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Macroeconomic and Monetary Developments in the Third Quarter of 2010-11 -Released on January 24, 2011

Highlights of Macroeconomic and Monetary Developments in the Third Quarter of 2010-11 :

Monetary and Liquidity Conditions
Large primary liquidity injected by the Reserve Bank to ease the liquidity pressures without diluting its anti-inflationary focus.

The liquidity conditions tightened significantly to the point of imposing constraints on growth in the terminal months of 2010.

The severe tightness in liquidity was caused by both frictional factors associated with unusually large surplus balances of the Government and structural factors as reflected in stronger credit growth relative to deposit growth as well as higher demand for currency.

The Reserve Bank introduced a number of measures with the aim of limiting the scale of the deficit, which remained consistent with its anti-inflationary policy stance.

The growth in non-food credit exceeded the indicative trajectory of the Reserve Bank and remained strong on account of growing credit demand associated with robust economic growth.

Recognising the need to firmly anchor inflationary expectations and contain inflation, the Reserve Bank has raised policy rates six times since March 2010.

As a result, along with the impact of the shift in the LAF mode from reverse repo to repo, the effective increase in policy rate has been 300 basis points.

Financial Markets
Deficit liquidity conditions helped in strengthening the transmission of policy rate actions to deposit and lending rates.

Reflecting the tight liquidity conditions, interest rates in the money market, particularly CBLO, T-bill, CP and CD segments hardened.

Recognising the structural imbalance between deposit growth and credit growth, as well as the underlying signals of the anti-inflationary monetary policy stance, banks raised their deposit rates to improve deposit mobilisation.

Several banks also revised their base rates upwards in the range of 25-100 basis points during July 2010 -January 17, 2011, and the associated increase in effective lending rates could be expected to contain demand pressures, going forward.

The pace of increase in housing prices varied across cities. The Reserve Bank has used macroprudential measures recently to restrain excessive leverage in asset price build-up.

Upside risks to inflation from structural demand-supply imbalance in certain sectors and hardening global commodity prices have increased.

WPI inflation had witnessed modest softening during August-November 2010 after remaining in double digits for five consecutive months up to July 2010.

In December 2010, however, renewed price pressures surfaced, driven by factors that were largely unanticipated.

Food inflation exhibited a strong rebound, led by onion and other vegetables, largely due to unseasonal rains and supply chain frictions.

The hardening of international commodity prices, in particular oil, happened sooner than anticipated.

The expected significant softening of food inflation after a normal monsoon did not materialise, reflecting the impact of growing structural imbalances in certain sectors, particularly non-cereal food items.

Non-food manufactured products inflation, which is a broad indicator of generalised and demand side price pressures, has remained stable in the range of 5.1 to 5.9 per cent so far during the year.

High month-over-month (annualised, seasonally adjusted) inflation in recent months as also the rising price index of the non-food manufactured group, however, suggest the combined impact of both input costs and demand pressures.

Even if inflation softens in the near-term, sustaining a low inflation regime would require addressing structural rigidities from the supply side in specific sectors, particularly in those items where supply-demand imbalances exert disproportionately larger impact on the headline inflation.

Since persistent high inflation could endanger the growth objective and also amplify risks to inclusive growth, containing inflation will have to be the predominant objective of monetary policy in the near-term.


Click Here For Third Quarter Review of Monetary Policy 2010-11

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