The RBI is perhaps preparing for coordinated global easing at a later stage. But rain, rupee and renewed growth weakness are forces to reckon with.

While there has been very little movement on the ground since the RBI announced its annual monetary policy in April 2012, what has changed is rising headwinds for the economy.

Growth is losing momentum, inflation remains elevated, and the large twin deficits, namely, current account deficit and fiscal deficit, pose significant risks to macroeconomic stability.

Slow growth could reduce revenue collections, and increased spending to counter the effects of drought could push up the fiscal deficit. Along with these, the uncertain global situation could unhinge growth in the Indian economy. Growth has slowed down significantly, with GDP not only slowing sequentially over the last four quarters but the 5.23 per cent GDP growth seen in Q4FY’12 was close to the trough at 5.27 per cent last seen in Q3FY’03.

Inflation, biggest risk

More worryingly, the economy is clearly growing below trend, capacity utilisation is low, and despite lower real interest rates, capex investments are not happening.

But the RBI sees inflation as the biggest risk. Poor monsoon will spell trouble for food availability and food prices in the country, which will get aggravated by food shortages in the global markets as drought in major crop producing countries also hits supplies.

Non-food manufactured products inflation, or core inflation, is also seen remaining firm.

Then there is suppressed inflation, and fuel price correction is yet to happen. A weak rupee will add to import costs, pushing up prices to that extent.

The RBI’s macro projections are more realistic but worrying. The FY’13 GDP growth projection has been cut from 7.3 per cent announced in April’12 to 6.5 per cent while the inflation projection has been raised to 7 per cent from 6.7 per cent for the same period.

Agriculture could suffer a setback due to poor monsoons and industrial production continues to remain anaemic; the services sector, which was seen holding up, is also now expected to slow down, reflecting weakness in industry.

Against this backdrop of heightened global uncertainty and domestic macroeconomic pressures, containing inflation, inflation risks and inflation expectations, even as growth is slowing, has become central to the RBI’s policy.

Perhaps by not cutting rates at this stage, the central bank is also keeping its powder dry in order to take concerted global action at a later stage if co-ordinated easing (as in 2008) becomes necessary.

Proactive measure

Already, the ECB is standing by to do whatever it takes. The Bank of England has decided to increase its quantitative easing asset purchase programme. Since May 2012, Australia, Brazil, South Korea, China, South Africa and ECB have cut policy rates to address growth risks.

Interestingly, the RBI kept its penchant for surprising the markets by announcing a 100 bps cut in SLR. As liquidity has become comfortable and all banks hold SLR securities well above the mandated 24 per cent, the immediate release of additional liquidity appears more as a proactive measure than a pressing requirement.

Banks can, of course, deploy the additional funds at 11-12 per cent and thus shore up their bottomlines.

While credit growth at 17.7 per cent, year-on-year, is above the 14.7 per cent year-on-year growth in deposits, the measure will help banks if there is a robust credit pick-up as we move into the busy season. A comfortable liquidity situation will also be helpful in case, given the global uncertainty, the RBI has to intervene in the forex market to support the rupee.

Overall, the Monetary Policy has been cautious and prudent, highlighting the supply-side deficiencies, thereby putting the ball in the Government’s court to get the economy up and running.

(The author is Head — Economic Research, State Bank of India.)

(This article was published on July 31, 2012)
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