1. Monetary and liquidity conditions have
eased during 2012-13 as cuts in cash reserve
ratio (CRR) and policy rates worked through
the system. The Reserve Bank cut CRR by 125
basis points (bps) and front-loaded the policy
rate reduction by cutting the repo rate by 50 bps
in April 2012. It, however, paused at its Mid-Quarter Review in June 2012 factoring in
inflation persistence and macro-economic risks
that emanated from lack of momentum in fiscal
consolidation. Significantly, while there is slack
in the economy, inflation remains persistent.
Going forward, monetary policy space needs to
be created through fiscal adjustment and
structural measures to improve supply conditions
and boost the investment climate, so that the
revival is supported in a non-inflationary
manner.
2. Growth in Q1 of 2012-13 is likely to have
stayed low after having dropped to a 29-quarter
low in the sequentially preceding quarter. While
the slowdown has been primarily driven by
investment, more recently and to a lesser extent,
consumption has also slowed. Global growth
prospects have worsened during Q1 of 2012-13,
thus putting domestic recovery at greater risk.
Inflation, after falling in Q4 of 2011-12 has
turned sticky. Price pressures remain with
significant suppressed inflation in domestic
energy prices and rupee depreciation, which
have partly off-set the gains from lower global
commodity prices.
Global Economic Conditions
Global growth prospects worsen with
growth also slowing in EDEs
3. Debt overhang and persistent euro area
problems coupled with still incomplete adjustment of the US economy from the 2008
financial crisis are keeping growth in Advanced
Economies (AEs) low. Deceleration in growth
in BRICS economies, which have so far been
the drivers of growth in Emerging and
Developing Economies (EDEs), has worsened
global growth prospects further.
Financial market stress accentuates
4. Global financial market stress eased
significantly during Q1 of 2012 after ECB made
a large liquidity injection, but was accentuated
again by the deepening crisis in the euro area,
especially in Greece and Spain. The recent
Libor fixing case has also added to the
uncertainty by drawing attention to how a few
large global financial institutions allegedly
manipulated one of the most commonly used
market rates. Meanwhile, falling commodity
prices and subdued inflation in large economies
provided additional space for monetary easing.
This fresh round of monetary easing has,
however, increased the risks of inflation in EDEs
even while inflation is likely to remain subdued
in most AEs.
Indian Economy: Developments and
Outlook
Output
Growth risks accentuate, negative output
gap likely to persist during 2012-13
5. Economic activity slowed down
considerably during Q4 of 2011-12 and has
likely stayed weak during Q1 of 2012-13.
Growth in 2012-13 is likely to remain below
potential. Newer risks to growth have arisen
from slowing global trade, domestic supply bottlenecks of industrial inputs, coal and
electricity and less-than-satisfactory monsoon
so far. Services growth is also showing signs of
slowing in line with slowing industrial growth
and weak global economy.
Aggregate Demand
Need for curtailing subsidies and propelling
a government investment stimulus to
address investment slack
6. Aggregate demand weakened further
during Q4 of 2011-12. The investment slowdown
seen since H2 of 2010-11 has extended to Q4 of
2011-12. Apart from the sharp fall in investment,
private consumption moderated during Q4 of
2011-12. Fiscal and monetary space to stimulate
the economy remain limited in the presence of
an already large fiscal deficit and persistent
inflation. The fiscal deficit target for 2012-13 is
at a risk of being breached due to likely
overshooting of subsidies and shortfall in
receipts. To address this risk, fiscal space needs
to be created by curtailing subsidies and
significantly boosting government capital
expenditures to provide an investment stimulus
to the economy, which would help crowd-in
private investment.
External Sector
CAD risks and concerns about sustainability
persist
7. Softening of global crude oil prices and
moderation of gold imports may bring some
relief to the balance of payments, but Current
Account Deficit (CAD) risks remain significant
for 2012-13. Slowing global growth and trade
are likely to keep expansion in exports of goods
and services low. Services exports net of
services imports have declined notably in Q1
of 2012-13. With lower growth, the sustainable
level of CAD has also come down to around 2.5
per cent of GDP. Financing a large CAD may
pose difficulties in face of slowing foreign
investment flows. External debt is likely to rise as increased debt flows bridge financing gap.
As a result, external vulnerability indicators
may deteriorate and would make economy
susceptible to external shocks unless trade
balance is compressed and FDI flows improve.
Monetary and Liquidity Conditions
Monetary and liquidity conditions ease
during 2012-13
8. A 50 basis points (bps) rate cut, following
a 125 bps CRR reduction, coupled with active
open market operation purchases have
significantly eased monetary and liquidity
conditions during 2012-13 so far. While these
measures are supportive of growth, the rate of
deposit expansion has slowed which could
adversely affect liquidity. Credit growth has
picked up in the current financial year and is in
line with the indicative projections. The flow of
resources from non-bank sources has also been
good. In spite of a relative improvement in
monetary and liquidity conditions during Q1 of
2012-13, the Reserve Bank would need to
closely monitor the liquidity and monetary
conditions ahead so that they remain consistent
with the evolving growth-inflation mix.
Financial Markets
Currency and equity markets remained
under pressure
9. Spillovers from global financial market
uncertainties and waning investor confidence
amidst deteriorating macroeconomic conditions,
kept domestic currency and equity markets
under pressure. The rupee depreciated by nearly
10 per cent during Q1 of 2012-13, before
staging some recovery in July 2012. Equity
markets remained range bound, with sharp
gains in May 2012 being nullified during June
2012. Money market rates and G-sec yields
eased reflecting improved liquidity and falling
global commodity prices. However, going
forward, financial stress is likely to remain with
falling earnings and high leverage for non-financial
firms.
Price Situation
Inflation pressures persist despite
weakening growth momentum
10. Headline WPI inflation persisted above
7 per cent, while consumer price inflation, as
per the new CPI, remains in double-digits.
Inflationary pressures have persisted, with
significant contribution from food and energy
segments. Going forward, the decline in global
commodity prices will provide some relief, but
the gains have been partly offset by rupee
depreciation. While core inflationary pressures
are currently muted, a continued rise in real
wages could spill over to core inflation.
Persistence of inflation, even as growth is
slowing, has emerged as a major challenge for
monetary policy.
Macroeconomic Outlook
Outlook remains weak, need to support
recovery in a non-inflationary manner
11. Growth risks in 2012-13 have been
amplified by decelerating global trade and
domestic supply constraints. At the same time,
inflation risks remain significant due to
suppressed inflation, poor supply responses
and deficit monsoon conditions. Various
surveys suggest that business and consumer
confidence remain low. Revival of investor
confidence would, therefore, need to be
supported by addressing concerns over policy
stasis, while putting in place complimentary
actions that address macro-economic
weaknesses.
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