RBI's Second Quarter Review of Monetary Policy 2012-13 - 30th Oct 2012
I. The State of the Economy
8. Notwithstanding modest improvement in growth performance in parts of the world in Q3 of 2012, the global economy remains sluggish. In the US, growth in Q3 picked up relative to the earlier quarter. In the UK, after three consecutive quarters of contraction, growth turned positive in Q3. The euro area continued to experience contraction in output in Q2, and recessionary headwinds have persisted in Q3. Growth decelerated significantly in Japan. High unemployment relative to trend persisted in all major AEs, although in September the US unemployment rate declined to below 8 per cent for the first time in four years. As regards the other BRICS – Brazil, Russia, China and South Africa – they have also slowed in the first half of 2012, with China decelerating further in Q3. Reinforcing this perspective, the average level of the global composite PMI for Q3 remained nearly unchanged from the three year low in the previous quarter.
9. In September, additional quantitative easing measures were announced by the US Fed, the European Central Bank and the Bank of Japan to which financial markets responded positively as reflected in the prices of risky assets and narrowing of spreads. According to the October 2012 Global Financial Stability Report of the IMF, however, risks to financial stability have increased since April as confidence in the global financial system remains fragile, notwithstanding greater monetary accommodation by central banks.
10. The loss of growth momentum that started in 2011-12 has extended into 2012-13 though the pace of deceleration moderated in Q1. Nevertheless, growth remains below trend and persisting weakness in investment activity has clouded the outlook.
11. After decelerating over four successive quarters from 9.2 per cent y-o-y in Q4 of 2010-11 to 5.3 per cent in Q4 of 2011-12, GDP growth was marginally higher at 5.5 per cent in Q1 of 2012-13. The slight improvement in GDP growth in Q1 of 2012-13 was mainly driven by growth in construction, and supported by better than expected growth in agriculture.
12. On the expenditure side, the growth of gross fixed capital formation decelerated from 14.7 per cent in Q1 of 2011-12 to 0.7 per cent in Q1 of 2012-13. The slowdown in growth of private consumption expenditure witnessed during Q4 of 2011-12 continued through Q1 of 2012-13. External demand conditions and crude oil prices have also remained unfavourable, adversely impacting net exports.
13. After declining for two consecutive months, the index of industrial production (IIP) posted a modest growth of 2.7 per cent in August. The upturn was visible in mining and manufacturing sectors. However, over the period April-August, industrial activity was lacklustre at 0.4 per cent as against 5.6 per cent during the corresponding period last year. Most significantly, reflecting the retrenchment of investment demand, capital goods production declined by 13.8 per cent during April-August.
14. The seasonally adjusted manufacturing PMI in September was unchanged relative to its August level, but was below its level in June. The headline services business activity index, seasonally adjusted, was marginally higher in September than in August.
15. Notwithstanding apprehensions earlier in the season, rainfall deficiency during the south-west monsoon was 8 per cent of the long period average (LPA). However, the uneven temporal and spatial distribution of the monsoon this year is expected to adversely impact the Kharif output. According to the first advance estimates, production of Kharif foodgrains at 117.2 million tonnes (MT) in 2012-13 will be lower by 9.8 per cent than the record output in the previous year.
16. According to the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS), capacity utilisation of the manufacturing sector in Q1 of 2012-13 declined from the preceding quarter and a year ago. For Q2, business confidence, as measured by the business expectations index of the Reserve Bank’s industrial outlook survey (IOS), dipped relative to the previous quarter.
17. Headline WPI inflation remained sticky at above 7.5 per cent on a y-o-y basis through the first half of 2012-13. Furthermore, in September there was a pick-up in the momentum of headline inflation, driven by the increase in fuel prices and elevated price levels of non-food manufactured products. While this is in part attributable to some suppressed inflation in the form of earlier under-pricing being corrected, even after this, the momentum remains firm.
18. Even while y-o-y inflation of WPI primary food articles moderated since July due to the softening of prices of vegetables, prices of cereal and protein-based items such as pulses, eggs, fish and meat edged up. WPI food products inflation increased in September, mainly due to the firming up of the prices of sugar, edible oils and grain mill products.
19. Fuel group inflation registered a significant rise in September, primarily due to the WPI reflecting the sharp increase in prices of electricity effected from June, the partial impact of the increase in prices of diesel in mid-September and significant increase in non-administered fuel prices on account of rising global crude prices.
20. Non-food manufactured products inflation was persistent at 5.6 per cent through July-September and continued to exhibit upside pressures from firm prices of metal products and other inputs and intermediates, especially goods with high import content due to the rupee depreciation. The momentum indicator of non-food manufactured products inflation (seasonally adjusted 3-month moving average annualised inflation rate) also remained high.
21. The new combined (rural and urban) CPI (Base: 2010=100) inflation remained elevated, reflecting the build-up of food price pressures. CPI inflation excluding food and fuel groups ebbed slightly during June-September, from double digits earlier. Inflation based on the CPI for industrial workers recorded an upturn, primarily due to higher food inflation. The y-o-y increase in rural wages, though showing some moderation, has remained high.
22. Reflecting some softening in inflation from the high levels observed in the last two years, urban households’ inflation expectations showed a marginal decline in Q2 of 2012-13, though they remained in double digits.
23. The Reserve Bank’s quarterly house price index suggests that house price inflation remained firm in Q1 of 2012-13. Notwithstanding the increase in house prices, the volume of housing transactions grew y-o-y at a faster pace than in the preceding quarter.
24. An analysis of corporate performance in Q1 of 2012-13, based on a common sample of 2,308 non-government non-financial companies, indicates that y-o-y sales growth decelerated sequentially over the last three quarters, but remained positive after adjusting for inflation. Earnings, however, contracted sharply due to higher increase in expenditure relative to sales, indicating a decline in pricing power. The early results for Q2 of 2012-13 indicate that the drop in sales growth and earnings may be bottoming out.
25. Money supply (M3) moderated y-o-y to 13.3 per cent on October 5, 2012, lower than the indicative projection of 15 per cent set out in the Monetary Policy Statement 2012-13. This essentially reflected the deceleration of growth in aggregate deposits. Non-food credit growth at 15.4 per cent y-o-y was below the indicative projection of 17 per cent, reflecting the growth slowdown. Disaggregated data show that barring agriculture, credit growth decelerated on a y-o-y basis across all the major sectors, particularly infrastructure.
26. The estimated total flow of financial resources from banks, non-banks and external sources to the commercial sector at around `4,700 billion in 2012-13 (up to October 5, 2012) was lower than Rs 5,000 billion during the corresponding period of last year. Apart from the decline in the flow of resources from banks, the flow from external sources declined on account of lower external commercial borrowings (ECBs) and foreign direct investment (FDI) into India.
27. Following the cut in the policy repo rate in April and the cash reserve ratio (CRR) in September, several commercial banks reduced their deposit and lending rates. During H1 of 2012-13, the modal deposit rates of scheduled commercial banks declined by 13 bps across all maturities and the modal base rate of banks also declined by 25 bps.
28. Liquidity conditions, as reflected in the average net borrowing under the LAF at Rs 486 billion during July-September remained within the comfort zone of (+/-) one per cent of NDTL. However, liquidity conditions tightened in October, mainly on account of the build-up in the Centre’s cash balances and the seasonal increase in currency demand, taking the average LAF borrowing to Rs 871 billion during October 15-25, well above the band of (+/-) one per cent of NDTL.
29. During April-August, the Centre’s fiscal deficit was nearly two-thirds of the budget estimate for the year as a whole. In view of evolving patterns of revenues and non-plan expenditure, the revenue deficit (RD) and the gross fiscal deficit (GFD) for 2012-13 are expected to be higher than budgeted.
30. During Q2 of 2012-13, yields on government securities (G-secs) eased and have remained range-bound in October. Equity markets also improved in Q2 of 2012-13 on account of revival in sentiment and the turnaround in foreign institutional investor (FII) inflows.
31. The adverse external environment and, in particular, the slump in world trade took its toll on export performance. Exports declined in September for the fifth month in succession. However, with imports also declining, the trade deficit in H1 of 2012-13 remained broadly at the same level as a year ago. In terms of external financing, net inflows on account of FDI and ECBs were sizably lower than in the first half of the preceding year, but the shortfall was largely offset by a surge in non-resident deposits and a turnaround in FII flows in Q2. Reflecting these developments, the nominal exchange rate of the rupee vis-a-vis the US dollar moved within a relatively narrow range during Q2 compared with its behaviour in Q1. Overall, in H1 of 2012-13, the rupee depreciated in nominal terms by 7.8 per cent. In real terms, it depreciated by 5.4 per cent. The impact of real depreciation on net exports is being offset by global demand conditions.
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