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Third quarter review of Indian monetary policy 2009-10

Contributed by Nirmal Bang

By Nirmal Bang

Cash Reserve Ratio increased by 75 basis points

The Reserve Bank of India (RBI) increased cash reserve ratio by 75 basis point to 5.75 %, which will be adopted in two stages; first stage comprising of increase of 50 basis points will be effective from the fortnight beginning February 13, 2010, followed by next hike of 25 basis point effective from the fortnight beginning February 27, 2010. The rise in CRR will result in curbing liquidity to the extent of approximately Rs.36,000 crore. Meanwhile SLR, repo and reverse repo rates have been left unchanged.

GDP growth forecasted higher at 7.5%

The central bank has revised its growth estimate for 2009/10, to 7.5% from earlier 6%. Forecast has assumed a near zero percent growth in agricultural production and continued recovery in industrial production and services sector. However, it is expected that the economy might witness a slower GDP growth in third quarter as compared to second quarter primarily on account of the impact of the deficient south©\west monsoon rainfall on kharif crops.

Credit & Deposit growth revised downwards

During the year (as on January 15, 2010), money supply growth has moderated from 20% in the beginning of the financial year to 16.5%, reflecting deceleration in the bank credit growth. Non food credit growth after witnessing a slowdown in the previous quarters, stood at 14.4% (as on January 15, 2010) compared to 21.9% in the corresponding period previous year. However, considering total flow of financial resources from banks, domestic non©\bank and external sources to the commercial sector which stood at Rs. 5,89,000 crore, was marginally lower than Rs.5,95,000 crore in the corresponding period of the previous year. This depict that non©\bank sources of finance have significantly mitigated the impact of the slowdown in the bank credit outflow. Going forward, in the view of availability of funds from non©\bank and external sources, 18 % growth in the non food credit is unlikely. Therefore, RBI has lowered its projection for credit growth at 16% as compared to 18% and deposits growth at 17% as compared to 18% in the second quarter review.

WPI inflation projected at 8.5% per cent by end©\March 2010

Keeping in view the global trend in commodity prices and domestic demand©\supply, the baseline projection for WPI inflation at the end ?CMarch 2010 is placed at 8.5% as compared to 6.5% projected in the second Quarter review. Deficient monsoon and drought conditions in several parts of the country have accentuated the pressure on food prices, pushing up the overall inflation rate. Additional factors like rising crude prices and demand side pressures have added to upward pressure on WPI inflation. However, RBI expects inflation to moderate from July 2010 based on the assumption of normal monsoon and global oil prices remaining around the current level.

Government borrowing programme on the verge of completion

Measures taken by RBI such as front loading of the government borrowing programme, unwinding of MSS securities and OMO (open market operations) purchases, resulted in over 98% of the net market borrowing programme of the Central Government for 2009©\2010, completed by January 28, 2010. Therefore, it can be safely assumed that the anticipated increase in credit demand by the commercial sector in the remaining period of 2009©\10, can be easily supported from the market as adequate liquidity is available in the system.

Conclusion

According to IMF, global GDP is expected to witness a revival going forward. In addition, it is anticipated that emerging economies like India will witness a faster recovery. Considering these expectations and GDP growth in the previous quarters, central bank has increased GDP forecast. However, the economy is also facing a risk of spill©\over in inflation from supply side to demand side which can become a hurdle in smooth functioning of the country. Therefore, with increase in CRR, RBI has signaled constant effort to focus on the challenge of boosting economic growth along with maintaining price stability to keep inflation under control.