"The initial hope that the crisis could be contained in the financial sector has been belied." These words that commence the RBI's official statement on the third quarter review of the monetary policy highlight the context in which the central bank has put forth its views. The statement further goes on to emphasise on the fact that the loss of confidence in the global financial markets has set off a chain of deleveraging, declining asset values, falling income, contracting demand and rising unemployment.
More importantly, the Reserve Bank of India (RBI) has sought attention to the distinction in monetary policy actions in the developed and developing economies of late, which have been the underlying basis for the review. The central bank stated that while the crisis that originated in the financial sector in the US spread almost immediately to Europe, it did not disturb the fundamental strength of banking entities in developing markets. The latter were infact materially impacted by three factors - capital flow reversals, drying up of overseas lines of credit and significant deceleration in global trade reducing the demand for exports. Resultantly, the monetary policy actions in emerging markets have also been attuned to real economy problems rather than financial sector problems.
Projecting a real GDP growth of 7% YoY for FY09, the review outlined the risks to the growth in the service sector barring communications and freight movement. On the positive side, it expressed hope that the sustained performance of the agricultural sector, fiscal stimulus, falling global crude oil prices and softening of domestic input prices such as energy, cement and steel would have a positive impact on industrial production in the coming months.
The central bank expressed satisfaction over the curtailment of inflationary pressures and projected a decline in inflation level (measured in terms of WPI) to 3% by the end of the fiscal. It has, however, also stated that notwithstanding the projected decline in headline inflation, the figure at the consumer level (CPI) is yet to moderate and that the decline in CPI has not been commensurate with the sharp fall in WPI.
On credit growth
Both growth in non food credit and flow of credit to the commercial sector during the nine month period ended December 2009 were higher at 24% and 23% respectively as compared to 22% and 21% in the corresponding period of FY08. Nevertheless, despite the expansion in bank credit, there was a perception of lack of credit availability particularly due to the reduced flow of funds from non-bank sources, notably the capital market and external commercial borrowings. The RBI also revised its projections of growth in money supply (from 17% to 19% YoY), deposits (from 17% to 19% YoY) and non food credit (from 20% to 24% YoY) for FY09 upwards, due to lower inflationary risks.
On fiscal deficit
The RBI estimates that besides suffering revenue losses from lower direct tax collection on account of the economic slowdown, the government is likely to lose further revenues worth about 0.6% of GDP due to cuts in excise and customs duties, 2.8% of GDP due to the supplementary demands for grants (including subsidies, Sixth Pay Commission payments and farm loan waiver) and 1.1% of GDP due to special bonds issued to oil marketing and fertiliser companies. Infact, the review stated that the Economic Advisory Council had projected the consolidated fiscal deficit at 8% of GDP for FY09 (budget estimate of 2.5%) including all the additional expenses. In view of the alarming deficit figures, the RBI stated that it is critically important for the government to re-anchor to a revised Fiscal Responsibility and Budget Management (FRBM) mandate once the immediacy of the economic crisis is addressed.
Review of past measures
The RBI expressed satisfaction over the fact that the monetary measures taken by it in terms of infusing liquidity by cutting the key policy rates (repo, reverse repo), CRR and SLR have eased the liquidity pressure in the banking system over the past few months. In totality, the actions taken by the RBI since September 2008 have resulted in augmentation of liquidity by Rs 3,880 bn. In addition, the reduction in SLR (statutory liquidity ratio) by 1% has made available additional funds to the tune of Rs 400 bn available for the purpose of credit expansion.
While not making any changes in the key policy and reserve rates, the RBI has extended the liquidity window available to banks and Non Banking Financial Companies (NBFCs) under the special refinance facility upto September 2009 as against June 2009. At the same time, the central bank has promised additional liquidity infusions, if necessary, so as to be consistent with the revised money supply projections.
While the third quarter review of the monetary policy was a non event of sorts, the RBI's random policy actions in the past suggest the central bank's strategy to take calibrated measures keeping in view India's specific economic context.