Macroeconomic and Monetary Developments in the Second Quarter of 2011-12
-Released on October 24, 2011
The Reserve Bank of India today released the Macroeconomic and Monetary Developments Second Quarter Review 2011-12. The document serves as a background to the Monetary Policy Statement 2011-12 to be announced on October 25, 2011.
Widening CAD poses risk if global trade and capital flows shrink
The Current Account Deficit (CAD) widened in Q1 of 2011-12, despite a surge in exports and higher net invisibles receipts. Going forward, exports could decelerate as global growth slows down. Invisible earnings may also decelerate as slow down in US and euro area could impact software exports.
Sharp decline in FII flows in Q2 of 2011-12 has been largely offset by strong FDI flows. However, capital flows are entering an uncertain phase with increased financial stress and worsening global growth prospects. External sector outlook, although stable, warrants close monitoring.
Monetary and Liquidity Conditions
Liquidity remains comfortable, credit growth stays above trajectory
During Q2 of 2011-12, liquidity conditions, though in deficit mode in line with the policy objective, remained comfortable. Base money decelerated as currency growth moderated. Money (M3) growth, however, moderated less sharply and remained above the indicative trajectory as the money multiplier increased.
Bank credit growth is presently above the indicative trajectory. This has been supplemented by increased resource flows from non-banking sources. Going forward, credit growth is expected to moderate as growth slows.
Monetary policy has been significantly tightened since February 2010 with an effective increase of 500 bps in policy rates and a 100 bps increase in CRR; but monetary transmission is still unfolding and real interest rates remain low and non-disruptive to growth.
Volatility spillovers to domestic equity and currency markets are contained
Volatility was high in global financial markets in Q2 of 2011-12. Rising risk aversion caused credit spreads to widen. Volatility spillovers impacted domestic currency and equity markets in a limited way.
Rupee depreciation and the fall in equity indices in Q2 of 2011-12 were comparable to the patterns in most other emerging markets. Money market rates remained in line with policy signals, while G-sec yields hardened after the announcement of additional market borrowing.
Inflation risks stay as falling global commodity prices provide limited comfort
High inflation is likely to persist over next couple of months before moderating as falling global commodity prices so far has been offset by rupee depreciation. Incomplete pass-through is likely to limit the impact of falling global commodity prices. Financialisation of commodities leaves future commodity price path uncertain.
Domestic price pressures still remain significant and broad-based. Food inflation is likely to stay elevated due to demand-supply mismatches in non-cereals and large MSP revisions. Real wage inflation has extended into Q1 of 2011-12. In sum, the inflation challenge remains significant.
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