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First Quarter Review of Monetary Policy click here
First Quarter Review of Monetary Policy 2009-2010
-Announced on the 28th July 2009
II. Stance of Monetary Policy
52. The thrust of the various policy
initiatives by the Reserve Bank since
mid-September 2008 has been on providing
ample rupee liquidity, ensuring comfortable
dollar liquidity and maintaining a market
environment conducive for the continued
flow of credit to productive sectors. The
important measures initiated include
reduction of the repo and reverse repo rates,
reduction of the CRR and the SLR,
institution of several sector-specific liquidity
facilities, establishment of a forex swap
facility and relaxation in the guidelines for
raising external commercial borrowings
(ECBs). Also, the Reserve Bank allowed
restructuring of stressed assets by banks in
order to increase the flow of credit for
productive purposes.
53. In the Annual Policy Statement of
April 2009, the reverse repo and repo rates
were reduced by 25 basis points each.
Currently, the reverse repo rate is at 3.25
per cent and the repo rate is at 4.75 per cent.
These are at their historically lowest levels.
Liquidity Impact
54. The actions of the Reserve Bank
since mid-September 2008 have resulted in
augmentation of actual/potential liquidity of
Rs.5,61,700 crore (Table 20). In addition, the
permanent reduction in the SLR by one
per cent of NDTL has made liquid funds of
the order of Rs.40,000 crore available for
credit expansion. Analytically, the various
policy actions by the Reserve Bank since
mid-September 2008 have resulted in
expansion of its domestic assets, through
open market operations (OMO) and
redemptions of bonds under the Market
Stabilisation Scheme (MSS), among others,
for creating base money to support the
required monetary expansion. Liquidity
expansion has been consistent with the
Reserve Bank’s stance of ensuring a policy
regime that will enable credit expansion at
viable rates while preserving credit quality.
55. The liquidity situation has remained
comfortable as evidenced by the LAF
window being in an absorption mode since
mid-November 2008. During the current
financial year, the Reserve Bank has been
absorbing over Rs.1,20,000 crore on average
daily basis under the LAF window. Call
money rates have generally been close to
or below the lower bound of the LAF
corridor. Other money market rates such as
those for CBLO and market repo, and
discount rates of CDs and CPs, have also
declined significantly in tandem with the
call money rates. Most commercial banks
have reduced their deposit and benchmark
prime lending rates. As the overall liquidity
conditions remain comfortable, the total
utilisation under the special refinance/
liquidity facilities made available by the
Reserve Bank has been low. However,
bankers have indicated that the existence
of these facilities – even if they have not
been fully tapped – has provided the much
needed comfort to them as a potential fall
back option.
56. Since the crisis intensified in
September 2008, the Reserve Bank has been
taking necessary actions in order to cushion
the economy from its worst impact. For this
purpose, the Reserve Bank used a variety of
instruments such as the repo and reverse repo
rates, cash reserve ratio, statutory liquidity
ratio, open market operations including the
liquidity adjustment facility, the market
stabilisation scheme, special market
operations and sector-specific liquidity
facilities. The Reserve Bank has also used
prudential tools to modulate the flow of
credit to certain sectors consistent with the
objective of financial stability. The Reserve
Bank will continue to rely on these
multiple instruments to modulate the
liquidity and interest rate conditions in line
with the evolving global and domestic
macroeconomic conditions.
Growth Projection
57. In 2008-09, real GDP increased by
6.7 per cent, in line with the projection in
the Reserve Bank’s Annual Policy Statement
of April 2009. However, the growth pattern
was uneven as real GDP growth decelerated
from 7.7 per cent in the first half of the year
to 5.8 per cent in the second half. This was
mainly because of the global financial
crisis, which affected external demand,
domestic private consumption and
investment demand. The overall
macroeconomic scenario continues to be
uncertain, although it is expected that the
fiscal and monetary stimulus measures will
boost domestic demand in 2009-10.
58. Domestic and external financing
conditions are also now more favourable
than they were in the second half of 2008-09.
The business outlook has turned positive
signalling a revival of industrial activity. On
the other hand, keeping in view the sharp
contraction in world trade projected during
2009, export demand will continue to remain
weak. Similarly, during the earlier part of
2009-10, the services sector may experience
the drag of sluggish external demand and
the lagged adverse impact of the weak
industrial growth. Also, the onset of the
south-west monsoon has been delayed and
it remains below normal, increasing the
downside risks to agricultural production.
On balance, an uptrend in the growth
momentum is unlikely before the middle of
2009-10. On current assessment, the growth
projection for GDP for 2009-10 is placed at
6.0 per cent with an upward bias. This
updated growth projection for 2009-10, thus,
marks a slight improvement over the growth
expectations of around 6.0 per cent indicated
in the Annual Policy Statement.
Inflation Projection
59. Headline WPI inflation turned
negative in June 2009 as anticipated in the
Annual Policy Statement of April 2009.
However, negative WPI inflation in India is
due to the statistical base effect and, as
indicated in the April Statement, it should
not be interpreted as a contraction in demand.
This transitory negative WPI inflation may
not persist beyond a few more months.
However, food price inflation continues to
remain elevated. This is reflected in
stubbornly high CPI inflation. The uncertain
monsoon outlook could further accentuate
food price inflation. Moreover, the sharp
decline in WPI inflation has not been
commensurately matched by a similar
decline in inflation expectations.
60. Pressures from global commodity
prices, which had been abating markedly
since August 2008 on account of the slump
in global demand, seem to have bottomed
out in early 2009. In fact, commodity
prices have rebounded ahead of global
recovery. The Reserve Bank’s inflation
expectations survey shows that while
inflation expectations remain well
anchored, a majority of the respondents
expect inflation to rise over the next three
months to one year.
61. In the Annual Policy Statement of
April 2009, WPI inflation at end-March 2010
was projected at around 4.0 per cent. On a
financial year basis, WPI inflation has
already increased by 3.5 per cent by July 11,
2009. The base effect, which is generating
the negative WPI inflation, is projected to
completely wear off by October 2009.
Thereafter, the year-on-year WPI inflation
will creep up even without any major supply
shock. Keeping in view the global trend in
commodity prices and the domestic
demand-supply balance, WPI inflation for
end-March 2010 is projected at around 5.0
per cent. This is higher than the projection
of 4.0 per cent made in the Annual Policy
Statement of April 2009.
62. As always, the Reserve Bank will
endeavour to ensure price stability and
anchor inflation expectations. Towards this
objective, the Reserve Bank will continue
to take into account the behaviour of all the
price indices and their components. The
conduct of monetary policy will continue
to condition and contain perception of
inflation in the range of 4.0-4.5 per cent.
This will be in line with the medium-term
objective of 3.0 per cent inflation consistent
with India’s broader integration with the
global economy.
Monetary Projection
63. During 2008-09, money supply
(M3) increased by 18.6 per cent. The
year-on-year growth in M3 has remained
over 20.0 per cent throughout the current
financial year so far reflecting easy liquidity
conditions. The major source of M3
expansion has been the large increase in
bank credit to the Government, which also
included OMO by the Reserve Bank, while
credit to the commercial sector decelerated.
The Reserve Bank remains committed to
providing ample liquidity for all productive
activities on a continuous basis. In this
context, it is important that the increased
government market borrowing programme
does not crowd out credit flow to the private
sector. As such, money supply will have to
be higher than envisaged in the Annual
Policy Statement of April 2009. Accordingly,
for policy purposes, money supply (M3)
growth for 2009-10 is placed at 18.0 per
cent, up from 17.0 per cent projected in the
Annual Policy Statement. Consistent with
this, aggregate deposits of scheduled
commercial banks are projected to grow by
19.0 per cent. The growth in adjusted nonfood
credit, including investment in bonds/
debentures/shares of public sector
undertakings and private corporate sector
and CPs, has been retained at 20.0 per cent
as in the Annual Policy Statement. As
always, these numbers are provided as
indicative projections and not as targets.
Overall Assessment
64. At the global level, the financial
sector seems to be stabilising, but the real
sector continues to be in recession. In recent
months, there have been some positive
signals relating to consumer spending, credit
spreads and financing conditions. However,
the signals are too tentative and weak to
suggest any firm turnaround. Both
households and firms are still in the process
of rebuilding their balance sheets ruptured
by the crisis. As such, despite some measured
optimism of a turnaround sooner than
expected, a firm recovery at the global level
is unlikely before 2010. This continued
uncertainty in the immediate outlook is
reflected in the downward revision of global
growth for 2009 by the IMF from (-)1.3 per
cent made in April 2009 to (-)1.4 per cent in
July 2009.
65. Since the release of the April 2009
Policy Statement, there have been
progressive signs of recovery in India:
food stocks have increased; industrial
production has turned positive; corporate
performance has improved; business
confidence surveys are optimistic; leading
indicators show an upturn; interest rates
have declined; credit off-take has picked
up after May 2009; stock prices have
rebounded; the primary capital market has
witnessed some activity; and external
financing conditions have improved. On
the other hand, there are some negative
signs: delayed and deficient monsoon;
food price inflation; rebound in global
commodity prices; continuing weak
external demand; and high fiscal deficit.
66. On balance, the risks to the current
projections of real GDP growth and inflation
for 2009-10 are on the upside. The
comfortable levels of foodgrains stocks
should help mitigate the risks in the event
of price pressures from the supply side. The
Reserve Bank also will closely monitor the
level of liquidity so as to contain inflationary
expectations if supply side price pressures
were to rise.
67. The growth of 6.7 per cent during
2008-09 was better than most analysts had
expected, and decidedly better than the
performance of most other economies. The
growth projection for the current year of 6.0
per cent with an upward bias reflects the
absence of any firm signs of definite
recovery in the world economy. The
challenge for us is to return the economy to
the high growth rate of 9 per cent that we
averaged in the period 2005-08.
Notwithstanding the temporary hiccups of
the crisis period, India is not a demand
constrained economy; it is a supply
constrained economy. The critical
requirement for accelerated growth is to raise
the level of investment, particularly in
infrastructure.
68. Since the outbreak of the crisis in
mid-September 2008, the Reserve Bank has
maintained an accommodative monetary
stance. It will be the endeavour of the
Reserve Bank to maintain a policy stance
that will aid return of the economy to the
high growth path. At the same time, there
are factors – stubborn food price inflation,
rebound in world commodity prices,
expansionary monetary and fiscal policies
– that could potentially build inflationary
pressures. Accordingly, the task of returning
the economy to a high growth path, viewed
from the current perspective, throws up some
important challenges. These are highlighted
below.
69. First, the immediate challenge for
the Reserve Bank is to manage the balance
between the short-term compulsions of
providing ample liquidity and the potential
build-up of inflationary pressure on the way
forward. As indicated earlier, the negative
WPI inflation numbers are only a statistical
feature and do not have any structural
significance. Within WPI inflation, inflation
of primary articles, particularly food
articles, remains significantly positive.
Even as inflation of manufactured products
is negative, inflation of manufactured food
products is close to double digits. Moreover
consumer price indices (CPIs) have
remained elevated, indeed also hardened in
recent months. The task for the Reserve
Bank is to maintain the accommodative
monetary stance till demand conditions
further improve and the credit flow takes
hold, but to be ready with a roadmap to
reverse the expansionary stance quickly and
effectively thereafter.
70. The second challenge for the
Reserve Bank is to manage the
Government’s borrowing programme for
2009-10. As indicated earlier, Government
borrowing expanded very rapidly in 2008-09.
During the current year, the budgeted net
borrowing of the Central Government is 33
per cent higher than the already elevated
borrowing of last year. Despite active
liquidity management by the Reserve Bank,
yields on government securities firmed up
from a low of 5.8 per cent in January 2009
to around 7.0 per cent in July 2009. The
hardening of yields has clearly militated
against the low interest rate regime that the
economy requires in the current situation.
Private credit demand remains subdued as
of now, but is likely to pick up. In order to
manage the government borrowing without
crowding out present or potential private
credit demand, the Reserve Bank will
continue with its active liquidity
management policy. It may be noted in this
context that during the first half of 2009-10,
planned OMO purchases and MSS
unwinding will add primary liquidity of
Rs.1,50,000 crore, which by way of
monetary impact is equivalent to reduction
of CRR by over 3.5 percentage points.
71. By way of challenges, the third is
to spur private investment demand which has
been dented by the crisis. The growth of
gross fixed capital formation, with a weight
of nearly 32 per cent in the real GDP,
dropped from 12.9 per cent in 2007-08 to
8.2 per cent in 2008-09. Accelerating this
ratio back to the pre-crisis level and indeed
improving on that is critical for sustainable
growth in the medium-term. Of particular
importance is increased investment in
infrastructure. The Reserve Bank has
maintained a consistent stance of monetary
accommodation over the last nine months
in order to maintain a soft interest rate
regime. The banks have responded to the
monetary stance by reducing deposit and
lending rates, although there is scope for
further reduction. Going forward, the
Reserve Bank will meet the challenge of
spurring private credit demand by
maintaining policy rates and liquidity
conditions conducive for revival of private
credit demand.
72. Shifting from the immediate to the
short-to-medium term, the fourth challenge
is fiscal consolidation. In order to make up
for the deceleration in private consumption
and investment demand, it was necessary for
the Government to resort to countercyclical
public spending. This has, in a large way,
insulated the economy from the worst impact
of the crisis. The large and abrupt increase
in government borrowing has, however, led
to hardening of yields on government
securities which have impeded monetary
transmission. Furthermore, large fiscal
deficits, if continued strictly beyond the
recovery period, can crowd out private
investment and trigger inflationary
pressures. The Government will, therefore,
need to return to a path of fiscal
consolidation. This entails two facets on the
way forward. The first is to lay down the
roadmap for fiscal consolidation. This has
to go beyond merely indicating revised
FRBM targets to giving out the details of
the adjustment that will take place on the
revenue and expenditure fronts. That will
lend credibility to the fiscal stance and also
give predictability to economic agents. The
second facet is to focus on the quality of
fiscal adjustment even while pursuing
quantitative targets.
73. Finally, the big medium-term
challenge is to improve the investment
climate and expand the absorptive capacity
of the economy. Development experience
clearly demonstrates that no country has
been able to sustain a high growth episode
without a sustained increase in investment
together with improvements in productivity.
This entails two tasks. The first is to move
on with financial sector reforms to promote
financial inclusion, further widen and
deepen financial markets and strengthen
financial institutions. In doing so, we will
inevitably have to factor in the lessons of
the global economic crisis. The second task
is a big thrust on governance reforms that
should inspire the trust and confidence of
potential investors.
Policy Stance
74. On the basis of the above overall
assessment, the stance of monetary policy
for the remaining period of 2009-10 will be
as follows:
• Manage liquidity actively so that the
credit demand of the Government is met
while ensuring the flow of credit to the
private sector at viable rates.
• Keep a vigil on the trends and signals of
inflation, and be prepared to respond
quickly and effectively through policy
adjustments.
• Maintain a monetary and interest rate
regime consistent with price stability
and financial stability supportive of
returning the economy to the high
growth path.
75. It is worth reiterating that the
Reserve Bank will maintain an
accommodative monetary stance until there
are definite and robust signs of recovery.
This accommodative monetary stance is,
however, not the steady state stance. On the
way forward, the Reserve Bank will have to
reverse the expansionary measures to anchor
inflation expectations and subdue
inflationary pressures while preserving the
growth momentum. The exit strategy will
be modulated in accordance with the
evolving macroeconomic developments.
First Quarter Review of Monetary Policy 2009-2010... click here
Highlights of 1st Quarter Review of Monetary Policy 2009-2010... click here
RBI CREDIT AND MONETARY POLICIES (1999-2010)... click here
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