RBI's Annual Monetary Policy Statement for the Year 2013-14
- 3rd May 2013
II. Domestic Outlook and Projections
32. The macroeconomic outlook for 2013-14 is subject to a number of risks as indicated below.
i) By far the biggest risk to the economy stems from the CAD which, last year, was historically the highest and well above the sustainable level of 2.5 per cent of GDP as estimated by the Reserve Bank. Admittedly, the fiscal deficit is programmed to decline, but even factoring that in, it is still high. Large fiscal deficits can potentially spill over into the CAD and undermine its sustainability even further. A large CAD, appreciably above the sustainable level year after year, will put pressure on servicing of external liabilities.
ii) Even as the large CAD is a risk by itself, its financing exposes the economy to the risk of sudden stop and reversal of capital flows. Although the CAD could be financed last year because of easy liquidity conditions in the global system, the global liquidity situation could quickly alter for EDEs, including India, for two reasons. First, the outlook for AEs remains uncertain, and even if there may be no event shocks, there could well be process shocks which could result in capital outflows from EDEs. Second, with quantitative easing (QE), AE central banks are in uncharted territory with considerable uncertainty about the trajectory of recovery and the calibration of QE. Should global liquidity conditions rapidly tighten, India could potentially face a problem of sudden stop and reversal of capital flows jeopardising our macro-financial stability.
iii) Sustained revival of growth is not possible without a revival of investment. But investment sentiment remains inhibited owing to subdued business confidence and dented business profitability. Both borrowers and lenders have become risk averse. Borrowers have become risk averse because of governance concerns, delays in approvals and tighter credit conditions. For lenders, risk aversion stems from the erosion of asset quality, deteriorating cash flow situation of borrowers eroding their credit worthiness and heightened risk premiums.
iv) Looking ahead, the effectiveness of monetary policy in bringing down inflation pressures and anchoring inflation expectations could be undermined by supply constraints in the economy, particularly in the food and infrastructure sectors. Food price pressures, upward revisions in the MSPs and rapid wage increases are leading to a wage-price spiral. Without policy efforts to unlock the tightening supply constraints and bring enduring improvements in productivity and competitiveness, growth could weaken even further and inflationary strains could re-emerge.
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