First Quarter Review of Annual Monetary Policy for the Year 2007-08
II. Stance of Monetary Policy for the Remaining Period of 2007-08
88. In April 2007, at the time of the Annual Policy Statement for 2007-08, global growth was expected to moderate and inflationary pressures were seen as persisting worldwide. With demand pressures having intensified in the domestic economy along with supply-side constraints, the Annual Policy Statement reiterated the stance set out in January 2007 of reinforcing the emphasis on price stability and well-anchored inflation expectations so as to enable continuation of the growth momentum. Credit quality and orderly financial markets were re-emphasised in conjunction with greater credit penetration and financial inclusion. The Annual Policy Statement also reaffirmed the resolve to respond swiftly with all possible measures to developments impinging on inflation expectations and the growth momentum. It was recognised that the likely evolution of macroeconomic and financial conditions indicates an environment supportive of sustaining the current growth momentum and that the Indian economy is possibly poised on the threshold of a step-up in the growth trajectory, but that there is evidence of some cyclical elements embedded in the structural change. Noting that the overarching policy challenge is to manage the transition to a higher growth path while containing inflationary pressures, the policy preference for the period ahead was indicated as strongly in favour of price stability and well-anchored inflation expectations with the endeavour being to contain inflation close to 5.0 per cent in 2007-08 and to the range of 4.0–4.5 per cent over the medium-term.
89. On a review, the prospects for growth in 2007-08 appear positive at the current juncture. The IMD has maintained its initial forecasts of rainfall at 93 per cent of the LPA for the country as a whole in the 2007 south-west monsoon season. Accordingly, by current indications, a return to trend growth in agriculture should be realisable. Growth in industrial and service sector activity, which constitute more than 80 per cent of the economy and contribute over 94 per cent of headline growth, is expected to be sustained, given the current momentum of expansion despite evolving uncertainties observed in recent weeks. Overall, for policy purposes, the projection of real GDP growth in 2007-08 at around 8.5 per cent, as set out in the Annual Policy Statement of April 2007, is retained, barring domestic or external shocks.
90. There are indications that the combination of lagged and cumulative effects of monetary policy actions and fiscal and administrative measures for supply management has had a salutary effect on inflation expectations, and headline inflation has turned benign in sharp contrast to the last quarter of 2006-07. Going forward, monetary management would need to be watchful of movements in commodity prices, particularly oil prices, the elevated levels of asset prices and the re-emergence of pricing power among producers as potential threats to inflation expectations. Assuming that aggregate supply management will continue to receive public policy attention and that a more active management of the capital account will be demonstrated, the outlook for inflation in 2007-08 remains unchanged. Accordingly, holding headline inflation within 5.0 per cent in 2007-08 assumes priority in the policy hierarchy; while reinforcing the medium-term objective to condition policy and perceptions to reduce inflation to 4.0-4.5 per cent on a sustained basis.
91. For the purpose of monetary policy formulation, the Annual Policy Statement of April 2007 projected the rate of money supply (M3) at around 17.0-17.5 per cent for 2007-08 in consonance with the outlook on growth and inflation. Consistent with the projections of money supply, the growth in aggregate deposits in 2007-08 was placed at around Rs.4,90,000 crore while non-food credit including investments in bonds/debentures/shares of public sector undertakings and private corporate sector and commercial paper (CP) was projected to decelerate to 24.0-25.0 per cent in 2007-08 from the average of 29.8 per cent over 2004-07. While non-food credit growth has decelerated, the acceleration in money supply and reserve money warrants an appropriate response.
92. Recent developments in the external sector indicate that the overall trade and current account deficits in 2007-08 are evolving as per expectations. However, net capital flows have been very strong so far in the current financial year. Early fiscal indicators suggest that the Centre’s fiscal deficit is evolving as budgeted and is on course to meet the targets set in the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
93. By current reckoning, the global outlook is positive with continuing prospects for strong and stable growth but there are concerns about inflationary pressures worldwide. Monetary authorities are inclined to regard the current levels of real interest rates as warranting further withdrawal of monetary accommodation and are indicating a preparedness to respond to the manner in which the inflation scenario evolves. Financial markets have been aggressively re-pricing risks; however, the wide diffusion of risks and the abundance of liquidity has imparted considerable uncertainty. Visitations of volatility in equity and currency markets with worldwide ramifications have imparted an additional dimension of uncertainty to the evolution of the international economic environment. These developments are necessitating intensified policy monitoring with a policy preference for insulating domestic real activity from these shocks. Looking ahead, monetary policy in India would continue to be vigilant and pro-active in the context of any accentuation of global uncertainties that pose threats to growth and stability in the domestic economy. The domestic outlook continues to be favourable and would dominate the dynamic setting of monetary policy in the period ahead. It is important to design monetary policy such that it protects growth by contributing to the maintenance of stability. Accordingly, while the stance of monetary policy would continue to reinforce the emphasis on price stability and well-anchored inflation expectations and thereby sustain the growth momentum, contextually, financial stability may assume greater importance in the months to come.
94. Keeping the above in view, recent developments in financial markets in India and potential uncertainties in global markets warrant a higher priority for managing appropriate liquidity conditions in the policy hierarchy at the current juncture.
95. The Reserve Bank will continue with its policy of active demand management of liquidity through appropriate use of the CRR stipulations and open market operations (OMO) including the MSS and LAF, using all the policy instruments at its disposal flexibly, as and when the situation warrants.
96. In sum, barring the emergence of any adverse and unexpected developments in various sectors of the economy and keeping in view the current assessment of the economy including the outlook for inflation, the overall stance of monetary policy in the period ahead will broadly continue to be:
• To reinforce the emphasis on price stability and well-anchored inflation expectations while ensuring a monetary and interest rate environment that supports export and investment demand in the economy so as to enable continuation of the growth momentum.
• To re-emphasise credit quality and orderly conditions in financial markets for securing macroeconomic and, in particular, financial stability while simultaneously pursuing greater credit penetration and financial inclusion.
• To respond swiftly with all possible measures as appropriate to the evolving global and domestic situation impinging on inflation expectations, financial stability and the growth momentum.
Click Here For Highlights of First Quarter Review of its Annual Policy Statement for 2007-08
Click Here For Macroeconomic and Monetary Developments: First Quarter 2007-08