Third Quarter Review of Monetary Policy 2012-13


Dr. D. Subbarao



Since the Second Quarter Review (SQR) of Monetary Policy in October 2012, headwinds holding back the global economy have begun to abate gradually, although sluggish conditions prevail. In the US, activity gathered momentum in Q3 of 2012 but this is unlikely to have been sustained in Q4. While a political consensus to avert the ''fiscal cliff'' has calmed financial markets, how the debt ceiling is managed will be crucial in shaping market sentiment on the way forward. The euro area economy is threatened by continuing contraction, notwithstanding the liquidity firewall of the European Central Bank (ECB) and the commitment to act collectively to backstop the union. Overall, however, risks of the sovereign debt crisis disrupting the global financial system have ebbed. Japan has re-entered recession. Among the emerging and developing economies (EDEs), a pick-up in the pace of growth in China is likely. A combination of a slump in external demand and domestic structural bottlenecks has slowed down growth in most other EDEs. Furthermore, inflationary pressures persist in some of them. Overall, global economic prospects have improved modestly since the SQR even as significant risks remain.

  1. Domestically, growth remains sluggish, notwithstanding some tentative signs of the slowdown beginning to level off. Industrial activity weakened, reflecting subdued manufacturing, deceleration in electricity generation and contraction in mining activity. While the series of policy measures announced by the Government has boosted market sentiment, the investment outlook is still lacklustre, especially in terms of demand for new projects. Consumption demand too is slowing. As regards prospects for agriculture, whether the rabi output will offset the shortfall in the kharif output is as yet unclear. Lead indicators of service sector activity point to an expansion in the months ahead, albeit constrained by the drag imposed by depressed global demand conditions.

  2. Headline wholesale price inflation, led by non-food manufactured products inflation, has softened through Q3, providing some relief from the persistence that dominated the first half of the year. On the other hand, food inflation has edged up, pushing up consumer price inflation in turn. Lead indicators such as weaker pricing power of corporates, excess capacity in some sectors, the possibility of international commodity prices stabilising as assessed by the International Monetary Fund (IMF) and momentum measures suggest that inflationary pressures have peaked. However, further moderation in domestic inflation going into 2013-14 is likely to be muted as the correction of under-pricing of administered items is still incomplete and food inflation remains elevated. Accordingly, the setting of monetary policy has to remain sensitive to conflicting pressures and attendant risks.

  3. This policy review is accordingly set in the context of a slowly improving global environment and a tipping point in the balance of risks between growth and inflation on the domestic front. It should be read and understood together with the detailed review in Macroeconomic and Monetary Developments released yesterday by the Reserve Bank.

  4. 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

  5. Signs of stabilisation in global economic activity have been in evidence in recent months, led by stronger than expected growth in the US in Q3, acceleration in the pace of activity in China and a pick-up in industrial production in EDEs in Q4. Activity in the euro area continues to be in a contraction mode, though financial market confidence has improved. Japan has embarked on a fresh fiscal stimulus following contraction in Q3. In the UK, a modest GDP growth in Q3 was followed by a decline in Q4. The HSBC Emerging Market Index rose in Q4. The global composite purchasing managers'' index (PMI) also rose marginally in December.

  6. According to the IMF, consumer price inflation has eased in both advanced economies (AEs) and EDEs in 2012. However, risks to the inflation outlook from commodity price pressures persist.

    Domestic Economy

  7. Year-on-year (y-o-y) real GDP growth slowed from 5.5 per cent in Q1 of 2012-13 to 5.3 per cent in Q2. The decline in the GDP growth rate became broad based, with consumption demand also slowing alongside stalling investment and declining exports. On the supply side, there are indications of weakening resilience of services to sluggish global growth.

  8. Looking ahead, there are some tentative signs of a reversal in momentum. While industrial production slowed to a y-o-y increase of 1.0 per cent in April-November 2012, the seasonally adjusted three-month moving average of the index of industrial production (IIP) points to a pick-up. The manufacturing PMI rose in December on the back of higher order book volumes and new export orders. The services purchasing managers'' index (PMI) also rose in December on expectations of a revival of demand. The Reserve Bank''s industrial outlook survey indicates positive business sentiment in Q3 and Q4. Coverage under rabi sowing has been broadly the same as in the corresponding period of last year.

  9. Headline wholesale price index (WPI) inflation eased significantly from 8.1 per cent in September 2012 to 7.2 per cent by December. Notably, inflation on account of non-food manufactured products, which have a weight of 55...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT