1. Growth since Q4 of 2012-13 is expected to
stage a gradual recovery aided by some revival
in investment demand and the favourable
effect of some moderation in inflation on
consumption. Inflation in Q3 of 2012-13 has
trended down, though upside risks remain
from suppressed inflation which could impart
stickiness to inflation trajectory in 2013-
14. Core inflation pressures have receded
markedly and are unlikely to re-emerge quickly
on demand considerations. However, high food
and fuel inflation still remain a concern and
this in part is reflected in high CPI inflation.
2. Since the beginning of 2012, the Reserve
Bank has worked towards easing monetary and
liquidity conditions in a calibrated manner so
as to not jeopardise the trend of moderating
inflation. The strategy yielded dividends,
as headline and core inflation moderated
during Q3 of 2012-13. However, monetary
policy needs to continue to be calibrated in
addressing growth risks as inflation remains
above the Reserve Bank’s comfort level
and macroeconomic risks from twin deficits
persists.
Global Economic Conditions
Fiscal adjustments likely to keep global
recovery muted in 2013
3. Though the US registered high growth
in Q3 of 2012 and the pace of economic
contraction moderated in the euro area,
growth prospects for advanced economies
(AEs) in 2013 remain subdued. While the immediate risk of the fiscal cliff in the US has
been averted due to a hurried deal on tax rate
hikes, the debt ceiling limit and the sequester
issue pertaining to expenditure reduction are
still unsettled. Growth in emerging market and
developing economies (EMDEs) may have
bottomed out, but an enduring recovery hinges
on global headwinds.
Global commodity price inflation likely
to remain soft, although with some risks
from QE
4. Inflation in AEs is likely to remain
moderate as demand remains weak, leaving
the global inflation scenario benign in the near
term. As a baseline case, improved supply
prospects in key commodities such as oil and
food are also likely to restrain commodity
price pressures. However, upside risks persist,
especially on the back of some recovery in
EMDEs and large quantitative easing (QE) by
AE central banks. In the presence of significant
excess global liquidity, triggers for supply
disruptions or incremental news flow on
reduced slack could exacerbate price volatility
and become a source of inflationary pressure.
Unconventional monetary policies reduce
global financial stress in the interim, but
risks remain ahead
5. International financial market stress
moderated greatly following aggressive
monetary easing measures by the central
banks of AEs, as also recent policy initiatives
on fiscal consolidation in the euro area economies, encouraging capital flows into
EMDEs. However, in the absence of credible
long-term fiscal consolidation in the US, and
generally reduced fiscal space in AEs, the
efficacy of monetary policy actions may get
subdued. Risks to the global financial sector,
although moderating, are likely to persist.
Indian Economy: Developments and Outlook
Output
Growth remains below trend, recovery
likely in 2013-14
6. The Indian economy further decelerated in
the first half (H1) of 2012-13, with moderation
in all three sectors of the economy. The weak
monsoon dented agricultural performance.
Policy constraints, supply and infrastructure
bottlenecks and lack of sufficient demand
continued to keep industrial growth below
trend. Subdued growth in other sectors and
weak external demand pulled down the growth
of services as well. Though a modest recovery
may set in from Q4 of 2012-13 as reforms get
implemented, sustaining recovery through
2013-14 would require all-round efforts in
removing impediments to business activity.
Aggregate Demand
Improvement in investment climate is a
pre-requisite for economic recovery
7. Demand weakened in H1 of 2012-13. There
was significant moderation in consumption
as private consumption decelerated even as
government expenditure accelerated. On the
fiscal side, near-term risks have diminished
due to the government’s repeated avowal of
commitment to the revised fiscal deficit target
of 5.3 per cent of gross domestic product
(GDP) for the year. However, sustainable
fiscal consolidation would require bringing
current spending, especially on subsidies, under control and protecting, if not enhancing
capital expenditure. Going forward, the key to
demand revival lies in improving the investment
climate as well as investor sentiments through
sustained reforms.
External sector
Widening of CAD and its financing
remains a key policy challenge
8. The current account deficit (CAD) to
GDP ratio reached a historically high level of
5.4 per cent in Q2 of 2012-13. Low growth and
uncertainty in AEs as well as EMDEs continued
to adversely impact exports in Q3 of 2012-13.
This, combined with continuing large imports
of oil and gold, resulted in a deterioration of
the trade balance. For the time being, strong
capital flows have enabled financing of CAD
without a significant drawdown of foreign
exchange reserves. However, the possibility of
volatility in these flows, which may put further
pressure on the external sector, cannot be ruled
out. A two-pronged approach, of lowering CAD
in the medium term while ensuring prudent
financing of CAD in the interim, is necessary
from the policy perspective.
Monetary and Liquidity Conditions
With tightening cycle gradually impacting
inflation, the Reserve Bank takes measures
to combat tight liquidity conditions
9. Monetary policy in India has sought to
balance the growth-inflation dynamics that
included a frontloaded policy rate cut of 50
basis points (bps) in April 2012 and several
liquidity enhancing measures. These included
lowering of the cash reserve ratio (CRR) by
50 bps on top of a 125 bps reduction in Q4 of
2011-12 and the statutory liquidity ratio (SLR)
by 100 bps in a bid to improve credit flows. The
Reserve Bank also infused liquidity of over
`1.3 trillion through outright open market
operation (OMO) purchases during 2012-13 so far. However, growth in monetary aggregates
remains below the indicative trajectory.
Financial Markets
Domestic reform initiatives and surging
capital flows improve market sentiment and
revive the IPO market
10. Improved global sentiments along with
recent policy reforms by the government
beginning September 2012, and market
expectations of a cut in the policy rate in the
face of moderation in inflation, aided FII
flows into the domestic market. The equity
markets showed significant turnaround, while
the rupee remained range-bound. In addition,
revival is witnessed in the IPO segment.
Although Indian financial market sentiments
improved significantly in Q3 of 2012-13,
some macroeconomic concerns persist, as
witnessed in the inverted yield curve. Sustained
commitment to curtail twin deficits and nurture
growth without fuelling inflation is critical to
support investor confidence.
Price Situation
Headline and core inflation moderated,
but suppressed inflation poses risks
11. Headline inflation moderated in Q3 of
2012-13 with significant moderation in nonfood
manufactured products inflation. Both
weakening domestic demand and lower global
commodity prices contributed to the softening
of headline inflation. Though the recent hike
in diesel prices will put some pressure on the
overall price level, the near-term inflation
outlook indicates that the moderation may continue through Q4 of 2012-13. While the
pressure from generalised inflation remains
muted at the current juncture, risks from
suppressed inflation, pressure on food prices
and high inflation expectations getting
entrenched into the wage-price spiral need to
be reckoned with. The inflation path for 2013-
14 could face downward rigidity as some of the
risks from suppressed inflation materialise.
Macroeconomic Outlook
Balance of macroeconomic risks suggest
continuation of calibrated stance
12. Reforms since September 2012 have
reduced immediate risks, but there is a long
road ahead to bring about a sustainable
turnaround for the Indian economy. Business
sentiments remain weak despite reform
initiatives and consumer confidence is
edging down. The Reserve Bank’s survey of
professional forecasters anticipates a slow
recovery in 2013-14 with inflation remaining
sticky. Fiscal risks have somewhat moderated
in 2012-13, but a sustained commitment to
fiscal consolidation is needed to generate
monetary space. Widening CAD, which is at
historically high level, remains a constraint
on monetary easing. Against this backdrop,
while growth can be supported by monetary
policy if inflation risks recede, credible
fiscal correction with improved execution in
infrastructure space to boost investment would
be needed for a sustained revival. The balance
of macroeconomic risks suggest continuation
of the calibrated stance while increasingly
focussing on growth risks.
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