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RBI repo cuts to push growth?

A fter delivering some grim messages with a sombre outlook for the economy in 2013-14 in its Macro-Economic Survey, the Reserve Bank has kept up with policy easing to address risks to growth, albeit with a quarter percentage point cut in key lending rate, Repo, lowering it to 7.25 per cent with immediate effect.

The Cash Reserve Ratio (CRR) has been retained at 4 per cent of net demand and time liabilities. Other policy rates have been adjusted—reverse repo at 6.25 per cent and bank rate and marginal standing facility at 8.25 per cent each. RBI says it would ‘appropriately manage’ liquidity to ensure adequate credit flow to the productive sectors of the economy.

But the tenor of the Annual Monetary Policy Statement on 3 May is weighted against a likely resurgence of inflationary pressures during the year - with high food prices persisting, supply constraints being endemic and fuel price corrections releasing suppressed inflation.  This could lead to a generalisation of inflation and strains on the balance of payments, with the already widened current account deficit, it cautions.

The Reserve Bank’s current assessment is for activity to remain subdued during the first half of this year with a modest pick-up, subject to appropriate conditions ensuing, in the second half of 2013-14. Its base-line growth projection is 5.7 per cent for 2013-14 reflecting subdued growth in both industry and services and exports remaining sluggish. Even this order of growth is conditional upon a normal monsoon and agricultural growth returning to trend levels.

RBI’s projection is the lowest of GDP estimates for the year from among both global and leading forecasters.  IMF had projected 5.8 per cent and the World Bank 6.1 per cent. The Policy Statement underlines that unless tightening supply constraints are unlocked and productivity and competitiveness emerge, growth could weaken further along with resurgence of inflationary strains.

WPI inflation during 2013-14 is expected to be ‘range-bound’ around 5.5 per cent. While inflation may edge down in the first half from past policy actions, there could be some increase in the latter half, largely reflecting base effects. RBI says it would endeavour to condition the evolution of inflation to a level of 5.0 per cent by March 2014, ‘using all instruments at its command’.

At the same time, RBI has not ruled out policy recalibration ‘in either direction’ if headline inflation remains above the threshold - 5 to 5.5 per cent - and consumer prices also remain elevated, the combined effect of which would limit monetary space for accommodation.  Also, monetary policy by itself cannot revive growth and has to be supplemented by efforts to ease supply bottlenecks and step up public investment in infrastructure.

A major risk cited by RBI which would put it on alert relates to current account deficit and its financing which could warrant ‘a swift reversal of the policy stance’.

The risks from current account deficits are heightened by the uncertainty of growth outlook in advanced economies and a global liquidity situation which could alter for emerging economies including India exposing them to sudden stop and reversal of capital flows.

The Macro-economic Survey has also entered caveats about the current extent of dependence on external commercial borrowings and short-term debts for financing current deficits, and it has noted that private sector external debt has become large. Some prudence, therefore, is enjoined on these flows.  Private forecasts for CAD are around 4.5 per cent of GDP in 2013-14.

While the fiscal deficit is targeted at 4.8 per cent of GDP in 2013-14, even it may be large which can potentially spill over into CAD and undermine its sustainability further, according to RBI. Such a large CAD would strain servicing of external liabilities, it points out.

Overall, the balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing. Given the limitations of monetary policy to revive growth, the Macro-economic survey has called for public investment in infrastructure to crowd in private investment, i.e. a stimulus, it says, which could be rebalanced by revenue spending cuts.  

Such a key to the economy’s revival has to be achieved while adhering to the fiscal consolidation trajectory.

On Developmental and Regulatory Policies for 2013-14, the Policy Statement assesses the progress made on past policy announcements including on financial stability, and sets out the policy initiatives in key areas which include strengthening of financial market infrastructure and improving credit flow to productive sectors.

Revised guidelines have been issued for priority sector advances and loans to micro and small enterprises (MSEs) in the services sector whose maximum would be increased from Rs. 20 million to Rs. 50 million per borrower. RBI has also detailed plans for financial inclusion and direct benefits transfer via bank accounts.

On Gold, in order to reduce the demand for domestic use, RBI has decided to restrict the import of gold on consignment basis by banks only to meet the genuine needs of exporters of gold jewellery. It is also proposed to restrict the facility of advances against the security of gold coins per customer to gold coins weighing up to 50 gms. Detailed guidelines on imports as well as loans against coins would be issued by end-May 2013.

As a follow-up to the guidelines on Licensing of New Banks in the Private Sector issued in February 2013. RBI will issue a policy discussion paper on the banking structure for comments by end-June 2013. (IPA)
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