Press Statement by Dr. D. Subbarao, Governor-Third Quarter Review of Monetary Policy 2010-11
-25th January 2011
Monetary and Liquidity Conditions
12. While the year-on-year money supply (M3) growth at 16.5 per cent in December 2010 was close to the indicative projection of 17.0 per cent, non-food credit growth at 24.4 per cent was much above the indicative projection of 20.0 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.
13. Tight liquidity conditions persisted throughout the third quarter of 2010-11. While the overall liquidity in the system has remained in deficit consistent with the policy stance, the extent of tightness is beyond the comfort zone of the Reserve Bank, i.e., (+)/(-) one per cent of NDTL of banks. Above-normal government cash balances contributed to the frictional component of liquidity deficit. However, the widening difference between credit and deposit growth rates coupled with high currency growth accentuated the structural liquidity deficit.
14. The Reserve Bank instituted a number of measures to mitigate the liquidity deficit such as: (i) reduction in the statutory liquidity ratio (SLR) of scheduled commercial banks (SCBs) by one percentage point; (ii) conducting open market operation (OMO) purchase of government securities of the order of over `67,000 crore; (iii) additional liquidity support to SCBs under the LAF; and (iv) introduction of a second LAF window on a daily basis.
15. 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 projection. 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. The Reserve Bank will constantly monitor the credit growth and, if necessary, engage with banks which show an abnormal incremental credit-deposit ratio.
16. A brief, albeit important, comment about the external sector. In the first half of 2010-11, the current account deficit (CAD) expanded to 3.7 per cent of GDP from 2.2 per cent in the corresponding period of last year. Subsequent trade data indicate that exports have grown faster thanimports which will improve the CAD. For the year as a whole, we estimate that the CAD will be close to 3.5 per cent of GDP.
17. Now let me highlight the risks to our growth and inflation projections:
Food inflation has remained at an elevated level for about two years and the prospect of it spilling over to the general inflation process is rapidly becoming a reality.
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.
The estimated current account deficit of 3.5 per cent of GDP for 2010-11 is not sustainable.
On top of the level of CAD which is a risk, the financing of CAD is an additional risk. Should global recovery be faster than expected, it may also have implication for the financing of CAD.
The recent improvement in the fiscal situation owes largely to one-off revenues generated from spectrum auctions and disinvestment proceeds. However, the commodity price developments pose significant risks for fiscal consolidation in the year ahead. The efficacy of further fiscal adjustment will be influenced by the firming trend in commodity prices and the extent to which Government will allow this to pass through to consumers.
The combined risks from inflation, CAD and fiscal situation contribute to an increase in uncertainty about economic stability that consumers and investors have to deal with.
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