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Third Quarter Review of Monetary Policy 2011-12 click here

Third Quarter Review of Monetary Policy 2011-12
-Announced on the 24th January 2012

II. Outlook and Projections

Monetary Aggregates

42. Money supply (M3) growth at 15.6 per cent (y-o-y) in December 2011 was in line with the indicative trajectory of 15.5 per cent for 2011-12. However, non-food credit growth at 15.7 per cent was below the indicative projection of 18 per cent, reflecting the combined effect of a slowing economy and increasing risk aversion by banks. The deceleration in non-food bank credit is explained, to a large extent, by the expansion in net bank credit to the government which increased at a significantly higher rate of 24.4 per cent as compared with 17.3 per cent last year. Keeping in view the increased government borrowings and slowdown in private credit demand, M3 growth projection for 2011-12 has been retained at 15.5 per cent, while non-food credit growth has been scaled down to 16.0 per cent. These numbers, as always, are indicative projections and not targets.

Risk Factors

43. The indicative projections of growth and inflation for 2011-12 are subject to a number of risks as indicated below:

i) Sovereign debt concerns in the euro area pose a major downside risk to overall growth outlook. The absence of a credible solution to the euro area problem is weighing on global growth prospects even as recent data suggest that there is some improvement in the US recovery. Continuing uncertainty in the euro area will adversely affect Indian growth through trade, finance and confidence channels.

ii) Capital inflows to India have slowed down on account of portfolio re-balancing by FIIs due to global uncertainty. This raises concerns, especially because the current account deficit of India has widened. The exchange rate has already come under significant pressure, which has also added to inflationary pressures. If the global situation does not improve, capital inflows could continue to be adversely affected. In this scenario, the size of the current account deficit poses a significant threat to macroeconomic stability.

iii) Even as global food and metal prices have moderated further, global energy prices have increased. Should crude prices spike due to supply constraints on account of geo-political factors or decline significantly due to a deteriorationin the global macroeconomic situation, they will have implications for domestic growth and inflation. Exchange rate movements will also be an important factor in shaping the impact of global crude prices on domestic prices.

iv) Non-food credit growth has slowed down. Although some slowdown in credit growth was expected on account of monetary tightening, credit growth has decelerated more than expected and is currently below the indicative trajectory of 18 per cent. Apart from slowdown of economic activity, it also reflects increasing risk aversion by banks due to increase in non-performing assets. Although banks need to be prudent while sanctioning credit proposals, risk aversion by the banking sector could adversely affect credit flow to productive sectors of the economy.

v) Although food inflation has declined in the recent period, this was mainly due to a seasonal decline in vegetable prices. Going by past trends, the extent of decline in vegetable prices seen in December this year is usually observed in the winter season (December-February). As such, the decline in food inflation is likely to be limited in coming months. Beyond this, inflation in respect of protein-based items remains high. In the absence of appropriate supply responses of those commodities where there are structural imbalances, particularly protein-based items, risks to food inflation will continue to be on the upside. Significantly, there has been reduction in rabi acreage for pulses, which may have an adverse impact on prices.

vi) There is still a large element of suppressed inflation as domestic prices of some administered products do not reflect the underlying market conditions. This is particularly true of coal which had seen an increase towards the end of last year but no increase this year so far. Since coal is an input for electricity, coal prices, as and when raised, will also have implications for electricity tariffs. Further, the current levels of domestic prices of petroleum products do not reflect international prices. Petroleum product prices have also not been revised in response to crude oil prices, contributing to both fiscal slippages and suppressed inflation. Revision in domestic administered prices will add to inflationary pressures, although such revisions are necessary to maintain the balance between supply and demand. Particularly, as the food subsidy bill is expected to rise, it will be prudent to fully deregulate diesel prices to contain both aggregate demand and trade deficit.

vii) The fiscal deficit of the government has remained elevated since 2008-09. If the increase in government borrowing already announced is an indication, the gross fiscal deficit for 2011-12 will overshoot the budget estimate substantially. At the current juncture when there is a need to boost private investment, the increase in fiscal deficit could potentially crowd out credit to the private sector. Moreover, slippage in the fiscal deficit has been adding to inflationary pressures and it continues to be a risk for inflation.


Macroeconomic and Monetary Developments: Third Quarter Review 2011-12 ...Click Here
Highlights of Third Quarter Review of Monetary Policy 2010-11....Click Here

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