credit policy
overview
| news
| basics
|
lendings
|advanced banking
| products
| IT
in banking
articles
& policies |
banking software|
SBI page|
bank directory|
internet banking|
foreign currency rates
Special Features
Top Stories
Daily News RBI Credit Policies (1999-2005)
Part I. Mid-term Review of Annual Statement on Monetary Policy for the Year 2005-06
Stance of Monetary Policy for the Second Half of 2005-06
40. The First Quarter Review on July 26, 2005 reiterated the stance of the Annual Statement on Monetary Policy on the basis of a broadly unchanged assessment of the macroeconomic outlook. It, however, noted that increased global uncertainties, high and volatile international prices of oil, incomplete pass-through of oil prices domestically, upward trajectory of the policy rate in the US, overhang of liquidity, high credit growth, sustained industrial growth and possible capacity pressures, enlargement of the trade deficit, infrastructural constraints and delayed monsoon could prompt a change in the stance of policy. On the other hand, the monetary and fiscal measures to mitigate the impact of the oil price hike, increase in absorptive capacity of the economy, broad-based credit flow, revival in industrial growth after a long period of sluggishness, pick-up in investment demand and favourable investment climate, sustained corporate earnings and profits, moderate wholesale and retail inflation and projection of moderate global inflation for 2005 despite high oil prices favoured status quo on the monetary policy stance while monitoring the unfolding constellation of uncertainties, especially in the global arena.
41. The conduct of monetary policy during the first half of 2005-06 has been broadly in accordance with the stated stance. On balance, macroeconomic and financial conditions have evolved as anticipated. First, overall industrial growth has strengthened albeit with infrastructure emerging as a potential constraint. Second, monsoon fears have eased although the full effects on agricultural production would depend on the spatial distribution of rainfall, the impact of the initial delay in the onset of the monsoon and excess rainfall in the last week of July 2005. Third, non-food credit growth has been buoyant, broad-based and supportive of the acceleration in industrial activity. Nevertheless, the rising shares of housing and real estate, in particular, has warranted precautionary policy action to ensure credit quality. Fourth, the demand for government securities from insurance companies and other non-bank financial institutions has been sustained and the competing demand for funds between the government and the commercial sector has been balanced by appropriate liquidity management by the
Reserve Bank. Fifth, a pick-up in investment demand is evident and the business climate has improved considerably with external demand providing impulses of growth for a range of industries.
42. As regards the commitment to macroeconomic and price stability, there have been several developments that have reinforced the policy stance. First, monetary conditions have evolved in an orderly manner. Money supply remained below the projected trajectory in the first four months of the current financial year, though it has inched up during the last two months due to rapid credit expansion. Reserve money growth has been somewhat higher than in the previous year. Demand deposits have recorded strong growth pari passu with the expansion of non-food credit, compensating for the slower growth of time deposits. The slowdown in net bank credit to the Government sector has helped in accommodating the surge in credit to the commercial sector. Second, there has been a supportive response of liquidity management by the Reserve Bank to portfolio shifts of market participants. Liquidity mismatches have been met in an orderly manner with the flexibility available, particularly under the LAF mechanism and operation of MSS. Third, the pass-through of the escalation in international crude prices to domestic petroleum product prices has been managed well and timed into the ebbing phase of inflation. Accordingly, the inflationary outcome has so far turned out to be consistent with initial projections and inflationary expectations are contained. Fourth, financial markets have remained stable and supportive of growth. Fifth, even as high oil prices and domestic demand emanating from buoyant industrial activity have resulted in a significant widening of the trade deficit, this has automatically absorbed the capital flows and economised on monetary policy action to sterilise these flows. At the same time, the rising international competitiveness of India’s invisible exports and remittances from Indians working overseas have ensured that the current account deficit remains within manageable limits.
43. Several factors posing risks to the outlook on growth and inflation have, however, emerged in the recent months. First, it would be prudent to recognise the need to ensure credit quality in light of the high expansion of non-food credit so that a positive investment climate prevails with minimal risks and constraints. Second, infrastructure has emerged as a major bottleneck for development and the pace of investment in infrastructure needs to pick up further to support growth in the long-term. Despite high non-food credit growth, the share of credit to infrastructure remains low relative to the size and state of the economy. Third, inflation is low in terms of commodity prices but asset prices, especially housing prices, have registered a substantial increase. Asset price changes can have a powerful effect on investment and/or consumption through a financial accelerator effect and in this context, large swings in asset prices continue to pose a challenge for monetary policy. From an analytical perspective, especially in view of non-linearities in asset price changes, such a high growth needs to be monitored carefully. Fourth, global crude oil prices continue to be high and volatile and an overwhelming part of the increase in recent years is now increasingly being regarded as permanent. So far, the second round impact of the increase has not been as strong as anticipated earlier but withholding of prices by companies treating the increase as a transitory supply shock will slowly have to give way. Given the persistent nature of the oil price increase, the possibility of a larger pass-through cannot be ruled out. The oil economy, nevertheless, poses a serious challenge to sustaining low inflationary expectations. Fifth, the trade deficit has been widening with the surge in imports, both oil and non-oil, but the invisible surplus and capital inflows have ensured a comfortable balance of payments situation. No doubt, evolving magnitudes of the current account deficits need to be recognised even though they are manageable. The level of foreign exchange reserves provides some comfort on this front though the situation needs a careful watch. Sixth, international interest rates cycles had so far shown mixed behaviour but currently the general indications are that the accommodative stance is being withdrawn and, in some cases, may be tightened. This has implications for capital flows. Nevertheless, the overall positive sentiment, the business confidence of the private sector and the strength as well as resilience of the domestic economy would continue to be the major determinants of capital flows. Ultimately, the approach to managing the external sector, the choice of instruments and the timing and sequencing of policies are matters of informed judgement. All these factors warrant close monitoring for sustaining the growth process with a tolerable level of inflation.
44. In the context of the evolving scenario for the oil economy, some key features merit clear recognition. First, at this stage of development, current levels of energy intensity of the Indian economy are likely to persist over the medium-term. Second, although attention has increasingly turned to conservation, energy saving devices are not likely to yield substantial gain in the short- to medium-term. Third, the level of domestic supplies of crude petroleum has stagnated over the past few years and significant increases are not envisaged in the immediate future. Furthermore, increases in global supplies are expected to be modest in view of capacity constraints. Fourth, global demand for petroleum products is expected to remain robust. The combined impact of these factors could result in a compositional shift in the supply side in favour of coal and gas, but the reliance on petroleum will continue to grow significantly. Accordingly, persistence of the Indian economy’s sizeable dependency on imports of petroleum and products is inevitable. Under these conditions, it is necessary to prepare for some further adjustments in relative prices. Thus, upside inflationary pressures from oil prices can be expected to continue with attendant direct and indirect effects. So far, there has been only partial pass-through of international crude prices into domestic prices of petroleum products and second round effects have not yet become noticeably significant. At this stage, therefore, it is necessary to contain inflationary expectations in response to the evolving oil scenario and continue to take measures in a forward looking manner.
45. In Section I of this Part, detailed analysis has been presented on the likely levels of major macroeconomic and monetary aggregates after assessing the relevant factors. In view of these and for the purpose of monetary management: (i) based on the current assessment of a pick-up in agricultural output and in the momentum in industrial and services sectors, GDP growth in 2005-06 is placed in the range of 7.0-7.5 per cent against around 7.0 per cent as projected earlier; and (ii) the commitment to price stability has earned some success during the year so far. Given the outlook for inflation primarily in the context of the oil economy in India, however, it may be difficult to contain the inflation in the range of 5.0-5.5 per cent projected earlier without an appropriate policy response. It is also necessary to recognise and formulate a forward looking policy response in a manner that the growth momentum and the potential for higher growth is realised without adding to inflation expectations. Accordingly, expansion in M3 would be somewhat higher than 14.5 per cent projected earlier and growth in aggregate deposits would be higher than Rs.2,60,000 crore projected earlier. Non-food bank credit including investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper (CP), etc., is expected to increase significantly, higher than 19.0 per cent projected earlier. There are several factors that warrant continuous vigilance for ensuring macroeconomic and financial stability which is critical for maintaining the growth momentum. While rapid growth in non-food credit requires due diligence, the oil economy and price changes would also need careful monitoring for reining in inflationary expectations. The level of capacity utilisation is high and in the current phase of economic growth, capacity expansion in the Indian industry needs to be supported. The liquidity position continues to be comfortable, providing some flexibility to support the investment and export demand in the economy to maintain the growth momentum without undue pressure on prices and in this context, monetary policy would continue to strive for maintaining stable inflationary expectations and orderly financial markets while ensuring the continuation of the positive investment climate.
46. Against the backdrop of developments during 2005-06 so far, the stance of monetary policy would depend on the macroeconomic developments including the global scenario. A key factor is the assessment of the risks in as accurate a manner as is feasible. Globally, the major risks are from heightened uncertainties associated with the unwinding of macroeconomic imbalances and consequent currency adjustments as well as the future course of international crude prices. A significant part of the oil price rise, which is currently being treated as permanent, would result in higher pass-through and, coupled with the secondary effect, poses a challenge for monetary policy. Domestically, the related adjustment of prices of petroleum products and second round effects on overall inflation, the rapid credit growth and potential for erosion in credit quality are factors that warrant careful and continuous monitoring. As regards the external sector, the growing trade deficit and its financing are relevant to the monetary policy stance. At the same time, there is need to recognise the favourable factors that characterise the Indian economy. The oil price hike has not seriously hampered growth prospects or significantly affected inflationary expectations so far. Investment demand is strengthening amidst a congenial business climate and corporate earnings and profits have been sustained.
47. In the annual policy Statement of April 2005, attention was drawn to several global uncertainties which complicate the conduct of monetary policy. In particular, it was indicated that the rise in oil prices appears to have a large permanent component which makes it important to factor in the second round effects in assessing the impact on inflation and growth. More recently, the large increase in export earnings of oil-exporting countries has added to the overhang of global liquidity which could accentuate inflationary pressures if capacity pressures emerge and market conditions tighten. Second, in the context of the inflation scenario, the turning up of the interest rate cycle was expected to weigh heavily on the outlook for financial stability. Third, risks to global growth were also seen in the incomplete and delayed adjustment of major currencies to the global imbalances. At the current juncture, it appears that some of these uncertainties seem to be materialising, resulting in rising inflation expectations and the withdrawal of accommodation in the monetary policy stance in several economies. While in India, the domestic factors continue to prevail over global factors, suggestive of continued preference for stability, recent domestic developments add to the case for a prompt policy response. While responding appropriately to the current situation, it is necessary to be in readiness to take further measures as warranted to meet the challenges posed by the evolving situation, given the unfolding of the risks.
48. It is necessary, both for policy makers and market participants, to recognise interest rate cycles and strengthen risk management processes to cope with eventualities so that financial stability could be maintained and interest rate movements could be transited in a non-disruptive manner. In this regard, it is instructive to observe global trends as the Indian economy is progressively getting linked to the world economy. While domestic liquidity, partly mirroring global liquidity, is critical, the trends in global interest rates, inflation expectations and investment demand would also have some relevance in the evolution of domestic interest rates. It will, therefore, be desirable to contain inflationary pressures to stabilise domestic financing conditions both for the government and the private sector.
49. The Reserve Bank will continue to ensure that appropriate liquidity is maintained in the system so that all legitimate requirements of credit are met, consistent with the objective of price stability. Towards this end, RBI will continue with its policy of active demand management of liquidity through OMO including MSS, LAF and CRR, and using all the policy instruments at its disposal flexibly, as and when the situation warrants.
50. In sum, barring the emergence of any adverse and unexpected developments in various sectors of the economy and keeping in view the current assessment of the economy including the outlook for inflation, the overall stance of monetary policy for the remaining part of the year will be:
• Consistent with emphasis on price stability, provision of appropriate liquidity to meet genuine credit needs and support export and investment demand in the economy.
• Ensuring an interest rate environment that is conducive to macroeconomic and price stability, and maintaining the growth momentum.
• To consider measures in a calibrated and prompt manner, in response to evolving circumstances with a view to stabilising inflationary expectations.
<<< Back To MAIN PAGE OF Mid-term Review of Annual Policy for the year 2005-06
Advertise
| Book Store |
About us |
Contact us
| Terms of use | Disclaimer
© Banknet India |
All rights reserved worldwide.
Best viewed with IE 4.00 & above at a screen resolution of 800 x 600
or higher