Third Quarter Review of Monetary Policy 2011-12

By Dr. D. Subbarao Governor

The Term Monetary Policy

Credit policy' or called 'RBI's money management policy' in India. How much should be the supply of money in the economy? How much should be the ratio of interest? How much should be the viability of money? etc. It is related to the demand and the supply of money.

"A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy." According to: Prof. Harry Johnson

Inflation has provided some relief, even though this was caused largely by a seasonal decline in vegetable prices. Consistent with the Reserve Banks earlier projections, inflation is likely to decelerate further to 7 per cent by March 2012.
The new combined (rural and urban) consumer price index (base: 2010=100) declined marginally from 114.4 in November to 113.9 in December, reflecting softening of food prices. Liquidity which has remained in deficit during 2011-12, tightened in the second week of November 2011, reflecting the RBI forex market operations and advance tax outflows around mid-December. Average borrowings under daily liquidity adjustment facility (LAF) increased from around `480 billion during April-September 2011 to around `920 billion during November and further to `1,170 billion in December 2011. Average daily borrowings under the LAF were about `1,200 billion during January (up to January 20, 2012). To ease the tightness in liquidity, the Reserve Bank conducted open market operations (OMOs) aggregating over `700 billion during November 2011-mid January 2012.

Money supply (M3) growth, which was 17.2 per cent at the beginning of the financial year, reflecting the strong growth in time deposits following increase in interest rates by banks, moderated to 15.6 per cent by end-December 2011 consistent with the projected trajectory of 15.5 per cent for the year. Deposit rate of banks increased by 44 basis points for maturity up to 1 year, and 9 basis points for maturity between 1 to 3 years. During Q3, 23 banks raised their base rates by 10-100 basis points even as the modal base rate of banks remained unchanged at 10.75 per cent. The slowdown in total resource flow to the commercial sector and the peaking of base rates of banks reflect slowing down of investment activity.

Baseline projection of GDP growth for 2011-12 is revised downwards

from 7.6 per cent to 7.0 per cent

Monetary Measures
Cash reserve ratio (CRR) : January 2010- October 2011, the RBI cumulatively raised (CRR) by 100 basis points and the policy rate (the repo rate)from 8 to 13 times by 375 basis points as the liquidity in the system transited fron a surplus to a deficit mode. Thus reduction in the (CRR) of scheduled banks by 50 basis points from 6.0 per cent to 5.5 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning January 28, 2012. As a result 320 billion of primary liquidity will be injected into the banking system. Repo Rate: the liquidity adjustment facility (LAF) has been retained at 8.5 per cent. Reverse Repo Rate: the LAF, determined with a spread of 100 basis points below the repo rate, stands at 7.5 per cent. Marginal Standing Facility (MSF) Rate: with a spread of 100 basis points above the repo rate, stands at 9.5 per cent. Bank Rate: has been retained at 6.0 per cent.

Expected Outcomes The policy actions in this Statement given are expected to:
In reducing the CRR, the RBI has attempted to address the structural pressures on liquidity in a way that is not inconsistent with the prevailing monetary stance and for allow future rate actions towards lowering them. Shift in the balance of aggregate demand from public to private and from consumption to capital formation. Ease liquidity conditions. Mitigate downside risks to growth. Continue to anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation.

Table VII.4 : Median Forecasts of Select Macroeconomic Indicators by Professional Forecasters 2011-12 and 2012-13 Actua Annual Forecasts l 2011-12 2012-13 201011 E L E L 1 2 1. Real GDP growth rate at factor 8.5# cost (in per cent) a. Agriculture & Allied Activities 6.6# b. Industry c. Services 2. Gross Domestic Saving (per cent of GDP at current market price) 3. Average WPI-Inflation 7.8# 9.2# 3 7.6 3.2 6.4 9.1 4 7.0 3.4 4.1 9.0 5 7.7 3.0 6.9 9.0 6 7.3 3.0 5.8 8.8 Quarterly Forecasts

2011-12
Q3 E 7 7.7 2.7 7.1 9.2 L 8 6.7 3.3 2.7 8.9 E Q4 L E Q1 L E Q2 L

2012-13
Q3 E 15 -

9 10 11 12 13 14 7.8 7.0 7.6 6.8 7.6 7.1 3.1 7.6 9.1 3.5 3.8 8.5 3.0 7.2 8.9 3.0 4.4 8.5 3.2 6.8 9.1 3.2 5.1 8.7 -

- 34.0 33.0 34.6 33.5

9.6

8.8

8.8

6.7

6.5

8.8 8.8*

7.0

6.8

6.6

6.4

6.6

6.2

4. Exchange Rate (INR/1USD end period) 5. T-Bill 91 days Yield (per centend period) 6. 10-year Govt. Securities Yield (per cent-end period) 7. Export (growth rate in per cent)! 8. Import (growth rate in per cent)! 9. Trade Balance (US$ billion)

44.6 47.0 52.0 45.0 48.0 48.0 53.3 47.0 52.0 46.1 50.8 45.8 49.3 * 8.2 8.3 8.2 7.7 7.5 8.4 8.3 8.3 8.0 7.9 -

37.3 19.5 17.5 20.0 14.3 26.7 24.4 20.6 18.0 14.4

- -37.7 -42.4 -39.0 -34.0 -38.0 -43.8 -38.0 -40.2 130.6 E: Previous Round Projection. L: Latest Round Projection. #: Revised Estimate. -: Not available. *: Actual. ! : In US$ on BoP basis. Note :The latest round refers to Eighteenth round for the quarter ended December 2011, while previous round refers to Seventeenth round for the quarter ended September 2011. Source : 18th round of Survey of Professional Forecasters, Q3: 2011-12.

Macroeconomic Outlook
Growth in India is moderating more than was expected earlier. It is likely to be below potential during 2011-12, but is expected to recover at a modest pace in 2012-13. The slack in investment and net external demand components of aggregate demand may keep the pace of recovery low. Inflation has started to fall, broadly in line with the projected trajectory. Nonetheless, price pressures remain, with risks emanating from suppressed domestic energy prices, the incomplete pass-through of rupee depreciation and slippage in fiscal deficit. The decline in food inflation is likely to reverse ahead with the waning of base effects and seasonal factors behind the fall.

Objectives of Monetary Policy

Rapid Economic Growth Price Stability Exchange Rate Stability Balace of Payment (BOP) Equilibrium Full Employment Neutrality of Money Equal Income Distribution