Third Quarter Review of Monetary Policy 2011-12

Dr. D. Subbarao


Since the Second Quarter Review (SQR) of Monetary Policy in October 2011, there have been significant changes in the global scenario. On the one hand, concerns over the sustainability of sovereign debt problem in the euro area have intensified. On the other, there are modest signs of improvement in the US. In the emerging and developing economies (EDEs), growth has been moderating, reflecting the sluggishness in the advanced economies and the impact of earlier monetary tightening. Overall, notwithstanding the signs of recovery in the US, global growth prospects have weakened since the SQR.

  1. Growth in India has also moderated. In particular, investment activity has decelerated sharply, reflecting heightened global uncertainty and domestic fiscal, monetary, political and administrative conditions.

  2. Inflation is beginning to moderate as projected, despite the significant depreciation of the rupee. In particular, the higher than expected deceleration in food inflation has provided some relief, even though this was caused largely by a seasonal decline in vegetable prices. Consistent with the Reserve Bank''s earlier projections, inflation is likely to decelerate further to 7 per cent by March 2012.

  3. Non-food manufactured products inflation, however, continues to remain high and well above the comfort zone. While indicators of pricing power suggest that the moderating trend will continue, upside risks remain significant. The momentum indicator of non-food manufactured products inflation is yet to show a discernible downward trend. Accordingly, while the Reserve Bank''s policy stance has to become more sensitive to growth risks, it also needs to guard against persistent inflation risks.

  4. This policy review is set in the context of ahighly uncertain global environment and a delicately poised domestic balance between growth and inflation. It should be read and understood together with the detailed review in Macroeconomic and Monetary Developments released yesterday by the Reserve Bank.

  5. 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; and Section IV specifies the monetary measures.

    I. The State of the Economy

    Global Economy

  6. US GDP growth in Q3 of 2011 [quarter-on-quarter (q-o-q), seasonally adjusted annualised rate (saar)] was revised downwards from 2 per cent to 1.8 per cent. Although this is better than the sub-one per cent growth in the first half of 2011, it is still substantially below trend. In the euro area, GDP growth (q-o-q, saar) decelerated from 0.8 per cent in Q2 to 0.4 per cent in Q3. In Japan, growth (q-o-q, saar) recovered to 5.6 per cent in Q3 from the setbacks suffered in Q2 (-2.0 per cent) and Q1 (-6.6 per cent) due to earthquake/tsunami.

  7. Amongst the major EDEs, growth [year-on-year (y-o-y)] in China slowed to 8.9 per cent in Q4 of 2011 from 9.1 per cent in Q3 and 9.5 per cent in Q2; it also slowed in Brazil to 2.1 per cent in Q3 from 3.3 per cent in Q2 and in South Africa to 3.1 per cent from 3.2 per cent. Growth in Russia, however, accelerated to 4.8 per cent in Q3 from 3.4 per cent in Q2 of 2011. Various international agencies have scaled down their growth estimate for 2011 and projection for 2012 both for the advanced economies and EDEs.

  8. The global purchasing managers'' index (PMI) for manufacturing recovered to an expansionary mode in December after remaining below the benchmark 50-mark (suggesting contraction) in both October and November 2011. The services index remains above the 50-mark (suggesting expansion) and improved from 52.7 in November to 53.2 in December. The composite PMI of the euro area has remained well below the benchmark of 50 since September 2011, although the index improved marginally to 48.3 in December from 47.0 in November.

  9. Beginning the fourth week of December 2011, increase in international crude oil prices has been driven largely by geo-political uncertainties. In contrast, weak global economic activity has led to some softening of non-oil commodity prices. The World Bank''s index of non-energy prices declined by 11 per cent (y-o-y) in December 2011

  10. Reflecting international commodity price dynamics, headline measures of inflation moderated in November-December 2011 in a number of countries, but still remain at elevated levels. Among the major advanced economies, headline inflation was 3.0 per cent in the US and 2.7 per cent in the euro area. Amongst the EDEs, headline inflation was 4.1 per cent in China, 6.5 per cent in Brazil and 6.1 per cent in Russia and South Africa. Notably, in many EDEs, the softening, in varying degrees, of the impact of global commodity prices on inflation was offset by the sizeable depreciation of their currencies in the second half of 2011.

  11. Given the renewed strains in global financial markets, six major central banks announced coordinated actions in November 2011 to enhance their capacity to provide liquidity support to the global financial system. The European Central Bank (ECB) also announced longer-term refinancing operations (LTROs) with a maturity of 36 months. These measures are intended to encourage bank lending in money markets and sovereign bond markets.

    Domestic Economy

  12. At home, GDP growth moderated from 7.7 per cent in Q1 (April-June) to 6.9 per cent in Q2 (July-September) of 2011-12. This was mainly due to deceleration in industrial growth from 6.7 per cent to 2.8 per cent. However, the services sector held up relatively well. Consequently, GDP growth during H1 (April-September) of 2011-12 slowed to 7.3 per cent from 8.6 per cent in H1 of last year.

  13. On the demand side, the contraction in fixed capital formation in Q2 was the main factor behind the slowdown in growth. The real gross fixed capital formation to GDP ratio declined from 31.2 per cent in Q1 to 30.5 per cent in Q2. This pattern, should it persist, will hurt medium-term growth. Private consumption grew by 5.9 per cent in Q2, slightly slower than 6.3 per cent in Q1, but substantially slower than 9.0 per cent a year ago. The global environment is only partly responsible for the weak industrial performance and sluggish investment activity; several domestic factors -- the unhealthy fiscal situation, high interest rates and policy and administrative uncertainty -- are also playing a role.

  14. The index of industrial production (IIP) remained volatile. The y-o-y industrial growth recovered from (-) 4.7 per cent in October to 5.9 per cent in November. Over the year, however, growth in industrial production slowed down to 3.8 per cent during April-November 2011 from 8.4 per cent a year ago. The slowdown was mainly on account of the manufacturing and mining sectors. In terms of the use-based classification, weakness in the capital goods, intermediate goods and consumer durables sectors dragged down industrial production. However, the PMI-Manufacturing rebounded to 54.2 in December 2011 from 51.0 in November. The PMI-Services also recovered markedly to 53.2 in November and further to 54.2 in December from the below 50 levels in the preceding two months. On the agriculture front, rabisowing as of January 20, 2012 was marginally lower (-1.1 per cent) than that in last year.

  15. According to the Reserve Bank''s order books, inventories and...

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