Monetary Policy Statement 2012-13

Dr. D. Subbarao


This Annual Policy for 2012-13 is set in a challenging macroeconomic environment. At the global level, concerns about a crisis have abated somewhat since the Third Quarter Review (TQR) in January 2012. The US economy continues to show signs of modest recovery. Large scale liquidity infusions by the European Central Bank (ECB) have significantly reduced stress in the global financial markets. However, recent developments, for example in Spain, indicate that the euro area sovereign debt problem will continue to weigh on the global economy. Growth risks have emerged in emerging and developing economies (EDEs). And, amidst all these, crude oil prices have risen by about 10 per cent since January and show signs of persisting at current levels.

  1. Domestically, the state of the economy is a matter of growing concern. Though inflation has moderated in recent months, it remains sticky and above the tolerance level, even as growth has slowed. Significantly, these trends are occurring in a situation in which concerns over the fiscal deficit, the current account deficit and deteriorating asset quality loom large. In this context, the challenge for monetary policy is to maintain its vigil on controlling inflation while being sensitive to risks to growth and other vulnerabilities.

  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 two parts. Part A covers Monetary Policy and is divided into four Sections: Section I provides an overview of global and domestic macroeconomic developments; Section II sets out the outlook and projections for domestic growth, inflation and monetary aggregates; Section III explains the stance of monetary policy; and Section IV specifies the monetary and liquidity measures. Part B covers developmental and regulatory policies and is organised into five sections: Financial Stability (Section I), Financial Markets (Section II), Credit Delivery and Financial Inclusion (Section III), Regulatory and Supervisory Measures for Commercial Banks (Section IV) and Institutional Developments (Section V).

    Part A. Monetary Policy

    I. The State of the Economy

    Global Economy

  4. Global macroeconomic conditions have shown signs of modest improvement. In the US, the GDP growth [quarter-on-quarter (q-o-q), seasonally adjusted annualised rate (saar)] accelerated to 3.0 per cent in Q4 of 2011. Consumer spending has been improving. While the unemployment rate has been trending down, concerns remain about the sustainability of this trend.

  5. The immediate pressures on the financial markets in the euro area have been alleviated to a large extent by the ECB injecting liquidity of more than one trillion euro through two long-term refinancing operations. However, a sustainable solution to the euro area debt problem is yet to emerge. GDP growth (q-o-q, saar) in the euro area declined by 1.2 per cent in Q4 of 2011. The fiscal correction necessitated by the large public debt levels, tightening of credit conditions and persistently high unemployment have added to the downward pressure on the economic activity in the euro area.

  6. Growth also slowed down in EDEs reflecting the combined impact of monetary tightening and slowdown in global growth. As regards BRICS, GDP growth [year-on-year (y-o-y)] in China declined from an average of 9.6 per cent in the first half of 2011 to 8.1 per cent in Q1 of 2012. The slowdown in growth was also sharp in Brazil in Q4 of 2011, but relatively modest in Russia and South Africa.

  7. Headline measures of inflation in major advanced economies continued to soften in March 2012. Amongst the BRICS, while headline inflation moderated in Brazil and Russia in March, it edged up in China.

  8. International crude oil prices have surged since the beginning of 2012 reflecting both geo-political concerns and abundant global liquidity. The price of Brent variety of crude rose from US$ 111 per barrel in January to over US$ 120 per barrel by mid-April. Similarly, the price of the average Indian basket of crude increased from US$ 110 per barrel to US$ 119 per barrel during the same period.

    Domestic Economy

  9. GDP growth moderated to 6.1 per cent during Q3 of 2011-12 from 6.9 per cent in Q2 and 8.3 per cent in the corresponding quarter of 2010-11. This was mainly due to moderation in industrial growth from 2.8 per cent in Q2 to 0.8 per cent in Q3. The services sector held up relatively well (with growth being 8.7 per cent in both Q2 and Q3 of 2011-12). Overall, GDP growth during April-December 2011 slowed significantly to 6.9 per cent from 8.1 per cent in the corresponding period of the previous year.

  10. On the demand side, gross fixed capital formation contracted in Q2 (-4.0 per cent) andQ3 (-1.2 per cent) of 2011-12. The government final consumption expenditure increased by 6.1 per cent in Q2 and 4.4 per cent in Q3. Private final consumption increased by 2.9 per cent in Q2 and 6.2 per cent in Q3.

  11. Growth in the index of industrial production (IIP) decelerated to 3.5 per cent during 2011-12 (April-February) from 8.1 per cent in the corresponding period of the previous year. In terms of use-based classification, while capital goods and intermediate goods sectors registered negative growth of 1.8 per cent and 0.9 per cent, respectively, the growth of the consumer durables sector decelerated to 2.7 per cent. These trends suggest that activity may have expanded slower than 6.9 per cent in Q4 implied in the advance estimates of GDP.

  12. For the month of March 2012, the manufacturing purchasing managers'' index (PMI) moderated to 54.7 from 56.6 in February reflecting lower new orders. The composite (both manufacturing and services) PMI also moderated to 53.6 in March from 57.8 in February.

  13. According to the Reserve Bank''s order books, inventories and capacity utilisation survey (OBICUS), new orders and capacity utilisation of the manufacturing sector increased in Q3 of 2011-12 as compared with the previous quarter. Business confidence, as measured by the business expectations indices of the Reserve Bank''s industrial outlook survey, showed a pick-up in the business sentiment in Q4 of 2011-12, but a marginal moderation in Q1 of 2012-13.

  14. Headline wholesale price index (WPI) inflation, which remained above 9 per cent during April-November 2011, moderated to 6.9 per cent by end-March 2012, consistent with the Reserve Bank''s indicative projection of 7 per cent. However, while the moderation in inflation in December-January owed largely to softening of food prices, the moderation in February-March was largely driven by core non-food manufactured products inflation, which fell below 5 per cent for the first time after two years.

  15. Food articles inflation, which was 8.1 per cent during April-December 2011, briefly turned negative in January 2012 reflecting the seasonal decline in food prices, particularly of vegetables, combined with a high base effect. However, it increased sharply to 6.1 per cent in February and further to 9.9 per cent in March 2012 with the wearing-off of the base effect and rise in vegetables prices. Inflation in protein-based items -- ''eggs, fish and meat'', milk and pulses remained high, reflecting persistent structural demand-supply imbalances.

  16. Fuel inflation moderated from over 15 per cent in November-December 2011 to 10.4 per cent in March 2012 even as global crude oil prices rose sharply, reflecting the absence of commensurate pass-through to domestic consumers. However, mirroring the high international crude oil prices, inflation in respect of non-administered mineral oils remained elevated at 19.8 per cent in March.

  17. Non-food manufactured products inflation, which was 8.4 per cent in November 2011, decelerated significantly to 5.8 per cent in February and further to 4.7 per cent in March 2012. This reflected both a slowdown in domestic demand and softening of global non-oil commodity prices. The momentum indicator of non-food manufactured products inflation (seasonally adjusted 3-month moving average inflation rate) also showed a declining trend.

  18. Notably, consumer price index (CPI) inflation (as measured by the new series, base year: 2010) increased sharply from 7.7 per cent in January to 8.8 per cent in February reflecting a reversal in food inflation. CPI, excluding food and fuel, was in double digits, suggesting that price pressures were still high at the retail level. Driven by food prices, inflation based on other CPIs reversed its declining trend of previous four months to increase in February. According to the latest round of household survey conducted by the Reserve Bank, inflation expectations, although still elevated, have moderated after rising for the previous three quarters.

  19. An analysis of corporate performance during Q3 of 2011-12, based on a common sample of 2,352 non-government, non-financial companies, indicates that sales growth was relatively robust even after adjusting for inflation. However, earnings before depreciation, interest and tax (EBDITA) and profit after tax (PAT) margins continued on the downward trajectory that began earlier in the year. These patterns suggest a steady decline in the pricing power, as producers found it increasingly difficult to pass on rising input costs to their customers.

  20. Money supply (M3) growth, which was 17 per cent at the beginning of the financial year 2011-12, reflecting strong growth in time deposits, moderated during the course of the year to about 13 per cent by end-March 2012, lower than the Reserve Bank''s indicative trajectory of 15.5 per cent, mirroring both tightness in primary liquidity and lower credit demand during most part of the year.

  21. Non-food credit growth decelerated from 22.1 per cent at the beginning of 2011-12 to 15.4 per cent by February 2012 reflecting slower economic activity...

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