Annual Policy Statement for the Year 2010-11- 20th April 2010
Part A. Monetary Policy
II. Outlook and Projections
20. In its World Economic Outlook Update for January 2010, the International Monetary Fund (IMF) projected that global growth will recover from (-) 0.8 per cent in 2009 to 3.9 per cent in 2010 and further to 4.3 per cent in 2011. Organisation for Economic Co-operation and Development’s (OECD) composite leading indicators (CLIs) in February 2010 continued to signal an improvement in economic activity for the advanced economies. Three major factors that have contributed to the improved global outlook are the massive monetary and fiscal support, improvement in confidence and a strong recovery in EMEs.
21. US GDP rose by 5.6 per cent on an annualised basis during Q4 of 2009. However, household spending remains constrained by high unemployment at 9.7 per cent. Though business fixed investment is turning around and housing starts are picking up, investment in commercial real estate is declining. Growth in the euro area, on a quarter-on-quarter basis, was 0.1 per cent in Q4 of 2009. It may remain moderate in 2010 because of the ongoing process of balance sheet adjustment in various sectors, dampened investment, low capacity utilisation and low consumption. Though exports are improving and the decline in business fixed investment is moderating, several euro-zone governments are faced with high and unsustainable fiscal imbalances which could have implications for medium and long-term interest rates. In Japan, improved prospects on account of exports have been offset by the levelling off of public investment and rise in unemployment.
22. Amongst EMEs, China continues to grow at a rapid pace, led mainly by domestic demand. Malaysia and Thailand have recovered to register positive growth in the second half of 2009. Indonesia recorded positive growth throughout 2009.
23. Globally, headline inflation rates rose between November 2009 and January 2010, softened in February 2010 on account of moderation of food, metal and crude prices and again rose marginally in some major economies in March 2010. Core inflation continued to decline in the US on account of substantial resource slack. Inflation expectations in advanced countries also remain stable. Though inflation has started rising in several EMEs, India is a significant outlier with inflation rates much higher than in other EMEs.
24. The Indian economy is firmly on the recovery path. Exports have been expanding since October 2009, a trend that is expected to continue. The industrial sector recovery is increasingly becoming broad-based and is expected to take firmer hold going forward on the back of rising domestic and external demand.
25. Surveys generally support the perception of a consolidating recovery. According to the Reserve Bank’s quarterly industrial outlook survey, although the business expectation index (BEI) showed seasonal moderation from 120.6 in Q4 of 2009-10 to 119.8 in Q1 of 2010-11, it was much higher in comparison with the level of 96.4 a year ago. The improved performance of the industrial sector is also reflected in the improved profitability in the corporate sector. Service sector activities have shown buoyancy, especially during the latter half of 2009-10. The leading indicators of various sectors such as tourist arrivals, commercial vehicles production and traffic at major ports show significant improvement. A sustained increase in bank credit and in the financial resources raised by the commercial sector from non-bank sources also suggest that the recovery is gaining momentum.
26. On balance, under the assumption of a normal monsoon and sustenance of good performance of the industrial and services sectors on the back of rising domestic and external demand, for policy purposes the baseline projection of real GDP growth for 2010-11 is placed at 8.0 per cent with an upside bias.
27. Headline WPI inflation, which moderated in the first half of 2009-10, firmed up in the second half of the year. It accelerated from 1.5 per cent in October 2009 to 9.9 per cent by March 2010. The deficient south-west monsoon rainfall accentuated the pressure on food prices. This, combined with the firming up of global commodity prices from their low levels in early 2009 and incipient demand side pressures, led to acceleration in the overall inflation rate – both of the WPI and the CPIs.
28. The Reserve Bank’s baseline projection of WPI inflation for March 2010 was 8.5 per cent. However, some subsequent developments on both supply and demand sides pushed up inflation. Enhancement of excise duty and restoration of the basic customs duty on crude petroleum and petroleum products and the increase in prices of iron ore and coal had a significant impact on WPI inflation. In addition, demand side pressures also re-emerged as reflected in the sharp increase in non-food manufactured products inflation from 0.7 per cent to 4.7 per cent between December 2009 and March 2010.
29. There have been significant changes in the drivers of inflation in recent months. First, while there are some signs of seasonal moderation in food prices, overall food inflation continues at an elevated level. It is likely that structural shortage of certain agricultural commodities such as pulses, edible oils and milk could reduce the pace of food price moderation. Second, the firming up of global commodity prices poses upside risks to inflation. Third, the Reserve Bank’s industrial outlook survey shows that corporates are increasingly regaining their pricing power in many sectors. As the recovery gains further momentum, the demand pressures are expected to accentuate. Fourth, the Reserve Bank’s quarterly inflation expectations survey for households indicates that household inflation expectations have remained at an elevated level.
30. Going forward, three major uncertainties cloud the outlook for inflation. First, the prospects of the monsoon in 2010-11 are not yet clear. Second, crude prices continue to be volatile. Third, there is evidence of demand side pressures building up. On balance, keeping in view domestic demand-supply balance and the global trend in commodity prices, the baseline projection for WPI inflation for March 2011 is placed at 5.5 per cent (Chart 2).
31. It would be the endeavour of the Reserve Bank to ensure price stability and anchor inflation expectations. In pursuit of these objectives, the Reserve Bank will continue to monitor an array of measures of inflation, both overall and disaggregated components, in the context of the evolving macroeconomic situation to assess the underlying inflationary pressures.
32. Notwithstanding the current inflation scenario, it is important to recognise that in the last decade, the average inflation rate, measured both in terms of WPI and CPI, had moderated to about 5 per cent from the historical trend rate of about 7.5 per cent. Against this background, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5 per cent. This will be in line with the medium-term objective of 3.0 per cent inflation consistent with India’s broader integration into the global economy.
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