Second Quarter Review of the Monetary Policy for 2011-12
-Announced on the 25th October 2011
Part A. Monetary Policy
II. Outlook and Projections
33. Global growth prospects have significantly weakened over the past few months, primarily reflecting increased concerns over sovereign debt sustainability in some euro area countries. This has added to the existing vulnerabilities in the major advanced economies arising out of elevated oil and other commodity prices, high unemployment rates, depressed consumer confidence and weak housing markets. In contrast, growth has remained relatively resilient in EMEs, notwithstanding some moderation in response to monetary tightening. However, a prolonged slowdown in advanced economies would also weaken the growth prospects of EMEs. In its September 2011 World Economic Outlook (WEO), the IMF scaled down its projection for world GDP growth to 4.0 per cent for both 2011 and 2012 from its earlier (June) projections of 4.3 per cent and 4.5 per cent, respectively.
34. Despite significant weakening of economic activity, global commodity prices have corrected only marginally. Supply limitations remain a key upside risk to commodity prices. According to the IMF (WEO, September 2011), consumer price inflation is likely to increase from 1.6 per cent in 2010 to 2.6 per cent in 2011 in advanced economies, and from 6.1 per cent to 7.5 per cent in emerging and developing economies.
35. In its May and July Quarterly Review Statements, the Reserve Bank projected GDP growth of 8.0 per cent for 2011-12. The mid-quarter review of September, however, pointed out that the risk to the growth projection was on the downside mainly on account of slowing down of the global economy and moderating domestic demand. Slower global growth will have an adverse impact on domestic growth, particularly on industrial production, given the rising inter-linkages of the Indian economy with the global economy. The growth in the service sector is holding up well, although some moderation is possible here too on account of inter-sectoral linkages. Based on the normal south-west monsoon and first advance estimates that suggest a record kharif production, agricultural prospects look good. This should provide a boost to rural demand. However, investment demand has slackened reflecting slower clearance and execution of projects, concerns about inflation and rising interest rates. On these considerations, the baseline projection of GDP growth for 2011-12is revised downwards to 7.6 per cent
36. Going forward, the inflation path will be shaped by both demand and supply factors. First, it will depend on the extent of moderation in aggregate demand. Some signs of demand moderation are evident, although the impact is being felt more on the investment side.
37. Second, the behaviour of crude prices will be a crucial factor in shaping the outlook of domestic inflation in the near future. Despite the sluggish growth prospects of the global economy, crude prices have moderated only marginally. Also, the benefit of decline in global crude prices in the recent period so far has been more than offset by the depreciation of the rupee in nominal terms. Thus, the exchange rate will also have some impact on the behaviour of domestic petroleum prices.
38. Third, the inflation outlook will also depend on the supply response in respect of those commodities where there are structural imbalances, particularly protein items. Therefore, concerted policy focus to generate adequate supply response in respect of items such as milk, eggs, fish, meat, pulses, oilseeds, fruits and vegetables will play a major role in shaping the behaviour of food inflation in the near term.
39. Fourth, there is still an element of suppressed inflation as domestic prices of administered petroleum products do not reflect the full pass-through of global commodity prices. As the decline in crude prices has been offset by the depreciation of the rupee, under-recoveries continue to occur in respect of administered petroleum products. In addition, there are already large accumulated under-recoveries. Therefore, an increase in administered petroleum prices cannot be ruled out even in a scenario of stable or declining global crude prices. In addition, there are other items such as coal whose current prices do not reflect the underlying market conditions. Since coal is an input for electricity, coal prices, as and when raised, will also have implications for electricity tariffs.
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