditions prevail. In the US, activity gathered momentum in the third
quarter of 2012 but this is unlikely to have been sustained in the fourth
quarter. While a political consensus to avert the ‘fiscal cliff’ has calmed
financial markets, how the debt ceiling is managed will be crucial in shaping
the market sentiment on the way forward. The euro area economy is threatened by
continuing contraction, notwithstanding the liquidity firewall of the European
Central Bank (ECB) and the EU’s commitment to act collectively to backstop the
union. Overall, however, apprehensions that the sovereign debt crisis will
disrupt the global financial system have ebbed.
17. A
pick-up in the pace of growth of China is likely. But growth in other emerging
and developing economies has slowed owing to a combination of a slump in
external demand and domestic structural bottlenecks. Furthermore, inflationary
pressures persist in some of them. Overall, global economic prospects have
improved modestly since the Reserve Bank’s last review in October 2012 even as
significant risks remain.
Indian Economy
18. Moving
on to the domestic economy, GDP growth slowed significantly this year, dropping
to 5.5 per cent in the first quarter, and dropping even further to 5.3 per cent
in the second quarter. The decline in the GDP growth rate became more broad
based, with consumption demand also slowing alongside stalling investment and
declining exports.
19. In
July 2012, the Reserve Bank projected GDP growth for the current year, 2012-13,
of 6.5 per cent. In the October Review, we revised this downwards to 5.8 per
cent, signalling increasing global risks as well as accentuated domestic risks.
As part of this review, we revisited this growth projection taking into account
developments over the last three months. During this period, industrial
activity has remained subdued. Sluggish external demand continues to inhibit
improvement in services. While the coverage of rabi sowing has picked
up, severe winter in certain parts of the country could affect crop prospects.
New investment demand, which should be the key driver of an upturn, continues
to be weak. While the series of recent policy initiatives by the Government has
boosted market sentiment, it will take some time to reverse the investment
slowdown and reinvigorate growth.
20. Accordingly,
we have revised downwards our baseline projection of GDP growth for the current
year from 5.8 per cent to 5.5 per cent.
Inflation
21. Let
me now turn to inflation. Headline WPI inflation eased significantly from 8.1 per
cent in September 2012 to 7.2 per cent by December. Notably, inflation on
account of non-food manufactured products, which have a weight of 55 per cent
in the WPI, fell sharply in November-December as input price pressures eased.
The momentum indicators too suggest a moderation in headline as well as
non-food manufactured products inflation. The Reserve Bank’s industrial outlook
survey also points to a softening of the rate of increase of output prices,
suggesting that the pricing power of corporates has weakened. Fuel group
inflation moderated in December, mainly reflecting the tempering of inflation
of non-administered petroleum products as well as the range-bound exchange rate
of the rupee.
22. Food
inflation, on the other hand, showed a contrarian behaviour, moving into double
digits in December, reflecting both cyclical and structural factors.
23. In
contrast to WPI inflation, CPI inflation as measured by the new consumer price
index, rose to 10.6 per cent in December, largely reflecting the surge in food
inflation. Excluding food and fuel groups, CPI inflation remained unchanged at
8.4 per cent during the third quarter.
24. In
the October Review, the Reserve Bank made a baseline projection of inflation
for March 2013 of 7.5 per cent. An environment of slower growth and excess
capacity in some sectors suggests that inflation has come off its peak.
However, it is expected to be range-bound around the current levels due to
persisting food inflation, the pass-through of diesel price adjustments over the
next several months and the possibility of adjustment in other administered
prices. If international commodity prices, including the price of crude,
further decline, they should cushion the phased increase in diesel prices, to
the extent they are not offset by exchange rate movements. A sustained
reduction in inflation pressure is, however, contingent upon alleviation of
supply constraints and progress on fiscal consolidation. This will also help
mitigate the cost-push pressures stemming from the surge in wages.
25. Keeping
in view the expected moderation in non-food manufactured products inflation,
domestic supply-demand balances and global trends in commodity prices, we
revised downwards the baseline WPI inflation projection for March 2013 from 7.5
per cent to 6.8 per cent.
Monetary and Liquidity Conditions
26. Let
me now turn to monetary and liquidity conditions. Money supply remained below
the indicative trajectory of the Reserve Bank. This essentially reflected the
deceleration of growth in aggregate deposits and moderation in economic
activity. On the other hand, the overall non-food credit growth was around the
indicative trajectory. However, bank credit to industry showed a significant
deceleration while credit to agriculture registered an increase.
27. Keeping
in view the seasonal pattern for the last quarter, M3 growth projection for the
current year has been scaled down to 13.0 per cent while non-food credit growth
projection is retained at 16.0 per cent.
28. Liquidity
conditions tightened from the second week of November on account of a build-up
in the Centre’s cash balances, festival-related lumpy increase in currency demand,
and structural pressures brought on by the widening wedge between deposit
growth and credit growth. Anticipating liquidity pressures, the Reserve Bank
lowered the CRR and conducted open market operations. Despite these measures,
the liquidity deficit in the system remained above the Reserve Bank’s comfort
level.
Risk Factors
29. Macroeconomic
management going forward is subject to a number of risks. Let me briefly
address them.
•
First,
the widening of the current account deficit (CAD) to historically high levels,
especially in the context of a large fiscal deficit and slowing growth, exposes
the economy to the twin deficit risk. Financing the CAD with increasingly risky
and volatile flows increases the economy’s vulnerability to sudden shifts in risk
appetite and liquidity preference, potentially threatening macroeconomic and
exchange rate stability. Large fiscal deficits will accentuate the CAD risk,
further crowd out private investment and stunt growth impulses.
•
Second,
despite the recent calm, global risks remain elevated, with the potential for
spillover into the Indian economy through trade, finance and confidence
channels. In the US, the risk of political inaction to manage the debt ceiling
or even a sudden onset of fiscal austerity can lead to a turmoil in financial
markets, followed by a downturn in economic activity. Escalation of the euro
area sovereign debt stress in view of the continuing absence of credible and
comprehensive policy responses remains a contingent global risk. Risks also
stem from geopolitical tensions that can adversely impact supplies and prices
of key commodities, particularly of crude oil. Furthermore, these forces can
potentially increase global risk aversion with implications for financing of
our CAD.
•
Third,
inflation over the last three years has been a result of demand pressures as
well as supply constraints. With demand pressures now on the ebb, the supply
constraints need to be urgently addressed. In the absence of an effective
supply response, inflationary pressures may return and persist with adverse
implications for macroeconomic stability.
•
Fourth,
the key to stimulating growth is a vigorous and sustained revival in
investment. Achieving this will, however, depend on a number of factors such as
bridging the infrastructure gaps, and resolute pursuit of structural and
governance reforms.
•
Finally,
risk aversion in the banking system stemming from concerns relating to growing
non-performing assets (NPAs) is constraining credit flow. Notwithstanding the
importance of repairing asset quality, banks should be discerning in their loan
decisions and ensure adequate credit flow to productive sectors of the economy.
30. Let
me conclude by summarising our macroeconomic concerns. Inflation has come off
from its peak, but its further downward movement is going to be slow and
gradual. On the other hand, economic activity has slowed, trailing well below
its potential and opening up a negative output gap. What the economy needs most
of all and most urgently is new investment. This will step up currently
flagging aggregate demand and also ease the supply constraints so that existing
capacity is fully utilised and new capacity is built up. A strong and effective
supply response is particularly important for bridging the infrastructure gaps
and correcting structural imbalances in other segments of the economy,
including key food articles. Critical to this effort are a credible and
comprehensive fiscal adjustment by the Government, implementation of structural
reforms, hastening the approval process, and improving governance to inspire
the trust and confidence of potential investors. The Reserve Bank, on its part,
will have to calibrate monetary policy to the evolving growth-inflation dynamic
and the management of the twin deficits risks.
31. Thank
you for your attention".