Annual Policy Statement for the Year 2010-11- 20th April 2010
Part A. Monetary Policy
III. The Policy Stance
38. In the wake of the global economic crisis, the Reserve Bank pursued an accommodative monetary policy beginning mid-September 2008. This policy instilled confidence in market participants, mitigated the adverse impact of the global financial crisis on the economy and ensured that the economy started recovering ahead of most other economies. However, in view of the rising food inflation and the risk of it impinging on inflationary expectations, the Reserve Bank embarked on the first phase of exit from the expansionary monetary policy by terminating some sector-specific liquidity facilities and restoring the statutory liquidity ratio (SLR) of scheduled commercial banks to its pre-crisis level in the Second Quarter Review of October 2009.
39. The process was carried forward by the second phase of exit when the Reserve Bank announced a 75 basis points increase in the CRR in the Third Quarter Review of January 2010. As inflation continued to increase, driven significantly by the prices of non-food manufactured goods, and exceeded the Reserve Bank’s baseline projection of 8.5 per cent for March 2010 (made in the Third Quarter Review), the Reserve Bank responded expeditiously with a mid-cycle increase of 25 basis points each in the policy repo rate and the reverse repo rate under the LAF on March 19, 2010.
40. The monetary policy response in India since October 2009 has been calibrated to India’s specific macroeconomic conditions. Accordingly, our policy stance for 2010-11 has been guided by the following three major considerations:
First, recovery is consolidating. The quick rebound of growth during 2009-10 despite failure of monsoon rainfall suggests that the Indian economy has become resilient. Growth in 2010-11 is projected to be higher and more broad-based than in 2009-10. In its Third Quarter Review in January 2010, the Reserve Bank had indicated that our main monetary policy instruments are at levels that are more consistent with a crisis situation than with a fast recovering economy. In the emerging scenario, lower policy rates can complicate the inflation outlook and impair inflationary expectations, particularly given the recent escalation in the prices of non-food manufactured items. Despite the increase of 25 basis points each in the repo rate and the reverse repo rate, our real policy rates are still negative. With the recovery now firmly in place, we need to move in a calibrated manner in the direction of normalising our policy instruments.
Second, inflationary pressures have accentuated in the recent period. More importantly, inflation, which was earlier driven entirely by supply side factors, is now getting increasingly generalised. There is already some evidence that the pricing power of corporates has returned. With the growth expected to accelerate further in the next year, capacity constraints will re-emerge, which are expected to exert further pressure on prices. Inflation expectations also remain at an elevated level. There is, therefore, a need to ensure that demand side inflation does not become entrenched.
Third, notwithstanding lower budgeted government borrowings in 2010-11 than in the year before, fresh issuance of securities will be 36.3 per cent higher than in the previous year. This presents a dilemma for the Reserve Bank. While monetary policy considerations demand that surplus liquidity should be absorbed, debt management considerations warrant supportive liquidity conditions. The Reserve Bank, therefore, has to do a fine balancing act and ensure that while absorbing excess liquidity, the government borrowing programme is not hampered.
41. Against this backdrop, the stance of monetary policy of the Reserve Bank is intended to:
Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
Maintain an interest rate regime consistent with price, output and financial stability.
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