Mid-Quarter Monetary Policy Review: September 2012
-Announced on the 17th Sept 2012 by Dr. D. Subbarao, Governor, Reserve Bank of India
Monetary and Liquidity Measures
On the basis of an assessment of the current macroeconomic situation, it has been decided to:
reduce the cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.75 per cent to 4.50 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning September 22, 2012. Consequently, around ` 170 billion of primary liquidity will be injected into the banking system; and
keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8.0 per cent. Consequently, the reverse repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 9.0 per cent
2. There have been several significant developments since the Reserve Bank’s First Quarter Review of Monetary Policy in July. Globally, as risks have risen, both the European Central Bank (ECB) and the US Fed have responded with liquidity measures intended to calm financial markets and provide further stimulus to economic activity. While these measures have certainly mitigated short-term growth and financial risks, they will also exert pressure on global asset prices, and particularly, commodity prices. Domestically, growth continues to be weak amidst a negative investment climate; however, the recent reform measures undertaken by the Government have started to reverse sentiments. The Government undertook long anticipated measures towards fiscal consolidation by reducing fuel subsidies and selling stakes in public enterprises. Further, steps taken to increase foreign direct investment (FDI) should contribute to both greater capital inflows and, over the long run, higher productivity, particularly in the food supply chain. Importantly, however, for the moment, inflationary pressures, both at wholesale and retail levels, are still strong.
3. In April, the Reserve Bank implemented a frontloaded policy rate reduction of 50 basis points on the expectations of fiscal policy support for inflation management alongside supply-side initiatives for addressing the deceleration of investment and growth. As these expectations did not materialise and inflation remained firmly above 7.5 per cent, the Reserve Bank decided to pause in its policy easing in the Mid-Quarter Review (MQR) of June and in the First Quarter Review (FQR) of July. As inflationary tendencies have persisted, the primary focus of monetary policy remains the containment of inflation and anchoring of inflation expectations. In this context, the Government’s recent actions have paved the way for a more favourable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI). Of course, several challenges remain, one of which is persistent inflation. But, as policy actions to stimulate growth materialize, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management. Only this will ensure that the economy derives the maximum benefit from the recent, and anticipated, fiscal and supply-side policy measures.
4. Global activity has been weakening in Q3 of 2012. Merchandise trade slowed considerably with absolute contractions in major economies. Global purchasing managers’ indices (PMI) point to contraction in manufacturing and only modest growth in services. Persistent sovereign debt pressures amidst weakening economic activity in the euro area pose significant downside risks to the global economy. These concerns have prompted the announcement of the programme of outright monetary transactions (OMTs) in the form of sovereign bond purchases by the ECB. The US Fed announced the purchase of additional agency mortgage-backed securities until labour market conditions improve substantially, and extended exceptional policy accommodation till mid-2015.
5. Growth in several major emerging and developing economies (EDEs) is also moderating, with China’s Q2 2012 growth slowing to its lowest rate in the past three years. Slowing global demand has adversely affected industrial activity and exports in these economies. Additionally, drought conditions in major grain-producing areas of the world and the possibility of further hardening of international crude prices in view of the fresh dose of quantitative easing impart ubiquitous risks to overall global macroeconomic prospects.
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