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Stance of Monetary Policy for the Remaining Period of 2005-06
Mid-term Review- July 26, 2005
37. The domestic factors, which are admittedly more relevant for India, continue to be positive. The performance of industrial sector is strengthening and the indicators of growth in services are positive. The upturn in industrial activity is supported by pick up in investment demand as reflected in the production and import of capital goods. Credit growth continues to be strong. The business expectation surveys also point to continued optimism. While the onset of monsoon was delayed, it has progressed well subsequently, but uncertainties remain on its progress during the season and consequently its impact on agricultural output. Supply constraints could also emanate from inadequate infrastructure, especially in power and ports, to support higher levels of domestic activity and export demand. On balance, though uncertainties remain, the domestic growth impulses appear to have been reinforced in the first quarter.
38. During the current year so far, inflation has remained on the expected lines. WPI inflation, excluding energy related items, continues to remain low as also prices of manufactured products. The inflation so far has been manageable. There is no evidence yet of generalised demand pressures, though credit growth is unusually strong. However, the progress of monsoon rainfall and movements in international oil prices would be the major determinants of supply factors that may continue to dominate the price situation, though the level of food stocks and forex reserves provide necessary cushion in supply management. While some pass-through of the increase in international oil prices has taken place, its second round impact is yet not apparent. On balance, during the first quarter, the underlying inflationary pressures appear to have been contained and inflationary expectations maintained, as anticipated.
39. The financial markets have, by and large, exhibited stability. While the money market interest rates moved up in tandem with changes in policy rate, there has been a greater convergence of rates between the collateralised and uncollateralised segments. While the yields in the government securities market have moderated from their observed peak levels in April, some upward movement is noticed and the yield curve has steepened. Though the Rupee has appreciated against major international currencies, the movement of exchange rate has been orderly. The equity market has exhibited optimism which is reflected in the magnitude of movement in stock indices.
40. Against the backdrop of developments during 2005-06 so far, the stance of monetary policy would depend on the macroeconomic developments including the global developments and the overall balance of risks. Factors such as increased global uncertainties, high and volatile international prices of oil, incomplete pass-through of oil prices domestically, upward trajectory of policy rate in the US, overhang of liquidity, high credit growth, sustained industrial growth and possible capacity pressures, enlargement of trade deficit, infrastructural constraints and delayed monsoon could prompt a change in the stance of policy. In favour of continuation of the stance, it could be argued that the oil price hike has been managed well with a combination of monetary and fiscal measures, overhang of liquidity has reduced with the increase in the absorptive capacity of the economy, excess liquidity remains sterilised, visible liquidity under LAF has reduced, money supply growth is within the projected trajectory, credit flow is getting broad-based, industrial growth has revived after a long period of sluggishness, pick up in investment demand is evident, investment climate remains favourable, corporate earnings and profits have been sustained, current level of inflation remains moderate both at the wholesale level and retail level, globally monetary policy continues to be somewhat accommodative, and global inflation during 2005 is projected to be moderate despite high oil prices. The considerations in favour of status quo are evenly matched by those for change in stance, but the balance of convenience at this juncture lies in continuing with status quo while monitoring the unfolding constellation of uncertainties, especially in the global arena.
41. In sum, the Reserve Bank's current assessment of macroeconomic outlook and the overall stance remains broadly unchanged from the annual policy Statement. It is apparent that there are several global uncertainties but there are domestic factors which indicate a confidently growing economy in a stable environment. While global factors are getting to be increasingly significant for India, the domestic factors still dominate and the latter point to favouring stability to maintain growth momentum at this juncture while being ready to respond to evolving circumstances. Accordingly, the overall stance of monetary policy for the remaining part of the year 2005-06 will continue to be as set out in the annual policy Statement of April 2005, but the Reserve Bank would respond, promptly and effectively, to the evolving situation depending on the unfolding of the risks.
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