Press Statement by Dr. D. Subbarao, Governor-Third Quarter Review of Monetary Policy 2010-11
-25th January 2011
"This morning, the Reserve Bank released its Third Quarter Review of Monetary Policy for 2010-11. Based on an assessment of the current macroeconomic situation, we decided to:
increase the repo and reverse repo rates by 25 basis points (bps) each. Accordingly, the repo rate stands at 6.5 per cent and the reverse repo rate at 5.5 per cent;
retain the cash reserve ratio (CRR) at 6 per cent of net demand and time liabilities (NDTL) of banks.
2. With the increases announced today, since mid-March 2010, the Reserve Bank has cumulatively increased the repo rate by 175 bps and the reverse repo rate by 225 bps. Additionally, the CRR was increased by 100 bps. Banks have responded to this calibrated tightening by raising their deposit and lending rates, suggesting strong monetary policy transmission.
3. In addition to changes in the policy rates, we made some decisions to manage the current liquidity situation. We decided to extend the two special measures currently in operation, viz.:
the additional liquidity support to scheduled commercial banks under the liquidity adjustment facility (LAF) to the extent of up to one per cent of their NDTL; and
a daily second LAF up to April 8, 2011.
Considerations Behind the Policy Move
4. Let me now explain the considerations that guided our monetary policy stance for the remaining period of 2010-11 :
Inflation is clearly the dominant concern. Even as the rate itself remains unacceptably high, the reversal in the direction of inflation is striking. Primary food articles inflation has risen again sharply. Non-food articles inflation and fuel inflation are already at elevated levels. Non-food manufacturing inflation has remained sticky. There are signs of food and fuel price increases spilling over into generalised inflation.
Second, there has been a sharp rise in global commodity prices which has heightened upside risks to domestic inflation.
Third, growth has moved close to its pre-crisis trajectory even in the face of an uncertain global recovery.
Fourth, the uncertainty with regard to global recovery has reduced.
5. Let me now give you a brief overview of the global economy. Advanced economies are showing firmer signs of sustainable recovery. Although uncertainty continues in the Euro area, there is an overall improvement in global growth prospects. However, inflation has edged up in major advanced economies even as a large slack persists, owing mainly to increase in food and energy prices. Whereas signs of inflation in the advanced countries are only incipient, many emerging market economies have been facing strong inflationary pressures, reflecting higher international commodity prices and rising domestic demand pressures. Significantly, food, energy and commodity prices are widely expected to harden during 2011, driven by a combination of supply constraints and rising global demand, as the advanced economies consolidate their recovery. This suggests that inflation could be a global concern in 2011.
The Indian Economy
6. Turning to the domestic macroeconomic situation, the 8.9 per cent GDP growth in the first half of 2010-11 suggests that the economy is operating close to its trend growth rate, powered mainly by domestic factors. The kharif harvest has been good and rabi prospects look promising. Good agricultural growth has boosted rural demand. Export performance in recent months has been encouraging.
7. With the risks to growth in 2010-11 being mainly on the upside, the baseline projection of real GDP growth is retained at 8.5 per cent but with an upside bias.
8. Moving on to the inflation situation, the moderation in headline inflation observed between August and November 2010 was along the projected trajectory of the Reserve Bank. This trend, however, reversed when WPI inflation (year-on-year) moved up from 7.4 per cent in November 2010 to 8.4 per cent in December 2010, due mainly to sharp increase in the prices of vegetables, mineral oils and minerals.
9. While the current spike in food prices is expected to be transitory, inflation stemming from structural demand-supply mismatches in several non-cereal food items such as pulses, oilseeds, eggs, fish, meat and milk is likely to persist till supply response kicks in. Non-food manufacturing inflation also remains above its medium-term trend of 4 per cent.
10. Going forward, the inflation outlook will be shaped by three factors: (i) on how the food price situation, both domestic and global, evolves; (ii) how global commodity prices behave; and (iii) the extent to which demand side pressures may manifest.
11. We have raised the baseline projection of WPI inflation for March 2011 from 5.5 per cent to 7.0 per cent. This upward revision was based on several considerations. First, the upside risks to inflation, as mentioned in the mid quarter review of December 2010, have materialised as reflected in the increase in prices of metals and non-administered fuel. Second, there have been some transitory supply shocks which triggered a sharp increase in vegetable prices. Third, petroleum and aviation turbine fuel prices went up in early January which will add 9 bps to WPI inflation. While the impact of transitory factors is expected to dissipate, price pressures on account of demand-supply imbalances in respect of some commodities will persist.
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