First Quarter Review of Monetary Policy 2012-13


Since the Monetary Policy Statement for 2012-13 in April 2012, macroeconomic conditions have deteriorated. Much of the global economy is in a synchronised slowdown, having lost the upward momentum seen in the early months of the year. Despite the slowing global economy, the outlook for commodity prices is uncertain. The situation in the euro area continues to cause concern even as the prospects of immediate default have been averted. While exports of emerging and developing economies (EDEs) have been dented by the weak global economic activity, capital flows into them have declined markedly because of the strains in the euro area financial market conditions.

  1. Domestically, the macroeconomic situation continues to raise concerns. While growth has slowed down significantly, inflation remains well above the comfort zone of the Reserve Bank. The large twin deficits, viz. current account deficit (CAD) and fiscal deficit, pose significant risks to macroeconomic stability. Against this backdrop of heightened global uncertainty and domestic macroeconomic pressures, the challenge for monetary policy is to maintain its priority of containing inflation and lowering inflation expectations. At the same time, monetary policy has also to be sensitive to risks to growth and financial 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 outlook and projections for growth, inflation and monetary aggregates. Section III explains the stance of monetary policy. Section IV specifies the monetary and liquidity measures.

    I. The State of the Economy

    Global Economy

  4. The global economy is slowing down. In its latest update of the World Economic Outlook (WEO), the International Monetary Fund (IMF) has revised its projection for global growth in 2012 marginally downwards to 3.5 per cent, but has emphasised further downside risks to growth. In the US, output growth decelerated to 1.5 per cent (seasonally adjusted annualised rate) in Q2 from 2.0 per cent in Q1 of 2012. In the euro area, growth was flat in Q1 after a contraction by 1.2 per cent in the previous quarter. In the UK, growth contracted by 2.8 per cent in Q2 of 2012 and 1.3 per cent in Q1. Output in Japan expanded by 4.7 per cent in Q1 after a low growth of 0.1 per cent in the previous quarter, supported by reconstruction related demand. The global manufacturing purchasing managers'' index (PMI) fell below the neutral level of 50.0 to 48.9 in June 2012 - the lowest in 3 years - suggesting contraction in manufacturing activity. The global composite (manufacturing and services) PMI at 50.3 in June 2012 suggests near stagnation.

  5. The decisions by the European Commission (EC) Summit on July 2, 2012 improved market confidence, but only temporarily. Without a sustained recovery in growth or moderation in sovereign debt stress, which are highly inter-linked, fiscal and financial stability pressures in the euro area remain the most significant source of systemic global risk. In recent weeks, renewed concerns about Greece and the need for greater collective support to Spain and Italy have amplified these risks. Consequently, the potential for negative spillovers to the euro area core countries and to the rest of the world have also increased.

  6. Importantly, risks to global growth, which stem from persistent weakness in advanced economies, have increased with EDEs also exhibiting moderation in growth. Among the BRICS countries, growth in China fell from 8.1 per cent in Q1 of 2012 to 7.6 per cent in Q2. Growth also moderated significantly in Brazil and South Africa in Q1. According to the IMF, growth in a number of major EDEs turned out to be lower than forecast by it earlier.

  7. Inflationary pressures softened across advanced and emerging economies, reflecting both weaker growth prospects and moderation in commodity prices. International (Brent) crude oil prices declined from an average of about US$ 125 per barrel in March 2012 to an average of about US$ 95 per barrel in June 2012. In July, however, the average price increased to above US$ 100 per barrel. In advanced economies, spare capacity in both product and labour markets limits risks to core inflation. Among the BRICS countries, inflation fell significantly in China and Russia. It also eased in Brazil and South Africa. Even as growth in India is slowing, it is clearly an outlier insofar as inflation is concerned.

    Domestic Economy

  8. Gross Domestic Product (GDP) growth decelerated over four successive quarters from 9.2 per cent in Q4 of 2010-11 to 5.3 per cent in Q4 of 2011-12. Significant slowdown in industrial growth as well as deceleration in services sector activity pulled down the overall GDP growth to 6.5 per cent for 2011-12, below the Reserve Bank''s baseline projection of 7 per cent.

  9. On the expenditure side, significant weakness in investment activity was the main cause of the slowdown. Gross fixed capital formation, which grew by 14.7 per cent in Q1 of 2011-12, moderated to 5.0 per cent in Q2 and then contracted by 0.3 per cent in Q3 before recovering to a growth of 3.6 per cent in Q4. Growth in private consumption also decelerated in 2011-12, even as it remained the key driver of growth. The positive impact of the rupee depreciation on exports is yet to be seen.

  10. Growth in the index of industrial production (IIP) decelerated from 8.2 per cent in 2010-11 to 2.9 per cent in 2011-12. Further, IIP growth during April-May 2012, at 0.8 per cent, was significantly lower than the expansion of 5.7 per cent registered in the corresponding period of last year. The PMI rose marginally to 55.0...

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