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First Quarter Review of Monetary Policy click here

First Quarter Review of the Monetary Policy for 2010-11
-Announced on the 27th July 2010

II. Outlook and Projections

Monetary Aggregates

41. While the current year-on-year money supply (M3) growth at 15.3 per cent is below the indicative projection of 17.0 per cent, non-food credit growth at 22.3 per cent was marginally higher than the indicative projection of 20.0 per cent. It is expected that even with the higher growth projection, monetary aggregates will evolve along the projected trajectory indicated in the April policy statement. Accordingly, the M3 and non-food credit growth projections for 2010-11 have been retained at 17 per cent and 20 per cent respectively. As always, these numbers are indicative projections and not targets.

Risk Factors

42. The above macroeconomic and monetary projections are subject to a number of upside and downside risks.

43. The main risk emanates from the global scenario and has two key dimensions. First, if the global recovery falters, the risk of which has increased since the April 2010 policy announcement, the performance of EMEs is likely to be adversely affected. While India’s trade linkages with the advanced economies are appreciably smaller than those of other major EMEs, a widespread slowdown in global trade will have an impact on important manufacturing and service sectors.

44. The more significant risk, though, is from a potential slowdown in capital inflows. India’s rapid recovery has resulted in a widening of the current account deficit, as imports have grown faster than exports. Even if exports slow down, the strength of domestic growth drivers will keep imports buoyant, suggesting a widening of the trade deficit. However, in the face of a global slowdown, increasing risk aversion amongst global investors may significantly reduce the flow of capital into EMEs, including India. Apart from narrowing the comfortable buffer between the current account deficit and net capital inflows, this may constrain domestic investment, which is critical to achieving and sustaining high growth rates.

45. Admittedly, the risk of capital flows runs both ways. Given the present state of global economy, central banks in advanced economies are likely to maintain accommodative monetary policies for an extended period. With the strong growth potential of EMEs, including India, this is likely to trigger large capital inflows. Large capital inflows above the absorptive capacity of the economy will pose a challenge for monetary and exchange rate management. This also has implications for asset prices. In this scenario, a widening current account deficit will help absorb a larger proportion of the inflows.

46. On the inflation front, the prospects of softening of domestic inflation around mid-year 2010-11 are contingent on moderating food prices. Rainfall has been generally adequate so far, indicating good prospects for the agricultural sector. But, with two months yet to go for the season, the risk of inadequate rainfall adversely affecting specific regions and crops remains.

47. However, with respect to controlling inflation, the global scenario may generate some favourable impulses. Slower global growth will help lower energy and commodity prices. Unutilised global capacity in many sectors will also ease pressure on prices.

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