The RBI kept the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8%.
The RBI in its Mid-quarter monetary policy review reduced the cash reserve ratio (CRR) of scheduled banks by 25 basis points Â from 4.75 % to 4.50 % of their net demand and time liabilities (NDTL) effective the fortnight beginning September 22, 2012. Â Consequently, around Rs. 17,000 ( USD 3.1 Billion) of primary liquidity will be injected into the banking system. The RBI kept the Â policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8%.
The RBI noted that growth continued to be weak amidst a negative investment climate but acknowledged the recent Â turnaround in sentiments due to a slew of reform measures undertaken by the Government towards fiscal consolidation such as Â reducing fuel subsidies and selling stakes in public enterprises. They believe that the increase in foreign direct investment (FDI) Â announced in key sectors would contribute to both greater capital inflows and, over the long run, higher productivity, Â particularly in the food supply chain. However, they opined that there were strong inflationary pressures, both at wholesale and retail levels.
In April 2012, the RBI frontloaded the policy rate reduction of 50 bps on the expectations of fiscal policy support for inflation management alongside supply-side initiatives for addressing the deceleration of investment and growth. As these expectations did not materialize and inflation remained firmly above 7.5% and the Reserve Bank decided to pause in its policy easing in the Mid-Quarter Review of June and in the First Quarter Review of July.
The RBI stated that as inflationary tendencies have persisted, the primary focus of monetary policy remained the containment of inflation and anchoring inflation expectations. In this context, the Governmentâ€™s recent actions have paved the way for a more favorable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI). RBI stated that problems of persistent inflation remain but as policy actions to stimulate growth materialize; monetary policy will reinforce the positive impact of these actions, while maintaining its focus on inflation management.
The RBI conceded that though the economic activity picked up modestly in Q1 of 2012-13, the sluggish momentum was evident across all sectors of the economy, particularly in industry. This was borne out by the weak Industrial production as it grew by just 0.1 % in July. In recent weeks, there has been some positive news due to a fall in the rainfall deficit as kharif sowing (summer crop) had improved and the late rains had augmented storage in reservoirs improving the prospects for the rabi (winter) crop.
On inflation front, the RBI opined that the demand-supply imbalances in respect of protein-rich items persist and the fuel price inflation picked up in August, largely reflecting the upward revision in electricity prices. Even as the overall demand pressures in the economy moderated, supply constraints and rupee depreciation have imparted pressures on prices, rendering them sticky.
While the recent upward revision in diesel prices and rationalization of subsidy for LPG is a significant achievement, in the short term, there will be pressures on headline inflation. Over the longer run, holding down subsidies to under 2 % of GDP as indicated in the Union Budget for 2012-13 is crucial to manage demand-side pressures on inflation.
On the liquidity front, the RBI stated that the wedge between deposit growth and credit growth could widen on the back of the seasonal pick-up in credit demand in the second half of the year. This, combined with outflows on account of advance tax payments and the onset of festival-related currency demand, could accentuate pressures on liquidity over the next few weeks. In these conditions, appropriate liquidity management assumes importance and this would largely explain the decision of theRBI to cut the CRR by 25 bps.
The RBI believes that the growth risks have increased even as inflation risks remain. Monetary policy has an important role in supporting the growth revival. However, in the current situation, persistent inflationary pressures alongside risks emerging from twin deficits â€“ current account deficit and fiscal deficit – constrain a stronger response of monetary policy to growth risks.
The stance of monetary policy will be conditioned by careful and continuous monitoring of the evolving growth-inflation dynamic and the management of liquidity conditions to ensure adequate flows of credit to productive sectors and appropriate responses to shocks emanating from external developments.
Overall, the monetary policy document clearly reveals a shift in language from the RBI and can be seen as an intention from the RBI to do more on the monetary policy front. Going forward, the policy rates could be nudged downwards in the coming months though the exact timing of these interest rate cuts would depend on the continuing consolidation efforts on the fiscal front.