First Quarter Review of the Monetary Policy for 2011-12
-Announced on the 26th July 2011
The State of the Economy
Domestic Economy (contd)
18. Non-food manufactured products inflation was 7.0 per cent in April 2011. According to provisional data, it rose to 7.3 per cent in May and remained high at 7.2 per cent in June. This should be seen in comparison with the average non-food manufactured product inflation of 4 per cent over the last six years. The persistence of high non-food manufactured products inflation suggests that producers, operating at high levels of capacity utilisation, are able to pass on rising commodity input prices and wage costs to consumers. Early corporate results for Q1 of 2011-12 suggest some moderation in margins. However, such moderation so far has been modest, implying that pricing power persists.
19. Fuel group inflation increased in June 2011 due, in part, to the impact of the administered price increases on June 25, 2011, even though non-administered fuel prices, especially that of aviation turbine fuel, declined.
20. Inflation in respect of protein rich items such as egg, fish, meat and milk remains elevated. According to the 66th Round of Consumer Expenditure Survey of the National Sample Survey Office (NSSO), the share of food items in total consumer expenditure declined between 2004-05 and 2009-10. However, during the same period, the share of protein-rich items in total consumer expenditure increased both in rural and urban areas.
21. Inflation, as measured by the consumer price indices (CPI), has been declining but remains high. Reflecting the moderation in food inflation, CPI inflation for industrial workers (CPI - IW) dropped from 9.4 per cent in April to 8.7 per cent in May 2011. With the latest reading of 108.8 in June 2011 (base: 2010=100), the new all-India CPI too suggests persistence of price pressures.
22. In response to the monetary policy measures initiated by the Reserve Bank, scheduled commercial banks (SCBs) have been raising their domestic deposit rates. During 2010-11, the modal term deposit rate of all SCBs rose by 165 basis points (bps). It rose further by about 60 bps during April-July, 2011.
23. As SCBs raised their deposit rates, they saw response by way of an acceleration in growth of deposits from 17.4 per cent, y-o-y, in early April 2011 to 18.4 per cent in early July 2011. Simultaneously, currency growth decelerated from 18.4 per cent to 15.0 per cent in the corresponding period. On the back of good deposit growth, y-o-y broad money supply (M3) increased by 17.1 per cent in early July 2011 outpacing the Reserve Bank’s indicative trajectory of 16 per cent. Though a decline in the currency-deposit ratio is desirable for efficient financial intermediation, paradoxically, its immediate impact in terms of a higher money multiplier may be in the form of increased inflationary pressure.
24. Year-on-year non-food credit growth decelerated from 21.3 per cent in March 2011 to 19.5 per cent as on July 1, 2011, but it was still above the May 3 Statement indicative projection of 19 per cent. Non-food credit growth was broad-based with credit to industry, services and personal categories registering higher growth. Disaggregated data suggest that credit to the industrial sector continued to be led by infrastructure.
25. The Reserve Bank’s estimates show that the total flow of financial resources from banks, domestic non-bank and external sources to the commercial sector during Q1 of 2011-12 was lower at ` 2,40,000 crore as compared with ` 2,63,000 crore during the corresponding period of last year.
26. The Base Rate system, introduced since July 1, 2010, has improved the transparency in lending rates and also enabled a more informed assessment of the transmission of monetary policy impulses to banks’ lending rates. Since July 2010, the modal Base Rate of banks has increased by 225 basis points. The Base Rate system of loan pricing coupled with deficit liquidity conditions has increased both the strength and the transparency of the monetary transmission process.
27. Consistent with the policy stance, liquidity conditions have generally remained in deficit mode so far in 2011-12. The average daily net injection of liquidity through the liquidity adjustment facility (LAF) window during this period till July 22 was around ` 48,000 crore, which was within one per cent of NDTL.
28. The 10-year government security yield increased from 8.1 per cent at end-April 2011 to 8.3 per cent in July 2011. However, short-term yields rose faster in response to policy rate hikes and increased issuance of short-term paper, resulting in flattening of the yield curve. One interpretation of the relatively stable long-term yields is that inflationary expectations over the longer-term horizon remain anchored.
29. The real estate market remained firm. The Reserve Bank’s quarterly house price index suggests that housing prices rose in most cities in Q4 of 2010-11. The volume of house transactions also picked up in Q4 of 2010-11 in most of the seven cities for which the index is compiled.
30. During April-May 2011, the Central Government’s revenue deficit and fiscal deficit turned out to be higher than the levels during the corresponding period of the previous year reflecting lower revenue receipts and higher expenditure. Up to July 18, 2011, the Central Government completed 34 per cent of its budgeted net market borrowing programme, as compared with 37 per cent in the corresponding period of last year.
31. The exchange rate moved in both directions in the range of `Rs 44.05–45.38 per US$ during Q1 of 2011-12. On an average basis, while the 6-currency real effective exchange rate (REER) appreciated by 1.5 per cent, both the 30-currency REER and the 36-currency REER depreciated marginally by around 0.6 per cent.
32. As regards the external sector, the current account deficit (CAD) moderated to 2.6 per cent of GDP in 2010-11 from 2.8 per cent of GDP in the previous year. Apart from sustained invisible receipts, this was due to robust export growth in the second half of 2010-11. In Q1 of 2011-12, export growth remained strong, expanding by 46 per cent over the corresponding quarter of the previous year; imports grew by 31 per cent during the quarter.
33. In Q1 of 2011-12, major components of capital inflows showed an increase. In particular, FDI inflows were US$ 7.8 billion in April-May 2011 compared with US$ 4.4 billion in the corresponding period of last year. ECB approvals were higher at US$ 8.1 billion in April-June 2011 compared with US$ 5.3 billion in the corresponding period of last year. Foreign exchange reserves were at US$ 314.5 billion as on July 15, 2011, up from US$ 304.8 billion at end-March 2011, largely reflecting normal accruals and valuation effects.
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