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Mid-Quarter Monetary Policy Review by RBI on 19th March 2013
Based on an assessment of the current macroeconomic situation, it has been decided to: reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per cent to 7.5 per cent with immediate effect; Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 8.5 per cent with immediate effect.
Introduction Since the Reserve Banks Third Quarter Review (TQR) of January 2013, global financial market conditions have improved, but global economic activity has weakened. On the domestic front too, growth has decelerated significantly, even as inflation remains at a level which is not conducive for sustained economic growth. Although there has been notable softening of non-food manufactured products inflation, food inflation remains high, driving a wedge between wholesale price and consumer price inflation, and is exacerbating the challenge for monetary management in anchoring inflationary expectations. Global Economy Global economic developments over the last few months present a mixed picture. US GDP estimates for Q4 of 2012 indicate a tentative upturn on the back of improvement in housing and payroll employment. However, US macroeconomic prospects are clouded by the uncertainty surrounding the temporary appropriations and the debt ceiling. In the euro area, plagued by contingent risks of political uncertainty and adjustment fatigue, GDP shrank for the third successive quarter in Q4. Output in Japan too contracted in Q4, and it is as yet unclear how effective the emerging package of stimulus measures will be and how quickly they will turn around the economy. While some emerging and developing economies (EDEs), including China, are gradually returning to faster growth, activity is slowing in others, hobbled by weak external demand and slack domestic investment. International non-fuel commodity prices have softened in Q4, but fuel prices have remained firm, despite the growth slowdown, portending persisting inflationary pressures, particularly for net energy importers.
Domestic Economy Growth Indias GDP growth in Q3 of 2012-13, at 4.5 per cent, was the weakest in the last 15 quarters. What is worrisome is that the services sector growth, hitherto the mainstay of overall growth, has also decelerated to its slowest pace in a decade. While overall industrial production growth turned positive in January, capital goods production and mining activity continued to contract. The composite EssaysforIIM.com 2009-13 Page 1
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purchasing managers index (PMI) declined in February, largely reflecting slower expansion in services. In the agriculture sector, the second advance estimates of kharif production indicate a decline in relation to the level last year. However, that may be offset, at least partly, by the rabi output for which sowing has been satisfactory. Inflation The year-on-year headline WPI inflation edged up to 6.8 per cent in February 2013 from 6.6 per cent in January, essentially reflecting the upward revisions effected to administered prices of petroleum products. On the other hand, non-food manufactured products inflation, and its momentum, continued to ebb along the trajectory that began in September 2012, enabled by softening prices of metals, textiles and rubber products. Worryingly, retail inflation continued on the upward path that set in from October 2012, with the new combined (rural and urban) CPI (Base: 2010=100) inflation at a high of 10.9 per cent in February 2013 on sustained price pressures from food items, especially cereals and proteins. Consequently, the divergence between wholesale and consumer price inflation continued to widen during the year.
Fiscal Situation The Union Budget for 2013-14 has made a firm commitment to fiscal consolidation. According to the revised budget estimates for 2012-13, the gross fiscal deficit (GFD)-GDP ratio, at 5.2 per cent, was contained around its budgeted level, mainly by scaling down plan and capital expenditures. The GFDGDP ratio is programmed to decline to 4.8 per cent in 2013-14 and further down to 3.0 per cent by 2016-17, in line with the revised road map for fiscal consolidation. External Sector With merchandise exports recording positive growth for the second successive month in February and non-oil imports contracting, the trade deficit narrowed significantly. For April-February 2012-13, however, the trade deficit was higher than its level a year ago with adverse implications for the current account deficit (CAD), already at a record high. Although capital inflows, mainly in the form of portfolio investment and debt flows, provided adequate financing, the growing vulnerability of the external sector to abrupt shifts in sentiment remains a key concern. Outlook There are several risks to the global outlook. The impact of sequestration in the US on the global economy is likely to be muted in view of legislation initiated to avert the debt ceiling. Nevertheless, lead indicators point to sluggish global growth. Political economy risks that block or delay credible and determined policy actions in advanced economies (AEs) are inhibiting recovery. For EDEs, risks of spillovers from AEs remain significant. While global inflationary pressures are likely to be subdued, given still large output gaps, several EDEs could potentially face the threat of elevated energy prices. EssaysforIIM.com 2009-13 Page 2
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On the domestic front, the key macroeconomic priorities are to raise the growth rate, restrain inflation pressures and mitigate the vulnerability of the external sector. The foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance.
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