RBI has raised bank ratios again by 25 basis points in its November 2 policy review. It has lifted the repo rate, at which it lends to banks, to 6.25 percent and the reverse repo rate, at which it absorbs excess cash from the system, to 5.25 percent. RBI has discussed global and domestic scenarios in its second review of monitory policy 2010-11.
The Global Economy
RBI has noted that though the IMF revised upwards its forecast for world growth in its October 2010 World Economic Outlook from 4.6 to 4.8 percent, growth in advanced economies like the US and Japan has been still sluggish. Unemployment, modest income growth, lower housing wealth and tight credit were impediments for the US growth, RBI said. It noted that slowdown in industrial production and exports’ growth reflected the moderation of economic recovery in Japan.
However, the Euro region is showing signs of resilience in the aftermath of the sovereign debt crisis which is again uneven. RBI has said the growth in the Emerging Market Economies (EMEs) continued to be strong. It has particularly pointed out that the strength of the EMEs is led by domestic demand but supported by exports, indicating that without the exports’ support, the growth could be weaker.
The Domestic Economy
RBI says India’s growth set in second half of last fiscal year, is consolidating with Q1 growth recording at 8.8 percent. It expects normal South-West monsoon will contribute to increase in Agricultural production. RBI and Planning Commission have been telling for last one and half years that the normal monsoon will help reduce the stubborn inflation, which is proved wrong. It seems they still do not find any fresh reason for showing as pretext for high inflation.
Industrial growth has been robust but volatile with average figure of 10.6 percent during April – August 2010. Volatility suggests deceleration but momentum is continuing. Direct and indirect taxes increased over the last year.
(I) Inflation Front
Inflation stood at 8.6 percent in September 2010, an increase from 8.5 percent in August. Overall food price inflation remains still higher at 15.7 percent. (RBI attributed this to growing demand for protein-based food items such as pulses, milk, eggs, fish and meat the inflations of which stood at 23.9 percent at in September. It seems RBI has found a minor pretext for high inflation but yet to find a major one.)
Inflation of non-food manufactured products grew from -2.0 percent in September 09 to 5 percent in September 10, a whopping 7 percent rise. Overall non-food items inflation rose from -2.9 percent in Sept. 09 to 7.8 percent in Sept. 10, a sharp rise of 10.7 percent.
Inflation based on CPI for industrial workers understate the underlying inflation. It is because it doesn’t take into consideration the shift of consumption pattern from cereals to protein-rich food items where price increase is high.
Money supply growth moderated to 14.5 percent as on October 8 from 16.8 percent at the end of March, owing to negative real interest rates for bank deposits thereby reducing the bank deposits and investing money in other assets like gold and real estate.
Base rates of major commercial banks that account for 94 percent of total bank credit are in the range of 7.5-8.5 percent in October after increase of 10-50 basis points from July figures.
Though the RBI has been increasing its bank rates, its liquidity injection through “Liquidity Adjustment Facility” has been on rise since Sept. 10, with an average daily net injection of around Rs. 24,000 Cr in Sept. and Rs. 61,700 Cr in October. The peak injection of Rs. 128,685 Cr was on Oct 30.
(II) Revenues and Expenditure
Fiscal consolidation is in line with RBI’s policy targets set out in the beginning of the fiscal year, as overall revenue realization has increased contributing to reduction in fiscal deficit. In this background the RBI has made an important suggestion, i.e. “The focus must be as much on expenditure restructuring as on revenue augmentation, recurring expenditure commitments should not be made against one off revenues such as from disinvestment (emphasis added) and the quality of adjustment should not be lost sight of.”
(This is somewhat a mild spat on government’s intention of reducing fiscal deficit through one off disinvestment, rather than using it for revenue generation or in productive sectors. Of course, this will not detract the government from its accelerating mode of disinvestment.)
(III) FIIs inflows
Large inflows of FIIs helped firming up of domestic equity prices driven by better domestic growth prospects and availability of global liquidity.
(Actually, global liquidity is flowing towards domestic equities in the form of FIIs in search of better returns as equities of developed economies are lagging behind EMEs in returns. Given the high degree of volatility of FII flows, the flow of FIIs is temporary phenomenon and it cannot be taken into consideration for policy review.)
As on October 22, 2011, the rupee appreciated by 0.4 percent on the basis of trade based 36-currency real effective exchange rate (REER) and by 3.1 percent on the basis of 6-currency trade based REER. (The RBI suggested to consider the former and to ignore the latter. Moreover, it is suggesting to ignore a fact that the foreign reserves are maintained in six major currencies but not in 36 trading partners’ currencies.)
(IV) TD and CAD
Exports decreased due to continuing sluggishness of the global economy, while imports growth accelerated due to domestic recovery. Both contributed to widening of trade deficit (TD) and current account deficit (CAD). CAD as a percentage of GDP will significantly be higher than the previous year, may be far more than the healthy CAD limit of 3 percent. This could be a challenge in short term and medium term for government as well as the RBI.
In its global outlook, the RBI admits global slowdown in the second half of current year and first half of 2011 would adversely impact EMEs including India through trade linkages. RBI observes that the room to provide additional fiscal stimulus to support the growth remains constrained due to debt sustainability issues in some major advanced economies. It says the upward risk to inflation has increased for EMEs both from rising domestic capacity utilization and from global commodity price increases.
As part of the domestic outlook the RBI retains the baseline projection of real GDP growth for 2010-11 at 8.5 percent as set out in July 10 policy review. The RBI suggests a dangerous observation, “Given the changing consumption patterns and as yet inadequate supply response, food price inflation is becoming increasingly structural in nature. Further, even as non-food manufacturing inflation has indeed moderated, it still remains above its medium-term trend.” It seems the RBI is preparing a ground for sustainability of higher food inflation by stating that the food price inflation is becoming increasingly structural in nature.
RBI says, the inflation outlook is shaped by three main factors: food price inflation, rising global commodity prices and demand pressures arising from sustained growth. WPI inflation projection for March 2011 remains at 5.5 percent based on new series of WPI (taking 2005-06 as 100), which is equivalent to 6.0 percent based on old series of WPI.
RBI’s policy review is mainly directed toward satisfying the interests of market players rather than improving the living standards of working people and reducing the poverty and indebtedness of the poor. Financial Conglomerates, FDIs, FIIs, national wealthy investors are taken care of while leaving out farmers, workers and vast masses of agricultural laborers. Ironically, those who are left out are the main wealth generators.