Press Statement by Dr. D. Subbarao, Governor-Annual Policy Statement for the Year 2010-11- 20th April 2010
Banks welcomed the Reserve Bank’s policy stance. They agreed that the monetary measures announced by the Reserve Bank today were appropriate given the growth-inflation dynamics. Apart from monetary policy, discussions centred around three specific issues: (i) government market borrowing programme; (ii) financial inclusion; and (iii) infrastructure financing. Banks indicated that the programmed government borrowings may not crowd out private sector demand given the projected level of resources in the system. Banks assured the Reserve Bank that they share their commitment to financial inclusion and indicated that they will work innovatively to promote financial inclusion. Banks were concerned about their growing exposure to the infrastructure sector. Although they welcomed the measures initiated by the Reserve Bank to promote infrastructure financing by banks, they indicated that there is a need to develop alternative sources for financing to supplement the efforts of the banking sector.
This monetary policy for 2010-11 is set against a rather complex economic backdrop. Although the situation is more reassuring than it was a quarter ago, uncertainty about the shape and pace of global recovery persists. Private spending in advanced economies continues to be constrained and inflation remains generally subdued making it likely that fiscal and monetary stimuli in these economies will continue for an extended period. Emerging market economies (EMEs) are significantly ahead on the recovery curve, but some of them are also facing inflationary pressures. This has prompted central banks in some EMEs to begin phasing out their accommodative monetary policies.
In India, economic recovery, which began around the second quarter of 2009-10, has since shown sustained improvement. Industrial recovery has become more broad-based and is expected to take firmer hold on the back of rising domestic and external demand. After a continuous decline for nearly a year, exports and imports have expanded since October/November 2009.
Flow of resources to the commercial sector from both bank and non-bank sources has picked up. Surveys by the RBI as well as others suggest that business optimism has improved. On balance, under the assumption of a normal monsoon and sustained good performance of the industry and services sectors, for policy purposes, the Reserve Bank projects real GDP growth for 2010-11 at 8.0 per cent with an upside bias.
The developments on the inflation front are, however, worrisome. Headline wholesale price index (WPI) inflation accelerated from 1.5 per cent in October 2009 to 9.9 per cent by March 2010. There has been a significant change in the drivers of inflation in recent months. What was initially a process driven by food prices has now become more generalised. This is reflected in non-food manufactured products inflation rising from (-) 0.4 per cent in November 2009 to 4.7 per cent in March 2010.
Going forward, three major uncertainties cloud the outlook for inflation. First, the prospects of the monsoon in 2010-11 are not yet clear. Second, crude prices continue to be volatile. Third, there is evidence of demand side pressures building up. On balance, keeping in view domestic demand-supply balance and the global trend in commodity prices, the baseline projection for WPI inflation for March 2011 is placed at 5.5 per cent.
Keeping in view the need to balance the resource demand to meet credit offtake by the private sector and government borrowings, monetary projections have been made consistent with the growth and inflation outlook. For policy purposes, money supply (M3) growth for 2010-11 is placed at 17.0 per cent. Consistent with this, aggregate deposits of scheduled commercial banks (SCBs) are projected to grow by 18.0 per cent. The growth in non-food credit of SCBs is placed at 20.0 per cent. As always, these numbers are provided as indicative projections and not as targets.
The overall liquidity remained in surplus though it declined towards the end of the year consistent with the monetary policy stance. Overnight interest rates generally stayed close to the lower bound of the LAF rate corridor. The large market borrowing by the Government put upward pressure on the yields on government securities which was contained by active liquidity management by the Reserve Bank.
The Union Budget for 2010-11 has begun the process of fiscal consolidation and the net market borrowing requirement of the Central Government in 2010-11 is budgeted lower than that in the previous year. However, fresh issuance of securities in 2010-11 will be 36 per cent higher than last year. Managing the borrowing is going to be more challenging than in last year for three main reasons.
First, the option for liquidity management through OMO and MSS which we used extensively last year will be limited this year.
Second, private credit demand will pick up, making crowding out a potential possibility.
Finally, inflation pressures are stronger.
Regardless, the Reserve Bank will ensure that credit requirement of both the government and the private sector are met.
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