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Annual Policy Statement for the Year 2012-13 click here

Press Statement by Dr. D. Subbarao, Governor- Monetary Policy Statement for 2011-12 (3rd May 2011)


The Annual Policy for 2011-12 is set in conditions significantly different from those a year ago. Last yearís policy was made in an environment of incipient domestic recovery and uncertainty about the state of the global economy. While signs of inflation were visible, they were driven primarily by food items. Nonetheless, there was a clear risk of food price pressures spilling over into more generalised inflation, as the recovery consolidated and domestic resource utilisation rose to levels which stretched capacities. Throughout last year, the goal of monetary policy was to nurture the recovery in the face of persistent global uncertainty, while trying to contain the spill-over of supply side inflation.

3. The Reserve Bank followed a policy of calibrated tightening last year. This was justified by the trend of moderating inflation and consolidating growth in the second and third quarters of 2010-11. However, the resurgence of inflation in the last quarter of last year became a matter of concern. Although the trigger for this was the sharp uptrend in international commodity prices, the fact that these have quickly passed through into the entire range of domestic manufactured goods indicates that pricing power is significant. In other words, demand has been strong enough to allow significant pass-through of input price increases. Importantly, this is happening even as there are visible signs of moderating growth, particularly in capital goods production and investment spending, suggesting that cumulative monetary actions are beginning to have an impact on demand.

4. Thus, three factors have shaped the outlook and monetary strategy for 2011-12.

First, global commodity prices, which have surged in recent months are, at best, likely to remain firm, and may well increase further over the course of the year. This suggests that higher inflation will persist, and may indeed get worse.

Second, headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concerns about inflation expectations becoming unhinged.

The third factor, one countering the above forces, is the likely moderation in demand, which should help reduce pricing power and the extent of pass-through of commodity prices. This contra trend cannot be ignored in the policy calculation. However, a significant factor influencing aggregate demand during the year will be the fiscal situation. The budget estimates offered reassurance of a fiscal rollback. However, the critical assumption, that petroleum and fertiliser subsidies would be capped, is bound to be seriously tested at prevailing crude oil prices. Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, the Reserve Bank believes that this needs to be done as soon as possible. Otherwise, the fiscal deficit will widen and will counter the moderating trend in aggregate demand.

5. The monetary policy trajectory that is being initiated in this Annual Statement is based on the following basic premise. Over the long run, high inflation is inimical to sustained growth as it harms investment by creating uncertainty. Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence.

Monetary Policy Stance

6. Against the above backdrop, the stance of monetary policy of the Reserve Bank will be as follows:

First, to maintain an interest rate environment that moderates inflation and anchors inflation expectations.

Second, to foster an environment of price stability that is conducive to sustaining growth in the medium-term, coupled with financial stability.

Third, to manage liquidity to ensure that it remains broadly in balance, with neither a large surplus diluting monetary transmission nor a large deficit choking off fund flows.

Changes in Operating Procedure of Monetary Policy

7. Before announcing our policy measures, let me make a comment on the changes we are making to the operating procedure of monetary policy.

8. Last July, the Reserve Bank constituted a Working Group to Review the Operating Procedure of Monetary Policy. The report of the Group, chaired by our Executive Director, Deepak Mohanty, was put out in the public domain in March 2011 inviting feedback and comments.

9. Based on the Groupís recommendations, and in light of the feedback received, it has been decided to make the following changes to the operating procedure of monetary policy:

First, the weighted average overnight call money rate will be the operating target of monetary policy of the Reserve Bank.

Second, there will henceforth be only one independently varying policy rate, and that will be the repo rate. This transition to a single independently varying policy rate is expected to more accurately signal the monetary policy stance.

Third, the reverse repo rate will continue to be operative, but it will be pegged at a fixed 100 basis points below the repo rate. Hence, the reverse repo rate will no longer be an independent variable.

Fourth, we will be instituting a new Marginal Standing Facility (MSF). Banks can borrow overnight from the MSF up to one per cent of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points above the repo rate.

As per the above scheme, the revised corridor will have a fixed width of 200 basis points. The repo rate will be in the middle. The reverse repo rate will be 100 basis points below it, and the MSF rate 100 basis points above it.

10. These changes in the operating framework, except that pertaining to the MSF, will come into force immediately. The MSF will come into effect from the fortnight beginning 7th May, 2011.

Click Here For Highlights of Annual Policy Statement for the Year 2011-12

Click Here For Macro economic and Monetary Developments : 2010-11

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