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RBI Hints at policy ease for growth

The Reserve Bank of India, in its mid-quarter policy review, as 2012 winds down, has left all key rates of interest unchanged but provides a clear indication of a shift to easing policy to support growth, if current pace of moderation in inflation is maintained going into 2013. A tangible move in this regard is likely in RBI’s Third Quarter Policy Review on 29 January.

RBI has not further brought down the CRR, as widely expected, despite tight liquidity conditions in the third quarter attributable to large government balances with the central bank and the widening wedge between deposit and credit growth. RBI has, however, been injecting primary liquidity through its open market operations in December.

The mid-quarter review keeps rates as they are: the repo rate - key lending rate - at 8 per cent, reverse repo at 7 per cent and MSF and Bank rate at 9 per cent. The Cash Reserve Ratio (CRR), which was twice brought down over the last three months is unchanged at 4.25 per cent of net demand and time liabilities of scheduled commercial banks.

The central bank’s brief review of trends since its second quarter review statement of 30 October does not exactly match the optimistic overtones on inflation and growth reflected in the finance ministry’s mid-year review presented to Parliament on 17 December. It does see growth evolving along with its revised baseline projection of 5.8 per cent and government’s latest projection is also in the range of 5.7 - 5.9 per cent in 2012-13 which, the FM review said, would require both fiscal and monetary policy being supportive.

The recent policy initiatives by the government and further reforms should help to boost business sentiment and improve the investment climate, RBI has noted. Depending on how growth-inflation dynamics evolves in the current quarter and into January, when both the latest industrial output for November and inflation data for December would be available, RBI would update its own growth and inflation projections for 2012-13 in its Third Quarter Review on 29 January.

It remains to be seen how far inflation trends down for RBI to re-fix its comfort zone for core inflation to guide its monetary policy stance in the next fiscal year.

Headline WPI inflation edged down to 7.2 per cent in November, but retail inflation remains elevated, especially food inflation. While headline inflation has been below the Reserve Bank’s projected 7.5 per cent, and core inflation is also somewhat comforting, whether these trends would continue over the next two months would determine the degree of policy accommodation that could be extended to support growth.

By deferring any immediate shift toward easing its current policy stance focussed on inflation to a greater extent, as government certainly desires, RBI would be able to gauge what further steps the government would be taking in the coming weeks to strengthen the fiscal position in order to make its deficit target of 5.3 per cent of GDP in the current year more credible.

This is a key area of the economy - watched by both international investors and global rating agencies which have warned of a possible downgrade in sovereign credit in the absence of effective fiscal consolidation and growth revival. The recent policy initiatives by the government and further reforms should help boost business sentiment and improve the investment climate. Also, a major concern for government and central bankers is the global outlook with the eurozone debt crisis and the US Fiscal Cliff at the turn of the year. Unless resolved before the end of the year, the Fiscal Cliff in the world’s largest economy could trigger another recession.

How the threat is averted would depend on current talks between President Obama and Republicans which would meet the aims of both sides. President Obama wants continuation of tax cuts for those in incomes below 250,000 dollars, i.e. 98 per cent of tax-payers or the middle class while allowing these Bush era tax cuts to expire on 1 January in the case of higher incomes. Republicans want deeper spending cuts in the Federal budget and a new ceiling for US debt which is now close to a little over 16 trillion dollars.

As RBI notes, the biggest risk to the outlook for all countries stems from ‘political economy considerations that could impede, delay or erode resolute policy action’ and the consequences could be ‘deepened financial stress and heightened risk aversion’. Already, the outlook for global trade remains depressed and capital flows volatile. To the extent these major global problems get resolved in the coming weeks, the outlook for world economy in 2013 would brighten and it would help emerging economies like India, in particular, short of capital flows to balance its deficits and finance investments. (IPA)
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