Grim economic outlook along with poor monsoon was the biggest concern last year, but for this year, inflation is the biggest challenge for the Reserve Bank of India.
Reserve Bank of India on Apr 20, 2010 has revised its policy rates and CRR by 25 bps. In response to the intimidating supply side factors, India’s inflation dynamic economic growth – as the domestic balance of risk shifts from economic slowdown to inflation, RBI decided to absorb liquidity from the market to control prices. The recovery process in the global economy persists amidst the policy support around the world. In India, RBI has forecasted the GDP growth for 2009-10 at 7.5 per cent while the CSO has forecasted the GDP growth at 7.2 per cent and may settle down in between 7.2 and 7.5 per cent.
Challenges remain in the economy, just perturbing factor has shifted from the economic slowdown to the inflation. Today, inflation is the biggest challenge for the RBI. The headline inflation – measured on WPI on year over year basis, expedited from 0.5 per cent in Sep 2009 to 9.9 per cent in Mar 2010, exceeded the RBI’s baseline projection of 8.5 per cent. Since the economic environment evolving very rapidly, the demand for non-food items also hasten which is propping-up the inflation, thus it is clear WPI is no longer driven by the supply side factors alone.
Raising substantial amount of money for the central government and at the same time, curbing additional liquidity to control prices will be a biggest challenge for the Reserve Bank of India to manage borrowings of the government during 2010-11.
During 2009-10, the Central government borrowed Rs398,411 Crores ($87.3 Billion approx.) through the market borrowing programme such as Market Stabilization Scheme (MSS) and open Market operations (OMO). This large market borrowing by the government pushing up the yields on government securities during the last financial year, however the lower demand for the credit by the private sectors and better liquidity management by the central bank has cushioned the yields. Moreover, the Union Budget for 2010-11 has begun the process of fiscal consolidation. Government budgeting to pull down the fiscal deficit to 5.5 per cent of the total GDP as compare to 6.7 per cent in 2009-10.
What would be the Possible Causes for Further Elevation in headline Inflation?
- Rise in Food as well as non-food articles as the prospect of monsoon is not yet clear.
- Rise in commodity prices poses greater risk to the inflation such as wild volatility in crude oil prices.
- Strong industrial output according to the IIP data shows the revived confidence in corporates and regaining their pricing power and building up of demand side pressure.
Initiating the fiscal consolidation process is a major positive development to enhance the monetary situation in the country as it aimed at reducing the government deficits. This will help avoid the unforeseen demand for private sector credit and would facilitate better monetary management. Nevertheless, the overall size of the government borrowing would exert pressure on the interest rates going forward.
After a series of monetary expansion during the financial crisis, Reserve Bank of India decided to curb liquidity by way of revising policy rates and CRR. In order to achieve the consolidating economic growth, RBI’s policy stance would be a meaningful step towards the resilient economic growth of the country despite the dubiety of rainfall, inflation is now become more generalized and no longer driven by supply side pressure and better liquidity management to make sure that government borrowing programme would not get hampered. In its latest monetary measures, RBI had the following plan of action for managing liquidity:
|Policy Rates as of Jun 2010|
|Reverse Repo Rate||3.75%||0.25|
|Cash Reserve Ratio||6%||0.25|
|Statutory Liquidity Ratio||25%||0|
Please read the latest VMW Research on the RBI’s Monetary Policy at VMW Blog!