The central bank will renew its focus on balancing the inflation versus growth paradigm at its mid-quarter policy review on September 16, a marginal but significant shift from its previous policy?s attempt to singularly try and temper inflation.
Growth versus inflation dynamics paradigm assumes importance due to global growth and domestic inflation worries.
A peep into the thinking of RBI came last week when governor D Subbarao said, ?Going forward, RBI will calibrate policy action to the evolving growth-inflation dynamics.?
This is not to say RBI won?t look at other factors such as liquidity and monetary transmission to shape its policy, but the remaining factors will be scrutinised with balancing of growth and inflation as the backdrop.
Some of the key issues highlighted by RBI at its previous policy and recent updates on the topics are:
Liquidity
* RBI?s finding in July 27 policy:
* Current market conditions indicate that while liquidity pressures will ease, the system is likely to remain in deficit mode for now
* Remedy prescribed:
* Manage liquidity to ensure that it remains broadly in balance so that excess liquidity does not dilute the effectiveness of policy rate actions
* Generate liquidity conditions consistent with more effective transmission of policy actions.
* Second set of daily liquidity adjustment facility tenders ended August 2.
* What happened after July 27:
* The improvement might be a consequence of increased the government spending
* The Centre?s cash balance with RBI slid to Rs 1 billion by August 20 from Rs 152 billion roughly a month ago
* RBI?s findings in July 27 policy:
* It is expected that even with the higher growth projection, monetary aggregates will evolve along the projected trajectory indicated in the April policy statement.? The RBI had projected M3 growth at 17%
* What happened after July 27:
* Broad money expansion remained low, decelerating to 14.8% by mid-August due to slowdown in bank deposits
Inflation
* RBI?s findings in Jul 27 policy:
* Inflationary pressures have ?exacerbated? and become generalised, with ?demand-side pressures clearly evident
* Inflationary expectations also remain at an elevated level
* Demand-side inflationary pressures need to be contained
* Imperative to continue normalising policy instruments to a level consistent with evolving growth and inflation scenario, while taking care not to disrupt the recovery
* Remedy prescribed:
* Contain inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures
* The conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5%
* Projection for Wholesale Price Index inflation for March increased to 6.0% from 5.5%
* What happened after July 27:
* Inflation continues to remain a key concern for the central bank because, despite normal monsoon, high food prices remain sticky and higher demand has led to generalised inflation
* Although headline inflation moderated to a provisional 9.97% in July, most analysts expect it to be revised upwards, as has been the trend with official statistics and data in recent months
* Late August, RBI?s Annual Report said going forward, as the monetary position is normalised, addressing structural constraints in several critical sectors is necessary to sustain growth and also contain supply-side risks to inflation
Growth
* RBI?s findings in Jul 27 policy:
* Global recovery appears to be increasingly uncertain, with possible adverse consequences for the emerging market economies (EMEs), including India
* Global growth in the second half of 2010 will be lower than that in the first half
* Domestic drivers of growth are robust. However, if the global recovery slows down, it will affect all EMEs, including India, through the usual exports, financing and confidence channels
* Should overall monsoon performance turn out to be as projected (102% of long-period average), there will be a pick-up in rural demand. This should give further momentum to the performance of the industrial sector
* GDP growth forecast for the fiscal year was raised to 8.5% from 8% with an upward bias
* What happened after July 27:
* RBI?s Annual Report said prospects of continuation of the momentum were good, ?driven by buoyant performance of the industrial sector, a better performance of the monsoon relative to last year, and sustained resilience of services
* Late August, government said India?s GDP expanded 8.8% in the first quarter of 2010-11, as was forecast by economists. In the previous three months, the expansion was 8.6% and year ago 6.0%
* India?s industrial output growth, however, moderated in June to 7.1% from 16.5% in April and 17.7% in December, mainly owing to higher base effect
* Although concerns about a possible weakening of global recovery persist, domestic risks to growth have receded
* The Annual Report warned persistence of risk aversion among global investors due to uncertain global environment could make capital inflows more volatile
Monetary transmission
* RBI findings in Jul 27 policy:
* Transmission of monetary policy through rate actions works most effectively when liquidity is being injected by the central bank, rather than when it is being absorbed
* Introduction of base rate system for banks? lending is expected to help in transmission
* The narrowing of the LAF corridor was expected to reduce volatility in interest rates
* What happened after July 27:
* Banks raised term deposit rates 25-200 basis points and benchmark prime lending rates by 50 bps
* The report said going forward narrowing of the LAF band (the difference between the repo rate and reverse repo rate that was initiated in Jul 27 policy with a larger increase in the reverse repo rate) will contribute to the intended anti-inflationary stance even if the LAF returns to the reverse repo mode?that is surplus liquidity situation?temporarily