First Quarter Review of the Monetary Policy for 2011-12
-Announced on the 26th July 2011
I The State of the Economy
8. The pace of global expansion moderated in Q2 of 2011. Several factors contributed to this - high oil and other commodity prices, supply chain disruptions from Japan, sovereign debt concerns in the euro area, and continued weakness in the US housing and labour markets.
9. Concerns over the euro area sovereign debt problem re-emerged on the back of Greece’s deteriorating fiscal position, downgrading of Portugal’s sovereign debt rating, and most significantly, signs of stress in Italy's sovereign debt. There is heightened anxiety about whether the euro area will be able to agree on an economically viable, fiscally sustainable and politically feasible solution to the vexing sovereign debt problem. In this regard, the agreement reached by the euro zone leaders in their meeting on July 21, 2011 is a positive development. However, its effective implementation remains to be seen.
10. Medium-term sovereign debt sustainability issues are also under debate in the US, although the near-term focus is on the constraints posed by the existing debt ceiling. The unemployment rate edged up in the US and showed no improvement in other major advanced economies. The US national home price index declined further in Q1 of 2011.
11. International prices of oil and other commodities softened in the weeks after the May 3 Policy Statement on the back of a slowdown in economic activity, but they remain at elevated levels. Crude prices, which moderated in June 2011 on account of the decision of the International Energy Agency (IEA) members to release 60 million barrels of crude from their strategic reserves to offset supply disruptions, have edged up again. Brent crude price has ruled above US$ 110 a barrel in July 2011 so far. On a year-on-year (y-o-y) basis, the World Bank’s index of energy prices was up by 39 per cent in June 2011. Also, the Food and Agriculture Organisation’s (FAO) food price index in June 2011 was 39 per cent higher than in June 2010.
12. Despite sluggish economic activity, inflationary pressures also emerged in advanced economies under the impact of high commodity prices. Core inflation has picked up in the US and the euro area. In view of headline inflation remaining above its target, the European Central Bank (ECB) raised its policy rate in July 2011, its second rate hike since it began to exit from its expansionary monetary stance in April 2011.
13. Reflecting high commodity prices as well as strong demand, headline as well as core inflation in EMEs remained elevated in the first half of 2011. Inflation in China reached a 3-year high of 6.4 per cent in June 2011. Many EMEs persisted with monetary tightening in Q2 of 2011.
14. GDP grew by 8.5 per cent during 2010-11. This estimate could undergo some upward revision since the new IIP series (base: 2004-05) shows that industrial growth did not moderate in the second half of 2010-11 as earlier thought. Latest available data for 2011-12, however, suggest some moderation in economic activity. The increase in the IIP by 5.7 per cent in April-May 2011 was lower as compared with the increase of 10.8 per cent in the corresponding period of last year. Merchandise trade, however, registered strong growth with exports expanding by 46 per cent during Q1 of 2011-12.
15. According to the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS), capacity utilisation in Q4 of 2010-11 increased significantly to 77.4 per cent. However, the forward-looking industrial outlook survey (IOS), conducted during June 2011, showed a decline in the overall business sentiment in Q1 of 2011-12 and further slippage for the following quarter. The HSBC purchasing managers’ index (PMI) for June 2011 showed moderation in the growth of manufacturing activity, although the PMI for services moved up marginally.
16. The south-west monsoon has been one per cent below normal so far (July 20, 2011). However, the Reserve Bank’s production weighted rainfall index at 104 shows an above normal trend so far. Area-wise, 88 per cent of the country received excess/normal rainfall. Significantly, kharif sowing this season (up to July 22, 2011) in respect of pulses, coarse cereals, oilseeds and cotton has been lower compared with the same period of last year.
17. Inflation continues to be the dominant macroeconomic concern. The headline WPI inflation rate was 9.7 per cent in April 2011. The provisional inflation figure was 9.1 per cent in May 2011 and 9.4 per cent in June. Given the recent pattern, these numbers are likely to be revised upwards. Thus, the headline WPI inflation rate for Q1 of 2011-12 remained stubbornly close to double digits and inflationary pressures continued to remain broad-based. Both the level and the persistence of WPI inflation are a cause for concern.
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