First Quarter Review of Monetary Policy 2013-14


Dr. D. Subbarao



Since early May when the Reserve Bank issued its Monetary Policy Statement for 2013-14, global growth has been uneven and slower than initially expected. The tail risks to global recovery had eased in the early part of the year, but that improvement was overtaken by the turmoil in financial markets because of the ''announcement effect'' of the likely tapering of quantitative easing (QE) by the US Fed. In advanced economies (AEs), activity has weakened. Emerging and developing economies (EDEs) are slowing, and are also experiencing sell-offs in their financial markets, largely due to the safe haven flight of capital. Market expectations of QE taper and the consequent increase in real interest rates in the US have translated into a rapid appreciation of the US dollar and consequent depreciation of EDE currencies. Commodity prices have generally softened, but the price of crude remains elevated. Although the inflation outlook in AEs is still benign, upside risks remain in several EDEs.

  1. On the domestic front, the foreign exchange market came under severe stress starting late May, prompting the Reserve Bank to initiate liquidity tightening measures to contain the volatility. As regards economic activity, risks to growth have increased notwithstanding the robust onset and spread of the monsoon. Industrial production has slumped, with lead indications of declining order books and input price pressures building on rupee depreciation. Meanwhile, depressed global conditions are undermining export performance, even as heightened volatility in capital flows has raised external funding risks. Wholesale price inflation pressures are on the ebb, but retail inflation remains high. Monetary policy going forward will be shaped by the considerations of supporting growth, anchoring inflation expectations and maintaining external sector stability.

  2. In the above context, this Statement should be read and understood together with the detailed review in Macroeconomic and Monetary Developments released yesterday by the Reserve Bank.

  3. This Statement is organised in four Sections: Section I provides an overview of global and domestic macroeconomic developments. Section II sets out the domestic outlook and projections for growth, inflation and monetary aggregates. Section III explains the stance of monetary policy. Section IV specifies the monetary measures.

    I. The State of the Economy

    Global Economy

  4. Global economic activity remains subdued with still elevated downside risks. In the US, incoming data point to a slower recovery in domestic demand and weak export activity. In the UK, recovery is gradually gathering momentum on the back of consumer spending. The euro area continues to be in recession with high unemployment. Japan''s economy is returning to positive growth with improved industrial production and retail sales.

  5. Among the BRICS countries, although retail sales in China have maintained the impetus of recent months, the manufacturing purchasing managers'' index (PMI) and industrial production declined in June. Growth has clearly lost momentum in Brazil, Russia and South Africa.

  6. Inflation remains subdued in AEs, but in several EDEs upside pressures persist. In China, inflation quickened in June, although it is expected to stay benign due to weak demand conditions. Inflation dropped sharply in Russia in June due to softening food prices.

  7. Non-fuel commodity prices have been easing, reflecting subdued global demand and comfortable supply levels. On the other hand, energy prices have firmed up due to a decline in US crude oil inventories and geo-political tensions in the Middle East.

    Domestic Economy

  8. Domestic economic activity weakened in Q1 of 2013-14. Lead indicators point to continuing headwinds facing manufacturing and services sector activity.

  9. Industrial production remained muted at 0.1 per cent during April-May; in May, there was an absolute decline of 1.6 per cent spread across all constituent sub-sectors, barring electricity generation. Capital goods production continues to contract, reflecting deteriorating investment conditions. Although the manufacturing PMI improved modestly in June, the pace of expansion was anaemic. With the decline in the services sector PMI in June, the composite PMI fell too, suggesting broad-based sluggishness in economic activity.

  10. Spurred by the timely arrival of the monsoon and above long period average rainfall so far (17 per cent excess up to July 26, 2013), kharif sowing has been significantly higher than a year ago, with total sown area at 74.8 million hectares as on July 26 as against 63.5 million hectares recorded by the same time last year. To date, all regions, except the east and the northeast, have received normal/excess rainfall.

  11. The deceleration in new orders growth reported in the Reserve Bank''s order books, inventories and capacity utilisation survey (OBICUS) indicates low activity levels in Q1. This is corroborated by the Reserve Bank''s industrial outlook survey (IOS) which indicates that the...

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