RBI for balancing between risks to growth and inflation

Unlikely to cut key policy rates today

The Reserve Bank of India (RBI), on Monday, released the Macroeconomic & Monetary Developments third quarter review 2011-12 wherein its stance is that the growth outlook has weakened and inflation risks remain.

The macro document released by RBI in the evening, which serves as a backdrop to the Monetary Policy Statement to be announced by the apex bank on January 24, 2012, also noted that the Growth outlook has weakened as a result of adverse global and domestic factors.

However, RBI stated, inflation and expectations of inflation remain high and upside risks emanate from exchange rate pass-through, revisions in administered prices and higher-than-expected government revenue spending. Consequently, it said that monetary actions will need to strike a balance between risks to growth and inflation.

Consequently, bankers over there may not see much action in terms of rate cut in the RBI's 3rd quarter review of monetary policy to be announced on Tuesday. Further, the apex bank maintained that the growth in 2011-12 is moderating more than was expected earlier. The business climate has weakened, while the slack in investment and net external demand may keep the pace of recovery slow in 2012-13, it said.

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 supply bottlenecks, this will be, at best, a temporary respite, the apex bank said. In addition, the expansionary fiscal stance has emerged as an upside risk to inflation, RBI maintained.

On global economic conditions, RBI viewed that the economy seems to be headed for another downturn after just three years.  The recovery is likely to lose traction due to the continuing euro area debt crisis. As fiscal austerity progresses, RBI said the euro area could enter into a recession. With growth decelerating even in emerging and developing economies (EDEs), the spillovers from euro area are likely to pull down global growth.

An adverse feedback loop between bank and sovereign debt brought euro area closer to contagion across the region. Tightening credit conditions, rising risk premia, deleveraging, weakening growth in the euro area are keeping global financial markets under stress.

Going forward, further softening in commodity prices on the back of weaker global growth is likely in 2012-13. However, upside risks to the oil price remain, including from recent geo-political uncertainty. On Indian economy, RBI said even as global linkages reinforce domestic factors to slow down economy, agricultural prospects remain encouraging but moderation is visible in industrial activity and some services. Industrial slack has emerged as export and domestic demand has decelerated.

A strong co-movement between domestic and global IIP series is observed. The RBI survey shows significant growth in new orders for some industries, but flat capacity utilisation in Q2 of 2011-12.

RBI also stated that external and investment demand may drag.  Private consumption continues to moderate. There has been some slackening of corporate sales growth, reflecting a gradual waning of demand. However, available early results for Q3 this fiscal indicate healthy sales growth.

RBI also noted that the Centre’s deficit indicators are under duress due to higher subsidies and lower tax collections. Fiscal slippages during 2011-12 may complicate the task of aggregate demand management. Therefore, RBI added, fiscal reforms, including the Direct Tax Code and the Goods and Services Tax are needed to contain deficits in 2012-13.