Mumbai: The Reserve Bank of India (RBI) is fairly upbeat about an economic recovery, but the optimism is laced with caution. The central bank is concerned that the speed of the recovery may be retarded by factors ranging from global uncertainties to a weak monsoon.
Mint’s Deputy Managing Editor Tamal Bandyopadhyay gives an audio synopsis of the Macro economic review
RBI’s macroeconomic review of the first quarter of fiscal 2010, released on Monday, one day before it unveils its quarterly monetary policy review, indicated a dramatic turnaround in business sentiment, based on the industrial outlook survey it conducted in April-May.
But the central bank refrained from raising its economic growth forecast, which many believed RBI would do in its review. In its annual monetary policy in April, RBI had projected 6% growth for India’s gross domestic product (GDP). Similarly, RBI also did not raise its 4% projection for wholesale priced-based inflation by the fiscal year-end although many analysts and economists are now convinced that the inflation rate would exceed the central bank’s forecast.
Instead of committing itself to higher growth and higher inflation and revising its April projections, RBI’s review simply presented both sides of the story: while there are telltale signs of an economic recovery and a possible rise in inflation, it’s too early to say that the economy is back on the high growth path.
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Persistent global uncertainties and a decline in consumer demand are the two key factors that the Indian central bank is keenly watching.
Apart from an uncertain outlook for the monsoon, the biggest worry for RBI is a slowdown in credit growth.
“For achieving the higher growth objective, credit flows to the private sector must...increase from the current depressed levels,” the survey said and made it clear that “the monetary policy response... would require continuous coordination with fiscal policy.”
In Parliament on Monday, finance minister Pranab Mukherjee announced fresh tax giveaways for housing to further boost housing demand in the economy, especially in second tier cities. The budgetary support in the form of a 1% subsidy on the interest rates paid by people with a home loan of up to Rs10 lakh would cost the exchequer Rs1,000 crore in the current fiscal year.
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Shubhada Rao, chief economist at Yes Bank Ltd said, “Recovery will gather momentum. We expect the RBI to revise its growth forecast by 50 basis points to 6.5%. (Economic) growth will pick up in the second and third quarters.” A basis point is one-hundredth of a percentage point.
According to Saugata Bhattacharya, economist at Axis Bank Ltd, maintaining growth impulses while ensuring price stability and keeping inflationary expectations in check is the key challenge facing RBI.
He expects RBI to maintain status quo on key policy rates in its quarterly review, but does not rule out the “possibility of a 25 basis points cut in reverse repo rate to spur bank credit.’’
Since October 2008, RBI has cut its cash reserve ratio, or the portion of deposits that banks are required to maintain with the central bank, by 400 basis points to 5%; the repo rate, or the rate at which it infuses liquidity in the banking system, by 425 basis points to 4.75%; and the reverse repo rate, or the rate at which is drains liquidity from the system, by 275 basis points to 3.25%.
The RBI review has listed many positive economic indicators that show that the growth story is back. For instance, industrial production data was positive in April and May and the growth in infrastructure in April-June was encouraging; cement production is also on the rise.
Some forward looking indicators in the services sector such as new cellphone connections, tourist arrivals and railway freight earnings are also positive.
RBI’s industrial outlook survey conducted in April-May suggested significant improvement in the respondents’ “assessment for April-June 2009” and “expectations for July-September 2009” by 20.3% and 14%, respectively, over the previous survey conducted during January-March.
At the same time, there are many bad omens and a weak monsoon is at the top of this list. Exports continue to decline and so do non-oil imports.
Ambiguity also persists on RBI’s inflation outlook at this point. While the base effect and a possible increase in food prices and higher global commodity prices, particularly oil prices, will fan inflation, the review said it will not be affected if global recession persists and deepens, and despite a delayed monsoon, agriculture growth remains unaffected.
Also, if it starts withdrawing its “accommodative” monetary policy, it will have a positive impact on inflation. Excess liquidity puts pressure on inflation, but RBI can start withdrawing its accommodative policy only when it is confident that the country is on a firm growth path. To that extent, growth and inflation are intricately linked.
“Recovery in the economy is likely to put pressure on inflationary expectations. The central bank will revise its inflation target upwards on the back of increases in international commodity prices during the first quarter of 2009-10 and changing domestic supply conditions,” said Rao of Yes Bank.
Anup Roy contributed to this story.