Second Quarter Review of Monetary Policy 2010-11
-Announced on the 2nd November 2010
I. The State of the Economy
9. India’s growth of 8.8 per cent in Q1 of 2010-11 suggests that the recovery set in the second half of 2009-10 is consolidating. The normal South-West monsoon and its delayed withdrawal have boosted the prospects of both kharif and rabi agricultural production.
10. Industrial growth has been robust, although apparently with a significant increase in volatility. The year-on-year increase in the index of industrial production (IIP) varied in a range of 5.6 to 15.2 per cent during April–August 2010, with an average of 10.6 per cent. Industrial growth was high in the capital goods, consumer durables and intermediate goods sectors. While the volatility raises concerns about a deceleration, other indicators of economic activity suggest continuing momentum. Exports have grown steadily during the first half of 2010-11, showing an increase of 27.6 per cent over the corresponding period of last year. Based on an analysis of a sample of 2,546 non-financial companies, private corporate sector sales rose by 24 per cent year-on-year in Q1 of 2010-11. Early results of corporate performance indicate sustained sales growth and improved profitability in Q2 of 2010-11. Direct tax collections, as reflected in advance taxes paid in September 2010, rose by 16.5 per cent over last year. Similarly, indirect tax collections during the April-September period were 43.1 per cent higher than in the corresponding period of 2009.
11. The buoyancy in various service sectors witnessed in the second half of 2009-10, has continued this year as well. The latest quarterly industrial outlook survey conducted by the Reserve Bank indicates improvement in the overall business conditions. Other business conditions surveys also indicate a similar trend. While the Reserve Bank’s survey on capacity utilisation indicates that there is a small decline in utilisation at the aggregate level, several sectors appear to be facing capacity constraints, resulting in increased imports.
12. On the inflation front, the new series of wholesale price index (WPI) released on September 14, 2010 is a better representative of commodity price levels with an updated base (2004-05=100) and wider coverage of commodities. While inflation at the aggregate level does not show much variation over the medium-term between the old and new series, there are significant differences in inflation at the disaggregated level. As per the new WPI series, the year-on-year inflation moderated to 8.5 per cent in August 2010 and 8.6 per cent in September 2010 after remaining in double digits during March-July 2010. At a disaggregated level, inflation in primary articles, especially food articles, in the new series has been significantly higher than in the old series, whereas for manufactured products, it has been somewhat lower.
13. During 2010-11, although the year-on-year primary food inflation moderated from 21.4 per cent in May 2010 to 15.7 per cent in September 2010, the moderation was not commensurate with patterns following a normal monsoon on previous occasions. This is partly a reflection of the growing importance of protein-rich items in the consumption basket for which price increases have been large. The year-on-year inflation rate in protein-based food items such as pulses, milk, eggs, fish and meat (with a combined weight of 6.4 per cent in WPI basket), peaked at 34 per cent in May 2010 and remained very high at 23.9 per cent in September 2010. Inflation in the other primary food articles (weight: 8.0 per cent) moderated from 14.0 per cent in June 2010 to 9.4 per cent in September 2010, more visibly reflecting the impact of normal monsoon on prices of major cereals, fruits and vegetables. In sum, despite some moderation, overall food price inflation remains at an elevated level. The year-on-year inflation as of September 2010 was also high for certain primary non-food articles such as raw rubber (57.4 per cent), sugarcane (53.3 per cent) and cotton (27.5 per cent). The rise in cotton prices reflected global trends.
14. Focusing on the manufacturing sector, the year-on-year WPI non-food manufactured products (weight: 55.0 per cent) inflation increased from (-) 2.0 per cent in September 2009 to a peak of 5.9 per cent in April 2010, before moderating to 5.0 per cent in September 2010. Non-food items inflation (WPI excluding food products and food articles), which was (-) 2.9 per cent in September 2009, rose sharply to 9.2 per cent in April 2010 before moderating to 7.8 per cent by September 2010. Non-food items (weight: 75.7 per cent) contributed 65.5 per cent to WPI inflation in September 2010, up from 40.5 per cent in January 2010.
15. Inflation based on CPI for industrial workers has moderated to single digit since August 2010 after remaining in double digits for 13 months. However, the various CPI baskets still reflect the consumption pattern of the mid-1980s and 2001 which have a relatively higher weight for cereals, whereas more updated (2004-05) WPI basket suggests that food consumption has shifted towards protein-rich items where price increase has been high. To that extent, CPI baskets understate the underlying food inflation.
16. Money supply (M3) growth moderated from 16.8 per cent on a year-on-year basis at end-March 2010 to 14.5 per cent at end-May 2010 before increasing to 15.2 per cent by October 8, 2010. At this level, it was below the indicative projection of 17.0 per cent for 2010-11. The lower M3 growth essentially reflected the moderation in growth in bank deposits, particularly long-term deposits. Furthermore, currency growth has been higher than deposits growth which reduced the money multiplier, thereby lowering M3 growth. A contributory factor to this trend has been negative real interest rates on deposits, which have induced depositors to both hold currency and invest in non-financial assets, including gold and real estate, whose prices have shown significant increases over the course of the current year.
17. Non-food credit growth accelerated from 17.1 per cent on a year-on-year basis at end-March 2010 to 22.3 per cent by July 2, 2010, reflecting in part the higher credit demand emanating from telecom spectrum auctions. Although it moderated to 20.1 per cent as of October 8, 2010, it was in line with the indicative trajectory of 20 per cent for 2010-11 set out in the Monetary Policy Statement of April 2010. Even after adjusting for spectrum auction related advances, growth in bank credit during the current financial year so far has been in line with the long-term trend. Disaggregated data suggest that year-on-year credit growth to large industries, including infrastructure (especially power and telecom), and housing sectors improved significantly. The increase in bank credit to the commercial sector was also supplemented by the higher flow of funds from other sources. Rough estimates showed that the total flow of financial resources from banks, non-banks and external sources to the commercial sector during the first half of 2010-11 was higher at `4,85,000 crore, up from `3,29,000 crore during the same period of previous year.
18. On the lending side, the Base Rate system replaced the Benchmark Prime Lending Rate (BPLR) system with effect from July 1, 2010. Base Rates of scheduled commercial banks (SCBs) were fixed in the range of 5.50-9.00 per cent. Subsequently, several banks reviewed and increased their Base Rates in the range of 10–50 basis points by October 2010. Base Rates of major banks, accounting for over 94 per cent in total bank credit, are in the range of 7.50-8.50 per cent. Banks have also raised their BPLRs in the range of 25-75 basis points for their old loans.
19. Liquidity conditions, which remained tight between end-May 2010 and July 2010 due to huge outflow of liquidity from the system, eased in August 2010. After alternating between surplus and deficit for a brief period, the Liquidity Adjustment Facility (LAF) window of the Reserve Bank has remained in an injection mode since September 9, 2010 with an average daily net injection of around `24,000 crore in September and `61,700 crore in October 2010 and a peak injection of `1,28,685 crore on October 30, 2010. While the injection mode in the LAF window has been consistent with the stated policy stance, the sharp changes have largely been due to significant increases in government cash balances, which stood at `77,736 crore as on October 30, 2010.
20. With a view to alleviating frictional liqudity pressure, the Reserve Bank on October 29, 2010 decided to conduct second LAF (SLAF) and also allowed scheduled commercial banks to avail of additional liquidity support under the LAF to the extent of up to 1.0 per cent of their NDTL as on October 8, 2010. In view of the likely persistence of the frictional liqudity pressure and in order to provide liquidity comfort, these measures have been extended up to November 4, 2010.
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