1. Since the beginning of 2012, monetary
policy has been aimed at maintaining monetary
conditions in line with the objective of containing
inflation, while ensuring that liquidity conditions
remain supportive of recovery. In this direction,
the Reserve Bank used the available space to
support growth by lowering the cash reserve
ratio (CRR) by 150 basis points on a cumulative
basis, the statutory liquidity ratio (SLR) by 100
bps, the repo rate by 50 basis points and infusing
over `1.7 trillion of liquidity through outright
open market purchases. As a result, liquidity in
2012-13 so far has stayed in line with policy
objective. Going forward, there is a need to
calibrate monetary policy factoring in the
evolving growth-inflation dynamics as also the
progress that may be made in containing the
twin deficits.
2. Growth in Q2 of 2012-13 is likely to have
stayed low with no perceptible signs of
improvement from the preceding quarter. Saving
and investment rates have declined in recent
years, pushing the economy’s potential growth
rate down to about 7 per cent. The reform
measures announced since mid-September 2012
can help improve growth subject to quick
implementation. As the policy environment,
pace of clearances for projects and input
supplies improve, the drag of stalled
infrastructure investment on growth would
decline.
3. Inflation has stayed sticky at around 7.5
per cent in 2012-13 so far. Non-food
manufacturing inflation has not softened in spite
of the negative output gap that has emerged as
a result of slowing growth. Fiscal imbalances, past exchange rate depreciation and feeble
supply response have impacted inflation. Going
forward, inflation is likely to remain sticky in
near months, but some relief may follow as
demand-side inflationary pressures ebb after a
period of high wage and cost push inflation.
Global Economic Conditions
Global growth prospects weaken
4. Growth prospects, both in advanced
economies (AEs) and emerging and developing
economies (EDEs) have weakened in Q2 of
2012. In October 2012, the International
Monetary Fund (IMF) revised its global growth
projections for both these groups downwards.
Weaker growth prospects largely reflect the
impact of sovereign debt overhang and banking
fragilities in the euro area coupled with fiscal
multipliers impacting growth with on-going
fiscal consolidation. Euro area risks have
affected business confidence and caused world
trade to decelerate. Consequently, several EDEs
face weaker external demand on top of an
already slowing domestic demand. Further
downside risks to global growth stem from a
possible “fiscal cliff” leading to sudden and
sharp fiscal consolidation in the US.
Global inflation likely to stay benign
5. With the slack in output and employment
in AEs and falling growth in many large EDEs,
global inflation pressures are likely to stay
muted during rest of 2012. Global commodity
prices are expected to remain range bound, but
event risks can disturb the current stability. The
renewed quantitative easing in some AEs poses some upside risks through liquidity and
exchange rate channels.
Contagion risks persist in global financial
markets
6. Risks of spillovers in global financial
markets remain large despite of credible policy
actions by major central banks. Unconventional
monetary policies hinging on exceptional
liquidity support and easy money have
transitorily moderated uncertainties in the
financial markets keeping them in a risk-on,
risk-off mode. However, the underlying stress
has not diminished with incomplete deleveraging
and unfinished financial sector reforms. This
has kept the financial systems fragile and
markets impacted by risk aversion.
Indian Economy: Developments and
Outlook
Output
Growth remains sluggish, reforms may
arrest downturn
7. Economic indicators suggest that the
slowdown has continued in Q2 of 2012-13 with
slack industrial activity and sub-par services
sector performance. However, recent policy
reforms should help, albeit with some lag, in
contributing to arresting the downturn. They
may support the recovery later upon successful
implementation. The improved prospects for
Rabi, following the reduction in monsoon deficit
with late rains are also expected to contribute
to improving growth and inflation outlook, even
though the recovery may take some time to set
in.
Aggregate Demand
Fiscal consolidation and removal of
impediments to infrastructure investments
hold the key to growth revival
8. Aggregate demand is weakening in 2012-
13 led by investment slowdown. Corporate sales
growth has also moderated significantly. In spite of recent measures aimed at lowering fiscal
deficits, fiscal slippage is likely in 2012-13
reinforcing the need for further measures for
fiscal consolidation to crowd-in private
investment. Rebalancing of aggregate demand
towards investment holds the key to growth
revival. It is, therefore, necessary to remove the
pending constraints in the power, coal and road
sectors at the earliest.
External sector
CAD wider than comfortable in spite of
BoP improvement
9. External sector risks remain in spite of
the improved balance of payments (BoP) during
Q1 of 2012-13. Though the merchandise trade
deficit in 2012-13 so far has been lower, it
largely reflects contraction in import demand
on the back of growth deceleration. Services
trade surplus is lower, leaving the current
account deficit (CAD) wide enough for reemergence
of financing pressures should global
risk aversion increase or domestic recovery
falter. Recent measures, including those to
augment FDI, should help in CAD financing.
However, external sector vulnerability and
sustainable level of CAD would need to be
considered, while framing medium-term trade
and capital account policies.
Monetary and Liquidity Conditions
Reserve Bank infuses liquidity, calibrates
monetary policy with evolving growth-inflation dynamics
10. Active liquidity management through
reductions in the CRR, and the SLR backed by
OMOs has kept liquidity largely in line with the
policy objective, factoring in inflation
persistence and the need to ensure credit supply
to support growth. Liquidity conditions remained
comfortable during Q2 of 2012-13. Monetary
and credit aggregates, however, remained below
the indicative trajectory. The current credit
slowdown largely reflects tepid demand conditions and distinctively lower credit
expansion in case of public sector banks,
reflecting mainly their risk aversion engendered
by deteriorating asset quality. Looking ahead,
monetary policy will need to factor in output
and inflation gaps, keeping in view the current
trajectory of liquidity, monetary and credit
aggregates.
Financial Markets
Markets respond to reform measures, but
more needed to revive primary capital
markets
11. Policy reform measures have shifted
market sentiments, strengthening the equity
prices and the rupee exchange rate. Gains for
the bond markets have been limited despite of
the G-sec auction calendar for the second half
of the year remaining in line with the budgeted
numbers. This may be due to markets factoring
in the inadequate fiscal adjustment in the current
year. There is need for steps to revive the primary
capital markets so that financing constraints for
corporate investments are reduced.
Price Situation
Inflation remains on a sticky path
warranting caution for some more time
12. Inflation has stayed sticky at around 7.5
per cent. Persistent non-food manufactured
products inflation, despite the growth slowdown, has emerged as a concern. While the near-term
inflation risks are on the upside, inflation should
start moderating from Q4 of 2012-13. These
expectations factor in the late revival of the
monsoon that can have a salutary effect on
current food inflation. With global inflation
likely to remain benign and suppressed inflation
pressures starting to recede, inflation could
soften further in H1 of 2013-14. However,
improved supply-responses and moderation of
wage inflation is vital for bringing down
inflation to comfort levels.
Macroeconomic Outlook
Policy calibration needed as inflation risks
persist, while growth remains weak
13. Business sentiments remain weak at the
moment and global growth projections,
including that for India, are getting revised
downwards. Domestic constraints, especially
in infrastructure space, have continued to
impede investments. However, the falling
growth cycle appears to have reached its
trough. Recent policy measures have reduced
macroeconomic risks, but speedy implementation
and sustained reforms are important for turning
the economy around. Meanwhile, inflation risks
persist, warranting a cautious policy calibration.
If macro-risks from inflation and twin deficits
recede further, that could yield space down the
line for monetary policy to respond to growth
concerns. |