First Quarter Review of Monetary Policy Statement 2012-13
-Announced on the 31st July 2012
I. The State of the Economy
5. The global economy is slowing down. In its latest update of the World Economic Outlook (WEO), the International Monetary Fund (IMF) has revised its projection for global growth in 2012 marginally downwards to 3.5 per cent, but has emphasised further downside risks to growth. In the US, output growth decelerated to 1.5 per cent (seasonally adjusted annualised rate) in Q2 from 2.0 per cent in Q1 of 2012. In the euro area, growth was flat in Q1 after a contraction by 1.2 per cent in the previous quarter. In the UK, growth contracted by 2.8 per cent in Q2 of 2012 and 1.3 per cent in Q1. Output in Japan expanded by 4.7 per cent in Q1 after a low growth of 0.1 per cent in the previous quarter, supported by reconstruction related demand. The global manufacturing purchasing managers’ index (PMI) fell below the neutral level of 50.0 to 48.9 in June 2012 - the lowest in 3 years - suggesting contraction in manufacturing activity. The global composite (manufacturing and services) PMI at 50.3 in June 2012 suggests near stagnation.
6. The decisions by the European Commission (EC) Summit on July 2, 2012 improved market confidence, but only temporarily. Without a sustained recovery in growth or moderation in sovereign debt stress, which are highly inter-linked, fiscal and financial stability pressures in the euro area remain the most significant source of systemic global risk. In recent weeks, renewed concerns about Greece and the need for greater collective support to Spain and Italy have amplified these risks. Consequently, the potential for negative spillovers to the euro area core countries and to the rest of the world have also increased.
7. Importantly, risks to global growth, which stem from persistent weakness in advanced economies, have increased with EDEs also exhibiting moderation in growth. Among the BRICS countries, growth in China fell from 8.1 per cent in Q1 of 2012 to 7.6 per cent in Q2. Growth also moderated significantly in Brazil and South Africa in Q1. According to the IMF, growth in a number of major EDEs turned out to be lower than forecast by it earlier.
8. Inflationary pressures softened across advanced and emerging economies, reflecting both weaker growth prospects and moderation in commodity prices. International (Brent) crude oil prices declined from an average of about US$ 125 per barrel in March 2012 to an average of about US$ 95 per barrel in June 2012. In July, however, the average price increased to above US$ 100 per barrel. In advanced economies, spare capacity in both product and labour markets limits risks to core inflation. Among the BRICS countries, inflation fell significantly in China and Russia. It also eased in Brazil and South Africa. Even as growth in India is slowing, it is clearly an outlier insofar as inflation is concerned.
9. Gross Domestic Product (GDP) growth decelerated over four successive quarters from 9.2 per cent in Q4 of 2010-11 to 5.3 per cent in Q4 of 2011-12. Significant slowdown in industrial growth as well as deceleration in services sector activity pulled down the overall GDP growth to 6.5 per cent for 2011-12, below the Reserve Bank’s baseline projection of 7 per cent.
10. On the expenditure side, significant weakness in investment activity was the main cause of the slowdown. Gross fixed capital formation, which grew by 14.7 per cent in Q1 of 2011-12, moderated to 5.0 per cent in Q2 and then contracted by 0.3 per cent in Q3 before recovering to a growth of 3.6 per cent in Q4. Growth in private consumption also decelerated in 2011-12, even as it remained the key driver of growth. The positive impact of the rupee depreciation on exports is yet to be seen.
11. Growth in the index of industrial production (IIP) decelerated from 8.2 per cent in 2010-11 to 2.9 per cent in 2011-12. Further, IIP growth during April-May 2012, at 0.8 per cent, was significantly lower than the expansion of 5.7 per cent registered in the corresponding period of last year. The PMI rose marginally to 55.0 in June 2012 from 54.8 in May. The composite (manufacturing and services) PMI also rose to 55.7 in June from 55.3 in May.
12. During the ongoing monsoon season, rainfall up to July 25, 2012 was 22 per cent below its long period average (LPA). The Reserve Bank’s production weighted rainfall index (PWRI) showed an even higher deficit of 24 per cent. Further, the distribution of rainfall was very uneven, with the North-West region registering the highest deficit of about 39 per cent of LPA. If the rainfall deficiency persists, agricultural production could be adversely impacted.
13. Capacity utilisation levels in Q4 of 2011-12 as reflected in the results of the Reserve Bank’s order book, inventories and capacity utilisation survey (OBICUS) revealed the usual seasonal improvement over the previous quarter. However, lead information from the Reserve Bank’s industrial outlook survey (IOS) indicates that capacity utilisation dropped in Q1 and Q2 of 2012-13. Moreover, overall business sentiment also moderated in both the quarters.
14. Headline Wholesale Price Index (WPI) inflation increased from 7.5 per cent in April to 7.6 per cent in May before moderating to 7.3 per cent in June 2012. The stickiness in inflation, despite the significant growth slowdown, was largely on account of high primary food inflation, which was in double-digits during Q1 of 2012-13 due to an unusual spike in vegetable prices and sustained high inflation in protein items.
15. Fuel group inflation moderated from 12.1 per cent in April 2012 to 11.5 per cent in May and further to 10.3 per cent in June on account of decrease in non-administered fuel prices, which in turn was due to decline in global crude oil prices. However, the reversal in crude oil prices in recent weeks may add to domestic inflationary pressure.
16. Non-food manufactured products inflation was at 4.8 per cent in May and June 2012. The momentum indicator of non-food manufactured products inflation (seasonally adjusted 3-month moving average annualised inflation rate), however, showed an upturn. Moreover, input price pressures persist due to both exchange rate movements and supply side constraints. Going forward, further pressure on non-food manufactured products inflation cannot be ruled out.
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