First Quarter Review of Monetary Policy 2009-2010
-Announced on the 28th July 2009
I. Macroeconomic and Monetary Developments
6. The deterioration in the global outlook that started in September 2008 continued in the second quarter of 2009, although some tentative signs of stabilisation have begun to emerge. Reflecting the continued decline, the IMF in its July Update of the World Economic Outlook (WEO) has projected that the global economy will shrink by 1.4 per cent in 2009, a shade more than the contraction of 1.3 per cent projected earlier in April 2009. The global economy is, however, projected to recover and expand by 2.5 per cent in 2010 (Table 1). Projections by other international agencies such as the World Bank also do not hold any promise of recovery in 2009.
7. In the US, real GDP declined at an annual rate of 5.5 per cent in Q1 of 2009, driven mainly by a decline in consumption and exports. The IMF’s July WEO Update has projected real GDP of the US to shrink by 2.6 per cent in 2009, a slight improvement from a contraction of 2.8 per cent projected in the April WEO. The main macroeconomic indicators continued to be adverse in Q2 of 2009 with the unemployment rate increasing to 9.5 per cent in June 2009 accompanied by a dip in wage growth, industrial production, capacity utilisation and consumer sentiment. Retail sales and consumption continued to be weak as households were still engaged in repairing their balance sheets ruptured by the fall in asset prices. The below trend growth is likely to persist for some more time. Consequently, spare capacity and unemployment are expected to rise.
8. The outlook for the euro area is worse than that for the US. Real GDP in the euro area declined by 4.9 per cent in Q1 of 2009 and unemployment rose to 9.5 per cent in May 2009. Although measures of consumer and business sentiment have improved somewhat, signs of recovery have been less evident than in the US. The July WEO Update has projected real GDP of the euro area to shrink by 4.8 per cent in 2009 and by 0.3 per cent in 2010. Real GDP in Japan contracted by 14.2 per cent in the quarter ended March 2009. However, subsequent data suggest that output is stabilising and consumer confidence is improving. According to the July WEO Update of the IMF, the Japanese economy is projected to shrink by 6.0 per cent in 2009 before recovering by 1.7 per cent in 2010.
9. Central banks across countries have continued with an easy monetary policy stance. Among the central banks in advanced countries, the European Central Bank (ECB) reduced its policy rate in two stages from 1.5 per cent in March 2009 to 1.0 per cent by May 2009 and also announced a programme to purchase bonds. The Federal Reserve, the Bank of Japan, the Bank of England and the Swiss National Bank have continued with their unconventional monetary policies, with policy rates in these countries being in the range of 0 – 0.75 per cent. The extraordinarily large, co-ordinated and concerted monetary measures by developed economies have begun to show results. Global credit spreads have tended to decline to levels prevailing prior to the collapse of Lehman Brothers in September 2008. In the US, domestic money market spreads have declined to around the lowest points since the onset of the financial crisis. The stress test results for the 19 largest banks in the US and the banks’ subsequent actions in raising funds had a positive impact on financial markets as evidenced by the decline in the credit default swap (CDS) spreads in the period after the announcement of the stress test results. However, sovereign CDS spreads remain above the pre-crisis level reflecting concerns over rising public debt levels.
10. In recent weeks, there have been some indications of the negative growth rates moderating in several countries. Overall, OECD’s Composite Leading Indicators point to an easing of the pace of deterioration in some major economies, especially Canada, France, Italy and the UK. Positive signals are also emerging in the world’s three largest economies – the US, Japan and Germany. In the US, most of the manufacturing sector surveys showed further improvement in June and July, and the Chicago PMI rose with new orders and production indicating improvement in business sentiment. Inventories at US wholesalers fell in May for the ninth straight month accompanied by an increase in sales. In Japan, there has been a strong recovery in the manufacturing PMI as also a pick-up in export volumes, after a precipitous fall in the late 2008 and early 2009. While some analysts contend that these ‘green shoots’ signal the beginning of a recovery, there is an influential view that the signals are too weak or fragile to indicate any sustainable turnaround before the close of 2009.
Emerging Market Economies
11. In its July WEO Update, the IMF projects the GDP growth of emerging and developing economies to decelerate to 1.5 per cent in 2009 from 6.0 per cent in 2008, before expanding to 4.7 per cent in 2010. The IMF, however, upgraded the growth outlook for developing Asia citing improved prospects in China and India. In 2009 so far (up to June 2009), industrial production has picked up in a wide range of Asian economies. The most notable has been the strong recovery in China’s industrial production following the very large increase in fixed capital investment by the public sector and strong credit growth. China has been able to at least partly neutralise the impact of contraction in exports by expanding domestic demand, especially government investment demand. Industrial output in Korea and Taiwan too has recorded a significant upturn.
12. The Indian economy grew by 6.7 per cent in 2008-09 according to the revised estimates of the Central Statistical Organisation (CSO) – better than most analysts had expected, but lower than the growth of 9.0 per cent in 2007-08. The deceleration in GDP growth was particularly pronounced during the second half of 2008-09, largely due to the adverse impact of the global economic crisis (Table 2).
13. The agriculture sector, which recorded an average annual growth rate of 4.9 per cent during 2003-08, expanded only by 1.6 per cent during 2008-09. In 2008-09, foodgrains production was 233.9 million tonnes, up from 230.8 million tonnes last year. This was also an all-time high. Allied activities – horticulture, floriculture, forestry, livestock and fisheries – which account for a substantial share in agriculture remained buoyant. However, the production of commercial crops such as major oilseeds, cotton, jute and sugarcane was lower. Looking ahead to the current year, the progress of the south-west monsoon has been slow and halting. By July 22, 2009, monsoon rainfall was 19 per cent below normal in the country as a whole. At a disaggregated level, rainfall was deficient/scanty in 19 of the 36 meteorological sub-divisions. While kharif sowing has picked up in July, the delayed monsoon can impact agricultural output. Although the share of agriculture and allied activities in GDP has declined over the years and is currently at 17.5 per cent, good agricultural performance is critical not only because it employs over 55 per cent of the labour force but also for ensuring stability in food prices.
14. Industrial sector growth decelerated significantly to 2.6 per cent in 2008-09 from 8.5 per cent in the previous year due largely to negligible/negative growth during four months in the second half of the year. This pushed down the growth rate of the index of industrial production (IIP) to an abysmally low of 0.4 per cent during the second half of 2008-09 from 5.0 per cent in the first half. During April-May 2009, however, industrial growth turned positive with IIP increasing by 1.9 per cent. While growth in the basic, intermediate and consumer durable goods sectors picked up, the capital goods and consumer non-durable sectors showed negative growth. The core infrastructure sector, with a weight of 26.7 per cent in the IIP, recorded a higher growth of 4.8 per cent during April-June 2009, up from 3.5 per cent in the corresponding period in the previous year. The leading indicators of industrial production, both quantitative and qualitative, suggest that the recent downturn has been arrested and a pick-up is on the way forward, albeit with some lag.
15. The performance of the services sector during April-May 2009 presents a mixed but predictable picture. Trade-related services such as cargo handled at major sea and airports, as also passengers handled at international terminals continue to show deceleration/negative growth. Domestic activity-related services such as communication and construction are showing signs of upturn.
Demand Components of GDP
16. India’s exports have contracted during each of the last eight months (October 2008-May 2009). However, imports in Q4 of 2008-09 contracted faster than exports on account of moderation in oil prices and reduction in non-oil imports. As a result, growth of net exports decelerated sharply. Private final consumption expenditure and gross fixed capital formation, together with a weight of nearly 90 per cent in GDP, decelerated significantly in the second half of 2008-09. However, a sharp increase in government consumption in the second half of the year, resulting from the Sixth Pay Commission payouts and fiscal stimulus measures, cushioned the overall decline in aggregate demand (Table 3).
17. In fact, the contribution of government final consumption expenditure to GDP growth expanded four-fold from 8.0 per cent in 2007-08 to 32.5 per cent in 2008-09, while the share of private final consumption expenditure nearly halved from 53.8 per cent to 27.0 per cent during the same period (Table 4).
18. The performance of the private non-financial corporate sector deteriorated in the second half of 2008-09, reflecting both demand slowdown and moderation in prices (Table 5). Profit margins were eroded by deceleration in sales, increased interest outgo, significant drop in non-sales income and losses on foreign currency related transactions. Early corporate results for Q1 of 2009-10 indicate moderate sales growth over Q4 of 2008-09 with improved profit margins.
19. The Industrial Outlook Survey of the Reserve Bank, conducted during April-May 2009, shows a turnaround in the business sentiment. The assessment for Q1 of 2009-10 suggests that the slide in sentiment in the preceding three quarters has been arrested on key indicators such as production, order book position, capacity utilisation, financial situation and availability of finance.
20. The business expectation index (BEI) for the forward July-September 2009 quarter crossed the neutral 100-mark and moved into the growth terrain on the perception of improvement in demand conditions. The Survey indicates that during Q2 of 2009-10, businesses expect improvement in capacity utilisation as also increase in both input and output prices, returning some pricing power to them. While there is a moderation of investment intentions in 2009-10 vis-ŕ-vis 2008-09, capital investments by big companies are expected in food, rubber, paper and cement groups. The overall findings of the Reserve Bank’s Industrial Outlook Survey are also corroborated by business confidence surveys conducted by other agencies such as Dun and Bradstreet, and FICCI.
>>> GO TO NEXT PAGE
First Quarter Review of Monetary Policy 2009-2010... click here
Highlights of 1st Quarter Review of Monetary Policy 2009-2010... click here
RBI CREDIT AND MONETARY POLICIES (1999-2010)... click here