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Third Quarter Review of Monetary Policy 2010-11 click here

Third Quarter Review of Monetary Policy 2010-11
-Announced on the 25th January 2011

II. Outlook and Projections

Domestic Outlook

Monetary Aggregates

39. While the year-on-year money supply (M3) growth at 16.5 per cent in December 2010 was close to the indicative projection of 17 per cent, non-food credit growth at 24.4 per cent was much above the indicative projection of 20 per cent. Credit expansion in the recent period has been rather sharp, far outpacing the expansion in deposits. Rapid credit growth without a commensurate increase in deposits is not sustainable.

40. As a result of injection of primary liquidity of over `67,000 crore through OMO auctions since early November 2010, the structural liquidity deficit in the system has declined significantly. While the Reserve Bank will endeavour to provide liquidity to meet the productive credit requirements of a growing economy, it is important that credit growth moderates to conform broadly to the indicative projections. This will prevent any further build-up of demand side pressures. Accordingly, the projection for 2010-11 of M3 growth has been retained at 17 per cent and that for non-food credit growth at 20 per cent. As always, these numbers are indicative projections and not targets.

Risk Factors

41. The growth and inflation projections as outlined above are subject to several risks.

i) Food inflation has remained at an elevated level for more than two years now. It is not only that the moderation in food price inflation as expected during a normal monsoon year has not occurred to the extent expected, but also that there has been sharp unusual increase in prices. It is also significant that food inflation is not confined to a few items which were affected by unseasonal rains in some parts of the country but is fairly widespread across several food items. The inflation rates for primary articles and fuel items have risen sharply. Inflationary expectations remain at elevated levels. As high food inflation persists, the prospect of it spilling over to the general inflation process is rapidly becoming a reality.

ii) Non-food manufacturing inflation is persistent and has remained sticky in recent months as several industries are operating close to their capacity levels. Imports as a means to supplement domestic availability for many commodities will become less of an option as global growth consolidates and capacity utilisation increases. This may accentuate demand side pressures.

iii) India’s CAD has widened significantly. Although recent trade data suggest moderation of the trade deficit in the latter part of the year, overall CAD for 2010-11 is expected to be about 3.5 per cent of GDP. A CAD of this magnitude is not sustainable. Further, commodity prices, which rose sharply even when the global recovery was sluggish, may rise further if the global recovery is faster than expected. This has implications for both the CAD and inflation. There is, therefore, a need for concerted policy efforts to diversify exports and contain the CAD within prudent limits.

iv) Apart from the level of CAD, financing of CAD also poses a risk. Global growth prospects have improved significantly in the recent period. Should global recovery be faster than expected, it may also have implication for the financing of CAD. Capital flows, which so far have been broadly sufficient to finance the CAD, may be adversely affected. Faster tthan expected g lobal re cover y may enhance the attractiveness of investment opportunities in advanced economies, which may impact capital flows to India. This may increase the vulnerability of our external sector. Hence, the composition of capital inflows needs to shift towards longer-term commitments such as FDI.

v) The recent improvement in the fiscal situation has been mainly the result of one-off revenue generated from spectrum auctions. The Government also had the benefit of disinvestment proceeds, which may continue to occur for some more time. However, fiscal consolidation based on one-off receipts is not sustainable. As emphasised in the Second Quarter Review of November 2010, fiscal consolidation is important for several reasons, including the fact that monetary policy works most efficiently while dealing with an inflationary situation when the fiscal situation is under control. Apart from this, the commodity price developments that have been referred to earlier pose significant risks for fiscal consolidation in the year ahead. Rising oil prices will impact prices of both petroleum products and fertilisers. If the Government chooses to restrict the pass-through to consumers and farmers, it will have to make adequate budgetary provisions, which will constrain its ability to reduce the fiscal deficit. If it does not, either fiscal credibility will be undermined or inflationary expectations will be reinforced by the likelihood of higher prices of these key inputs, both of which will further complicate inflation management.

vi) The combined risks from inflation, the CAD and fiscal situation contribute to an increase in uncertainty about economic stability that consumers and investors will have to deal with. To the extent that this deters consumption and investment decisions, growth may be impacted. While slower growth may contribute to some dampening of inflation and a narrowing of the CAD, it can also have significant impact on capital inflows, asset prices and fiscal consolidation, thereby aggravating some of the risks that have already been identified.


Click Here For Press Statement by Dr. D. Subbarao, Governor on Third Quarter Review

Macroeconomic and Monetary Developments: Third Quarter Review 2010-11 ...Click Here

Highlights of Third Quarter Review of Monetary Policy 2010-11....Click Here

Mixed reactions from Banks, Economists, India Inc on RBI 3rd Qtr Review 2010-11 ....Click Here

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