The Reserve Bank of India (RBI) on Monday said weakening economic growth prospects would provide “some space for the monetary policy” to address the concerns amid slowing inflation. However, it was quick to add a rider that the two critical factors in rate actions ahead would be core inflation and the exchange rate pass-through.
Though headline inflation in December was at a two-year low and in line with the central bank’s projection of seven per cent by March-end, non-food manufacturing inflation remained high, reflecting input cost pressures. According to the central bank, moderation in the growth momentum and subdued international commodity prices are expected to ease the inflationary pressures in non-food manufactured products, though the pace of moderation will depend on exchange rate changes and its pass-through to domestic prices.
The rupee, which depreciated around 18 per cent in 2011, has exerted pressure on inflation as the country imports most of its oil requirements. RBI also said the expansionary fiscal stance of the government had emerged as an upside risk to inflation.
The central bank will review its policy stance tomorrow and the house is divided on the possible outcome of the meeting. While economists ruled out a cut in the key policy rate, market participants are looking for some RBI action to get some respite from the high cost of money.
RBI also said it may resort to ‘additional instruments’ to ease liquidity pressures. RBI has been conducting open market operations to infuse liquidity and the earlier position was not to reduce the cash reserve ratio at a time when inflation was near the double-digit mark, which would have contradicted the anti-inflationary stance.
“While admitting liquidity conditions are tight, RBI is likely to pursue measures other than a CRR cut to tactically manage liquidity. For one, the SLR requirement could be reduced, so that banks currently availing the MSF facility could use the repo window instead,” said Sajjid Chinoy, India economist, JPMorgan.
“Additionally, RBI is likely to signal continuing open market operations so that liquidity stresses are contained till March, even without a CRR cut,” he said.
“Growth is moderating on account of large linkages of the manufacturing sector with global demand, investment uncertainty and high interest rates… The downside risks to growth in 2011-12 and the next year emanate from the possible recession in the euro area, deceleration in export growth in recent months, the lagged impact of weak investment activity and uncertainty with regard to availability of crucial inputs such as coal,” RBI said in the macroeconomic and monetary development report released a day ahead of the policy review.
The central bank had revised its growth estimate to 7.6 per cent from eight per cent. GDP growth moderated for the sixth consecutive quarter to 6.9 per cent in Q2 of 2011-12, the lowest growth in the last nine quarters. The central bank said though industrial growth rebounded in December, yet there were doubts on sustainability as it was due to a seasonal spurt in consumer non-durables and capital goods output, which remain volatile on a month-to-month basis.
Though RBI said the monetary policy would support growth as moderation in inflation provided the opportunity, it warned sustainable growth policy reforms were required to eliminate supply-side bottlenecks.
“While in the short run, moderating inflation will provide some space for monetary policy to address growth concerns, in the absence of structural measures to address a range of supply bottlenecks, this will be, at best, temporary respite,” RBI said.
The central bank unequivocally sounded the government on the need to unleash reform measures for a turnaround in growth in 2012-12. RBI emphasised on the need for cutting the government’s consumption expenditure and stepping up its capital spending to lift both current and future growth. “This will help the economy get back to higher potential growth that it had realised in the pre-crisis period,” it said.
It also said for the revival of business optimism, fiscal imbalances needed to be contained to provide more room on the monetary side. Implementation of the Direct Taxes Code has been described as critical to increase the tax revenue. It has also said a consensus needs to be built for the successful roll-out of the Goods and Services Tax in order to improve tax buoyancy and reliance on temporary measures such as disinvestment cannot be avoided. Even if growth is slowing down, RBI expects some recovery in the current quarter. “On the upside, as inflation decelerates, we could see a revival of demand and a pick-up in the momentum of production activity. If inflation recedes, the revival could be supported by the monetary policy,” it said.
