RBI’s second quarter review of monetary policy 2010-11- an analysis

The much expected event is over. Just before an upcoming monetary policy in India, I think this time RBI is facing really tough trade-offs, it is a tough call etc. And the next one just gets tougher. So in Apr-10 and Jul-10 policy, when I thought things could not be more complex the expectations from Nov-10 policy just got tougher. 

After much discussions and nervousness, we finally  have the policy review for Q2 2010-11. RBI raised its policy rates by 25 bps each in line with broad market expectations (and mine too! I got one call right after several quarters reviews). Actually markets were divided till RBI’s macroeconomic report released y’day. The report was quite hawkish on inflation which comforted markets over a rate hike.

The rates now are:

  • Repo Rate under LAF increased by 25 bps to 6.25%
  • Reverse Repo rate under LAF increased by 25 bps to 5.25%
  • CRR constant at 6% (some people had expected RBI to raise CRR which was highly unlikely given tight liquidity situation)

RBI says these actions are expected to:

i.   Sustain the anti-inflationary thrust of recent monetary actions and outcomes in the face of persistent inflation risks.
ii.   Rein in rising inflationary expectations, which may be aggravated by the structural nature of food price increases.
iii.  Be moderate enough not to disrupt growth.

As RBI has been innovating a little in each policy, one there is some innovation this time as well. RBI gives its expectations on future policy actions in very explicit words:

Based purely on current growth and inflation trends, the Reserve Bank believes that the likelihood of further rate actions in the immediate future is relatively low. However, in an uncertain world, we need to be prepared to respond appropriately to shocks that may emanate from either the global or domestic environment.

Great stuff. Forward guidance of markets.

Overall RBI’s stance remains to anchor inflation expectations and manage liquidity situation. The stance has not changed much since Jan-10 policy.

RBI Policy Stance in different meeting

October 2009 Policy January 2010 Policy April 2010 Policy July 2010 Policy

Nov 2010 Policy

  • Watch inflation trend and be prepared to respond swiftly and effectively
  • Monitor liquidity to meet credit demands of productive sectors while securing price and financial stability
  • Maintain monetary and interest rate regime consistent with price and financial stability, and supportive of the growth process

 

  • Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
  • Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
  • Maintain an interest rate regime consistent with price, output and financial stability.

 

  • Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
  • Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
  • Maintain an interest rate regime consistent with price, output and financial stability.

 

  • Contain inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures.
  • Maintain an interest rate regime consistent with price, output and financial stability.
  • Actively manage liquidity to ensure that it remains broadly in balance so that excess liquidity does not dilute the effectiveness of policy rate actions

 

  • Contain inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures.
  • Maintain an interest rate regime consistent with price, output and financial stability.
  • Actively manage liquidity to ensure that it remains broadly in balance, with neither a surplus diluting monetary transmission nor a deficit choking off fund flows.

 

 

 Macroeconomic assessment

  • Growth: GDP growth projection for FY 2010-11 has been kept unchanged at 8.5%. RBI is quite ok with the growth prospects. Most other agencies have revised their forecasts upwards for 2010-11
  Latest Projection Earlier Projection
  GDP Growth Month GDP Growth Month
Economic Advisory Council to the PM 8.5 Jul-10 8.2 Feb-10
Ministry of Finance 8.5 (+/-0.25) Feb-10 .. ..
IMF (calendar year) 9.7 Oct-10 9.4 Jul-10
ADB 8.5 Sep-10 8.2 Jul-10
NCAER 8.4 Oct-10 8.1 Jul-10
OECD 8.3 May-10 7.3 Nov-09
RBI Survey of Professional Forecasters 8.5 Nov-10 8.4 Jul-10

 

  • Inflation: The WP series base year has changed from 1993-94 to 2004-05.  There are changes in 2004-05 series but overall price trends are the same. The Primary article inflation  is higher in 2004-05 series compared to 1993-94 series. Whereas manufactured price inflation is lower in 2004-05. The net impact is slightly on the lower side. Given this change, RBI has revised WPI inflation lower from 6% in 1993-94 series to 5.5% in 2004-05 series. There is no change in inflation projection.RBI’s WPI projection looks very aggressive though. It looks around 6.5% by Mar-end.

    RBI continues to be worried over inflation trajectory. Despite good monsoon and kharif crop, food inflation remains very high. Core inflation has trended lower implying some impact of rate hikes starting from Mar-10. But still both headline and core are much above the comfort trend.

  • Monetary aggregates: It maintains its M3 and credit growth at 17% and 20% respectively. Though M3 growth has been lower around 15%, it is because of subdued growth in time deposits. Time deposits have  not grown much because of negative real interest rates and shift of finances to equity, gold and real estate. RBI notes banks have started mobilizing deposits by increasing deposit rates. M3 growth should follow.

RBI’s Indicative Projections for 2010-11 (All Fig In %, YoY)

 

Apr 10 Policy

Jul 10 Policy

Nov 10 Policy

GDP

8 with an upward bias

8.5

8.5

Inflation (based on WPI, for March end)

5.5

6

5.5

Money Supply (March end)

17

17

17

Credit (March end)

20

20

20

Deposit (March end)

18

18*

18*

Note: Deposit growth rate has not been indicated in both July-10 and Nov-10 policies. Hence, we take growth same as given in April 10 policy.

Source: RBI

Risks to outlook
There are several risk factors to the outlook both on the upside and downside:

  • If there is a prolonged slowdown in advanced economies, it will impact India as well. Though India is not as open but its industry and services will be impacted
  • Inflationary pressures may increase as prices of commodities rise. It adds despite fragile global economy, the prices of commodities has risen due to financialisation of markets and global liquidity
  • Capital inflows could rise further as advanced economies take more stimulus measures
  • Current account deficit (CAD) continues to widen. It says CAD upto 3% of GDP is considered as safe. In Q1 2010-11, CAD reached 3.9% of GDP. Lower than high of 4.6% of GDP in Q3 2008-09, it is higher than comfort mark.
  • Asset prices have risen sharply in quick time. Home prices above pre-crisis peak, gold at all time high and equity close to pre-crisis peak.

Overall summary of monetary policy
The policy hike was on expected lines. RBI has also clearly hinted that given current trend of growth and inflation, probability of further rate hikes is very low. But given the turbulent external environment nothing can be certain. Number of central banks are slated to meet this week –  RBA has already raised rates by 25 bps, Fed expected to pass QE2, BoJ, UK could also expand its asset purchase program (Posen voted last time to raise it), ECB etc. The outlook is weak and all eyes will be on them for their next steps.

Though am surprised  by RBI’s muted stance on capital inflows. It just mentions it as a risk and not much after that. It seems to be comfortable with current flows and has many options as well. Liquidity is tight so more flows only help. And then rupee has not appreciated compared to SE Asian peers, so relatively it is better placed. 

RBI has also initiated some regulatory measures. Will cover them in the next post.

4 Responses to “RBI’s second quarter review of monetary policy 2010-11- an analysis”

  1. RBI reviews regulatory polices and takes some macroprudential steps « Mostly Economics Says:

    […] Mostly Economics This blog covers research work in Economics with focus on India « RBI’s second quarter review of monetary policy 2010-11- an analysis […]

  2. What do you mean by Teaser Rates? « Mostly Economics Says:

    […] do you mean by Teaser Rates? By Amol Agrawal In second quarter review of monetary policy (see this, this, and this as well), RBI took some measures to discourage teaser loans by Indian […]

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