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Monetary Policy Review: RBI in neutral gear

Jul 28, 2009

Since the global financial and credit crisis intensified in September 2008, the Reserve Bank of India (RBI) has been taking necessary actions in order to cushion the economy from its worst impact. For this purpose, the bank has used a variety of instruments such as the repo and reverse repo rates, cash reserve ratio, and statutory liquidity ratio among others to infuse the much needed liquidity into the system. Now, confirming that the Rs 5.6 trillion of funds that it has released since September is enough for the time being, the RBI has maintained status quo in its 2009-10 monetary policy review announced today. The bank has kept its benchmark interest rates - repo, reverse repo, bank rate, and CRR - unchanged.

The RBI is of the belief that quick and aggressive policy responses both by itself and the government have mitigated the adverse impact of the global financial crisis. It adds that the large domestic demand bolstered by government consumption, provision of forex and rupee liquidity coupled with sharp cuts in interest rates, a sound banking sector and well-functioning financial markets have helped cushion the Indian economy from the worst impact of the crisis. And now it is seeing signs of an upturn in industrial production and revival of credit demand.

Source: RBI; As on July 23, 2009; CPI-Consumer Price Index inflation

Key projections from the RBI

  • Real GDP growth is estimated at 6% in FY10, from a growth of 6.7% achieved in FY09.
  • WPI inflation for end-March 2010 is projected at around 5%, up from the projection of 4% made in the annual monetary policy statement of April 2009. This is keeping in view the global trend in commodity prices and domestic supply constraints, especially on the food-grains front.
  • Money supply is estimated to grow by 18% in FY10, up from 17% projected in April 2009, and after a growth of 18.6% in FY09. This is assuming that the government's huge market borrowings will not crowd out private sector investments, and that the banks will increase their lending to the latter.

RBI's assessment of the overall macro situation

On world economy: At the global level, the RBI believes that the financial sector is showing some signs of stabilising, though the real economy continues to be in recession. It has indicated that in recent months, there have been some positive signals relating to consumer spending, and financing conditions. However, it adds a caveat that these signals are too tentative and weak to suggest any firm turnaround. Both households and firms are still in the process of rebuilding their balance sheets ruptured by the crisis. As such, despite some measured optimism of a turnaround sooner than expected, the RBI is of the belief that a firm recovery at the global level is unlikely before 2010. In this instance, it has cited the downward revision of global growth for 2009 by the IMF from -1.3% made in April 2009 to -1.4% in July 2009.

On Indian economy: The RBI has talked about the emergence of some signs of recovery in India since April 2009. It has cited certain factors - like increasing food stocks, improving industrial production and corporate India's performance, optimistic business confidence surveys, rising credit off-take, rebounding stock prices, and improvement in external financing conditions - to be indicative of the improvement in the overall macro picture in India.

Though it has also indicated that delayed and deficient monsoon, food price inflation, rising global commodity prices, weak exports, and high fiscal deficit pose the key risks to the economy's medium term performance. It also sees a potential build-up of inflation as a key challenge that India faces.

Source: RBI; WPI - Wholesale Price Index, CPI - Consumer Price Index,
All-All commodities, MP - Manufactured Products,
IW-Industrial Workers, AL - Agricultural Labourers

Also, while the RBI maintains that improving the investment climate - through financial sector reforms, further widening and deepening of financial markets and strengthening financial institutions - is an important task, we are yet to hear any concrete steps that the bank or the government are taking in this direction.

Overall, while the RBI has indicated of a wait and watch stance given that the Indian economy has still not shown clear signs of stability, it has clarified that it will maintain a soft interest rate regime until there are definite and robust signs of recovery.

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