Monetary Policy: RBI Waits And Watches

Vidrum / 15 Mar 2012

The Reserve Bank of India (RBI) released its Mid-Quarter Monetary Policy review today. The repo rate remains unchanged at 8.50 per cent and the reverse repo stands at the same level of 7.5 per cent.
The Reserve Bank of India (RBI) released its Mid-Quarter Monetary Policy review today. It was in line with our expectations with the central bank taking another pause before moving the interest rate in a reverse direction. The repo rate remains unchanged at 8.50 per cent and the reverse repo stands at the same level of 7.5 per cent. Much of this anticipated action was visible on March 9, 2012 when it reduced the cash reserve ratio (CRR) by 75 basis points to 4.75 per cent to enable liquidity flow of Rs 48,000 crore into the system. One of the reasons behind this was the liquidity crunch being faced by the banks due to the advance tax outgo. In its last policy declared on January 24, 2012, it had reduced the CRR to 50 basis points.
 
In terms of the global scenario, there are now signs of modest improvement. With the ECB providing a long-term refinancing option (LTRO) to the euro zone banks, there has been relief in pressure on the banks for repaying their debts. In the US the conditions of the labour market have seen an improvement too.

On the domestic front, the GDP growth for the December quarter came in at 6.1 per cent from 6.9 per cent posted for the September quarter of 2011. The Central Statistics Office (CSO) has estimated FY12 GDP growth at 6.9 per cent and this is in line with the RBI’s projection. We at DSIJ, in our reports published around December, had said that we would not be surprised if the growth for FY12 comes in below 7 per cent. 

On the other hand, the index of industrial production (IIP) has been very volatile. For the month of December it had came in at 2.5 per cent while for January it came in at 6.8 per cent which was well above the market expectation of around 2.1 to 2.4 per cent. However, the trend reflected by the IIP numbers does not provide an assurance of the economy being on the path of recovery. 

For the month of February the wholesale price index (WPI) inflation came in at 6.95 per cent (an increase by 40 basis points on a MoM basis) which is very close to the RBI’s comfort level of 7 per cent by FY12. Meanwhile, the consumer price index (CPI) which measures the prices at a retail level came in at 7.7 per cent for the month of January 2012, which is very high. One should watch out for the CPI for February 2012, scheduled on March 19, 2012.
        
Fiscal deficit, though, remains a major concern for the economy. In the period of April to January (10 months of FY12) the deficit has already crossed the budgeted estimate for the full year. According to FICCI’s estimates, the fiscal deficit for FY12 is likely to be around 5.7 to 5.8 per cent of the GDP which is much higher than the budgeted 4.6 per cent. Sluggish macro growth prospects coupled with surging crude prices will affect the growth of the emerging and developing economies. 

On the domestic side, inflation has cooled off to some extent i.e. from the levels of 9 and 10 per cent, which may improve corporate performance due to the input cost of raw material sliding down in the fourth quarter of 2011. However, the upside risk for inflation still continues to persist for the economy. The growth-inflation dynamics have prompted the RBI to initiate no further tightening and the future course of action will veer towards lowering the rates on the back of declaration in investment activities and the weak external demand. 

The RBI has guided that notwithstanding the declaration in growth the risk of inflation will remain, which will influence both the timing and the magnitude of the future rate actions. We believe one has to watch out for the CPI data which will be released soon and may provide cues for the RBI to take the next rate cut.

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