3. CONTENTS
Page No.
I. The State of the Economy
Global Economy..........................................................................2
Domestic Economy......................................................................3
II. Domestic Outlook and Projections
Growth.........................................................................................6
Inflation........................................................................................7
Monetary Aggregates...................................................................8
Risk Factors.................................................................................9
III. The Policy Stance............................................................................9
IV. Monetary and Liquidity Measures......................................... 11
iii
5. ABBREVIATIONS
bps - Basis Points
BRICS - Brazil, Russia, India, China and South Africa
CAD - Current Account Deficit
CI - Confidence Interval
CPI - Consumer Price Index
CRR - Cash Reserve Ratio
EC - European Commission
EDEs - Emerging and Developing Economies
GDP - Gross Domestic Product
IIP - Index of Industrial Production
IMF - International Monetary Fund
IOS - Industrial Outlook Survey
LAF - Liquidity Adjustment Facility
LPA - Long Period Average
M 3 - Broad Money
MQR - Mid-Quarter Review
MSF - Marginal Standing Facility
NDTL - Net Demand and Time Liabilities
OBICUS - Order Books, Inventories and Capacity Utilisation Survey
OMO - Open Market Operation
PMI - Purchasing Managers’ Index
POL - Petroleum, Oil and Lubricants
PWRI - Production Weighted Rainfall Index
Q - Quarter
REER - Real Effective Exchange Rate
SCBs - Scheduled Commercial Banks
SLR - Statutory Liquidity Ratio
UK - United Kingdom
US - United States of America
WALR - Weighted Average Lending Rate
WEO - World Economic Outlook
WPI - Wholesale Price Index
Y-o-Y - Year-on-Year
v
i
7. Reserve Bank of India
First Quarter Review of Monetary Policy 2012-13
By
Dr. D. Subbarao
Governor
Introduction account deficit (CAD) and fiscal deficit,
Since the Monetary Policy pose significant risks to macroeconomic
Statement for 2012-13 in April 2012, stability. Against this backdrop of
macroeconomic conditions have heightened global uncertainty and
deteriorated. Much of the global economy domestic macroeconomic pressures, the
is in a synchronised slowdown, having challenge for monetary policy is to
lost the upward momentum seen in the maintain its priority of containing
early months of the year. Despite the inflation and lowering inflation
slowing global economy, the outlook for expectations. At the same time, monetary
commodity prices is uncertain. The policy has also to be sensitive to risks to
situation in the euro area continues to growth and financial stability.
cause concern even as the prospects of 3. In the above context, this
immediate default have been averted. Statement should be read and understood
While exports of emerging and together with the detailed review in
developing 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 y
dented by the weak global economic Developments released yesterday by the
activity, capital flows into them have Reserve Bank.
declined markedly because of the strains 4. This Statement is organised in
in the euro area financial market four Sections: Section I provides an
conditions. overview of global and domestic
2. Domestically, the macroeconomic macroeconomic developments. Section
situation continues to raise concerns. II sets out the outlook and projections for
While growth has slowed down growth, inflation and monetary
significantly, inflation remains well aggregates. Section III explains the stance
above the comfort zone of the Reserve of monetary policy. Section IV specifies
Bank. The large twin deficits, viz. current the monetary and liquidity measures.
1
8. I. The State of the Economy
Global Economy inter-linked, fiscal and financial stability
5. The global economy is slowing pressures in the euro area remain the
down. In its latest update of the World most significant source of systemic
Economic Outlook (WEO), the global risk. In recent weeks, renewed
International Monetary Fund (IMF) has concerns about Greece and the need for
revised its projection for global growth greater collective support to Spain and
in 2012 marginally downwards to 3.5 per Italy have amplified these risks.
cent, but has emphasised further Consequently, the potential for negative
downside risks to growth. In the US, spillovers to the euro area core countries
output 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 global
the euro area, growth was flat in Q1 after
growth, which stem from persistent
a contraction by 1.2 per cent in the
weakness in advanced economies, have
previous quarter. In the UK, growth
increased with EDEs also exhibiting
contracted by 2.8 per cent in Q2 of 2012
moderation in growth. Among the
and 1.3 per cent in Q1. Output in Japan
BRICS countries, growth in China fell
expanded by 4.7 per cent in Q1 after a
from 8.1 per cent in Q1 of 2012 to 7.6
low growth of 0.1 per cent in the previous
per cent in Q2. Growth also moderated
quarter, supported by reconstruction
significantly in Brazil and South Africa
related demand. The global manufacturing
purchasing managers’ index (PMI) fell in Q1. According to the IMF, growth in
below the neutral level of 50.0 to 48.9 in a number of major EDEs turned out to
June 2012 - the lowest in 3 years - be lower than forecast by it earlier.
suggesting contraction in manufacturing 8. Inflationary pressures softened
a 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 weaker
50.3 in June 2012 suggests near growth prospects and moderation in
stagnation. commodity prices. International (Brent)
6. The decisions by the European crude oil prices declined from an average
Commission (EC) Summit on July 2, of about US$ 125 per barrel in March
2012 improved market confidence, but 2012 to an average of about US$ 95
only temporarily. Without a sustained per barrel in June 2012. In July, however,
recovery in growth or moderation in the average price increased to above
sovereign debt stress, which are highly US$ 100 per barrel. In advanced
2
9. economies, spare capacity in both significantly lower than the expansion of
product and labour markets limits risks 5.7 per cent registered in the
to core inflation. Among the BRICS corresponding period of last year. The
countries, inflation fell significantly in PMI rose marginally to 55.0 in June 2012
China and Russia. It also eased in Brazil from 54.8 in May. The composite
and South Africa. Even as growth in (manufacturing and services) PMI also
India 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 monsoon
Domestic Economy season, rainfall up to July 25, 2012 was
9. Gross Domestic Product (GDP) 22 per cent below its long period average
growth decelerated over four successive (LPA). The Reserve Bank’s production
quarters from 9.2 per cent in Q4 of weighted rainfall index (PWRI) showed
2010-11 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 was
industrial growth as well as deceleration very uneven, with the North-West region
in services sector activity pulled down registering the highest deficit of about 39
the overall GDP growth to 6.5 per cent per cent of LPA. If the rainfall deficiency
for 2011-12, below the Reserve Bank’s persists, agricultural production could be
baseline 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 Q4
significant weakness in investment
of 2011-12 as reflected in the results of
activity was the main cause of the
the Reserve Bank’s order book,
slowdown. Gross fixed capital formation,
inventories and capacity utilisation
which grew by 14.7 per cent in Q1 of
survey (OBICUS) revealed the usual
2011-12, moderated to 5.0 per cent in Q2
seasonal improvement over the previous
and then contracted by 0.3 per cent in Q3
before recovering to a growth of 3.6 per quarter. However, lead information from
cent in Q4. Growth in private consumption the Reserve Bank’s industrial outlook
also decelerated in 2011-12, even as it survey (IOS) indicates that capacity
remained the key driver of growth. The utilisation dropped in Q1 and Q2 of
positive impact of the rupee depreciation 2012-13. Moreover, overall business
on exports is yet to be seen. sentiment also moderated in both the
quarters.
11. Growth in the index of industrial
production (IIP) decelerated from 8.2 per 14. Headline Wholesale Price Index
cent in 2010-11 to 2.9 per cent in (WPI) inflation increased from 7.5 per
2011-12. Further, IIP growth during cent in April to 7.6 per cent in May before
April-May 2012, at 0.8 per cent, was moderating to 7.3 per cent in June 2012.
3
10. The stickiness in inflation, despite the weights of commodities, especially of
significant growth slowdown, was food items in the two indices. Second,
largely on account of high primary food even in respect of similar items, inflation
inflation, which was in double-digits was higher in CPI than in WPI, suggesting
during Q1 of 2012-13 due to an unusual that besides the incidence of higher
spike in vegetable prices and sustained service taxes, moderation in non-food
high inflation in protein items. manufactured products prices has not yet
been transmitted to the retail level. The
15. 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 in
non-administered fuel prices, which in 18. Among other factors, urban
turn was due to decline in global crude households’ inflation expectations, as per
oil prices. However, the reversal in crude the latest survey conducted by the
Reserve Bank, increased slightly in Q1
oil prices in recent weeks may add to
of 2012-13 after a decline in the previous
domestic 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 e
16. Non-food manufactured products moderation, wage inflation in rural and
inflation 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 e
non-food manufactured products
performance in 2011-12, based on a
inflation (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 remained
Moreover, input price pressures persist positive for the year even after adjusting
due to both exchange rate movements for inflation. However, earnings
and supply side constraints. Going decelerated due to an increase in
forward, further pressure on non-food expenditure, indicating decline in pricing
manufactured products inflation cannot power. Early results for Q1 of 2012-13
be ruled out. suggest that pricing power remained
17. The Consumer Price Index (CPI subdued.
new 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, was
food and non-food prices. The divergence marginally lower than the indicative
between WPI and CPI inflation was on trajectory of 15 per cent, non-food credit
account of two factors. First, there are growth at 17.4 per cent was slightly
differences in the composition and above the indicative projection of 17 per
4
11. cent. If we include banks’ investment in conditions was due to a decline in
commercial paper and other instruments, government cash balances with the
non-food credit growth was even higher Reserve Bank, injection of liquidity of
at 17.7 per cent. about `860 billion by way of open
21. The flow of resources to the market operation (OMO) purchases of
commercial sector, from both bank and securities and increased use of the export
non-bank sources, increased to `1.9 credit refinance facility by banks after
trillion in 2012-13 so far (up to July 13, the increase in the limit effected in the
2012) as compared with `1.4 trillion June Mid-Quarter Review. Reflecting the
during 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 the
paper increased significantly. Reserve Bank, stayed close to the policy
repo rate.
22. Following the reduction in the
repo rate in April, several commercial 24. During Q1 of 2012-13, yields on
banks reduced their lending rates. The government securities softened reflecting
modal base rate of scheduled commercial an improvement in liquidity, moderation
banks (SCBs) declined by 25 bps to in inflation and concerns about weakening
10.50 per cent during April-June 2012. of domestic and global growth. The
Significantly, on the basis of the weighted 10-year benchmark yield was
average lending rate (WALR) of significantly lower at 8.11 per cent on
commercial banks, adjusted for inflation, July 26, 2012 as compared with 8.63 per
real rates are now lower than they were cent at end-March 2012.
during the high growth five-year period 25. Housing prices continued to rise
of 2003-08. Banks’ actions on deposit despite the decline in volume of
rates, however, were muted due to the transactions. The Reserve Bank’s
slowdown in deposit growth. quarterly housing price index suggests
that prices increased in Q4 of 2011-12 in
23. Liquidity conditions have eased
most of the 9 cities for which the index
considerably since the April Policy. The
is compiled.
average daily net borrowing under the
liquidity adjustment facility (LAF), 26. During April-May 2012, while
which was 2.2 per cent of average net food subsidies were lower, fertiliser
demand and time liabilities (NDTL) in subsidies were more than twice the
Q4 of 2011-12, declined sharply to 1.3 previous year’s level. Clearly, if the
per cent in Q1 of 2012-13 and further to target of restricting the expenditure on
0.7 per cent in July 2012 (up to July 26, subsidies to under 2 per cent of GDP in
2012). The turnaround in liquidity 2012-13, as set out in the Union Budget,
5
12. is to be achieved, immediate action on previous year. Based on preliminary
fuel and fertiliser subsidies will be data, services exports rose moderately by
required. 3 per cent to US$ 35 billion, while
27. In 2011-12, the CAD rose to services imports surged by 19 per cent
US$ 78 billion (4.2 per cent of GDP) to US$ 21 billion in Q1. Accordingly, net
from US$ 46 billion (2.7 per cent of services exports of US$ 14 billion in Q1
GDP) in the previous year, largely of 2012-13 were lower by 12 per cent as
reflecting 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 trade
oil and lubricants (POL) as well as gold weighted real effective exchange rates
and silver. As capital inflows fell short (REER) depreciated in the range of 7-10
of the CAD, there was a net drawdown per cent, primarily reflecting the nominal
of reserves (on a BoP basis) to the extent depreciation of the rupee against the US
of US$ 13 billion in contrast to a net dollar by around 9 per cent. The
accretion to reserves of more or less of depreciation was mainly on account of
the same order in the previous year. the slowdown in capital inflows, the large
28. Reflecting the fragile global current account deficit, domestic
situation, India’s merchandise exports economic uncertainty and growing
declined by 1.7 per cent to US$ 75 billion apprehensions about the euro area
during Q1 of 2012-13. However, imports problem.
declined even more sharply, by 6.1 per 30. Exchange rate depreciation in Q1
cent, 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 large
was lower at US$ 40 billion in Q1 of current account deficits, the depreciation
2012-13 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 Projections
Growth in industrial activity. Both theses
31. In the April Policy, the Reserve assumptions did not hold. The monsoon
Bank 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 for
of a normal monsoon and improvement April-May suggest that industrial
6
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 is
domestic growth have intensified. First, revised downwards from 7.3 per cent to
global growth and trade volume are now 6.5 per cent (Chart 1).
expected to be lower than projected Inflation
earlier. Given the greater integration of
32. In the April Policy, the Reserve
the Indian economy with the global
Bank made a baseline projection of WPI
economy, 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 assumption
and the services sector. However, the of normal monsoon. The deficient and
lagged impact of depreciation of the uneven monsoon performance so far
exchange rate could partly offset this. will have an adverse impact on food
The impending “fiscal cliff” in the US in inflation. Notwithstanding some
2013, when temporary tax concessions moderation, international crude oil
expire and automatic spending cuts take prices remain elevated. This, coupled
effect, also entails additional risks to the with the pass- thr ough of r upee
growth outlook. Second, reflecting the depreciation to import prices, continues
lagged impact of weak industrial activity to put upward pressure on domestic fuel
and global slowdown, the services sector price inflation. In addition, with the
growth is also expected to slow down. adjustment of domestic prices of
7
14. petroleum products to international price 34. Although inflation has remained
changes still incomplete, embedded risks persistently high over the past two years,
of suppressed inflation could also impact it averaged around 5.5 per cent during
fuel 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 about
products inflation has not been 7.5 per cent. Given this record, the
commensurate with the moderation in conduct of monetary policy will continue
growth. Input price pressures on account to condition and contain perception of
of 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-term
minerals and power may exert upside objective of 3.0 per cent inflation
pressure on non-food manufactured
consistent with India’s broader integration
products inflation.
into the global economy.
33. Keeping in view the recent trends
Monetary Aggregates
in food inflation, trends in global
commodity prices and the likely demand 35. With nominal growth remaining
scenario, the baseline projection for WPI broadly at the level envisaged in the
inflation for March 2013 is now raised April Policy, monetary aggregates are
from 6.5 per cent, as set out in the April expected to move along the trajectories
Policy, to 7.0 per cent (Chart 2). projected in the Monetary Policy
8
15. Statement 2012-13. Accordingly, M3 adversities in several parts of the
growth projection for 2012-13 has been world, the outlook for food and
retained at 15 per cent and the growth commodity prices, especially crude
in non-food credit of SCBs at 17 per oil, has turned uncertain. These
cent. As always, these numbers are developments have adverse
indicative projections and not targets. implications for domestic growth
and inflation.
Risk Factors
36. The projections of growth and iii) While inflation in protein items
inflation for 2012-13 are subject to a remains elevated due to structural
number of risks as indicated below: demand supply imbalances,
additional risks to food inflation
i) 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 threatens
ii) Reflecting the setback to the global both macroeconomic stability and
recovery as also weather-related growth sustainability.
III. The Policy Stance
37. Keeping in view the slowdown developments suggested that even as
in growth, the Reserve Bank front- growth moderated, inflation remained
loaded the policy rate reduction in April sticky. Keeping in view the heightening
with a cut of 50 basis points. Subsequent risks to inflation, the Reserve Bank
9
16. decided to pause in the Mid-Quarter implications. In this context, investment
Review (MQR) of June 2012, even in activity has remained subdued over the
the face of slowing growth. last two years. External demand has also
38. Against the backdrop of global remained weak due to the slowdown in
and domestic macroeconomic conditions, global growth. Consequently, the post
outlook and risks, the policy stance in crisis trend rate of growth, which was
this review is shaped by three major earlier estimated at 8.0 per cent, has
considerations. 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 relatively
period during December-January,
small. Under these conditions, demand
headline WPI inflation edged up again
pressures on inflation can re-emerge
beginning February 2012 and has
quite quickly, exacerbating the existing
remained sticky, above 7 per cent, on
account of increase in food prices, supply pressures.
increase in input costs, and upward 41. Third, liquidity conditions play
revision in prices of some administered an important role in the transmission of
items such as coal. Headline inflation has monetary policy signals. Although the
persisted even as demand has moderated situation has eased significantly in the
and the pricing power of corporates recent period, it is necessary to ensure
weakened. Non-food manufactured that liquidity pressures do not constrain
products inflation has also not declined the flow of credit to productive sectors
to the extent warranted by the growth of the economy.
moderation. This reflects severe supply
constraints and entrenchment of inflation 42. Against this backdrop, the stance
expectations. of monetary policy is intended to:
40. Second, growth decelerated • contain inflation and anchor inflation
significantly to 6.5 per cent in 2011-12. expectations;
Although more recent data suggest some
• support a sustainable growth path
pick up, overall economic activity
over the medium-term; and
remains subdued. Importantly, the
current growth performance has to be • continue to provide liquidity to
seen in reference to the trend rate of facilitate credit availability to
growth in order to assess its inflationary productive sectors.
10
17. IV. Monetary and Liquidity Measures
43. On the basis of the current Guidance
assessment and in line with the policy
stance outlined in Section III, the 50. The primary focus of monetary
Reserve Bank announces the following policy remains inflation control in order
policy measures. to secure a sustainable growth path over
Repo Rate the medium-term. While monetary
actions over the past two years may have
44. It has been decided to retain the
repo rate under the liquidity adjustment contributed to the growth slowdown – an
facility (LAF) at 8.0 per cent. unavoidable consequence – several other
Reverse Repo Rate factors have played a significant role. In
the current circumstances, lowering
45. The reverse repo rate under the
policy rates will only aggravate
LAF, determined with a spread of 100
basis points below the repo rate, stands inflationary impulses without necessarily
at 7.0 per cent. stimulating growth. As the multiple
Marginal Standing Facility (MSF) constraints to growth are addressed, the
Rate Reserve Bank will stand ready to act
46. The MSF rate, determined with a appropriately.
spread of 100 basis points above the repo 51. Meanwhile, managing liquidity
rate, stands at 9.0 per cent. within the comfort zone remains an
Bank Rate objective and the Reserve Bank will
47. The Bank Rate stands at 9.0 respond to liquidity pressures, including
per 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 and
scheduled banks has been retained at the Reserve Bank stands ready to respond
4.75 per cent of their net demand and
to any such shocks swiftly, using all
time liabilities (NDTL).
available instruments.
Statutory Liquidity Ratio
49. 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. • 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 Monetary
Mid-Quarter Review of Monetary Policy 2012-13
Policy 2012-13 55. The Second Quarter Review of
54. The next Mid-Quarter Review of Monetary Policy for 2012-13 is scheduled
Monetary Policy for 2012-13 will be put for Tuesday, October 30, 2012.
Mumbai
July 31, 2012
12
