Third Quarter Review of Indian Economy

This morning (25.01.2011), the Reserve Bank of India (RBI) released its Third Quarter Review of Monetary Policy for 2010-11. In its Third Quarter Review the RBI has stated that "Inflation is clearly the dominant concern. Even as the rate itself remains unacceptably high, the reversal in the direction of inflation is striking."  Keeping in view to curtile raising inflation, it had increased the repo and reverse repo rates by 25 basis points (bps) each. Therefore the curremt repo rate stands at 6.5 per cent and the reverse repo rate at 5.5 per cent; whereas, it had retained the cash reserve ratio (CRR) at 6 per cent of net demand and time liabilities (NDTL) of banks.

With the increases announced today, since mid-March 2010, the Reserve Bank has cumulatively increased the repo rate by 175 bps and the reverse repo rate by 225 bps. Additionally, the CRR was increased by 100 bps. In addition to changes in the policy rates, it had made some decisions to manage the current liquidity situation. It had decided that the additional liquidity support to scheduled commercial banks under the Liquidity Adjustment Facility (LAF) to the extent of up to one per cent of their NDTL; and a daily second LAF up to April 8, 2011.

RBI has revised the baseline projection of Inflation (WPI) rate from 5.5% to 7% for March 2011-12. It also stated that there was a rapid credit growth without commensurate increase in deposits is not sustainable. It also expects that the Current Account Deficit for the whole year (2010-11) would be around 3.5% of the GDP, which is not sustainable.

(Source: RBI website)

Interestingly, Finance Minster of India said that, "There are inflationary pressures in India and the government will have to begin supply-side management to tackle food inflation" He also stated that "Central bank rate hike is in line with the government's thinking and policy." 

If we look at the policy, then we can understand one thing in general; that is Food Inflation is really a greater concern for both RBI and Finance Ministry. In my view, the RBI move of hiking the repo and reverse repo rate will not have much impact on Inflation. The Government has to find out the exact reason for rising food prices and should take necessary step to curtail it.

Now, there are few other worrying scenario like Credit Deposit ratio, Current Account Deficit which are rightly mentioned in the Third Quarter Review. Another greater concern is India's External Debt. The ratio of short-term to total external debt stood at 22.3 % at end-September 2010 against 20.0% at end-March 2010. The ratio of short-term external debt to foreign exchange reserves was 22.5 % at end-September 2010 as compared to 18.8 per cent at end-March 2010.

It is very early to say that the increase in Repo and Reverse Repo Rate will have impact on Inflation. Finance Minister rightly said that there should be supply-side management for controlling Inflation. But, we need to wait and watch how the current monetary policy will help to control Inflation and stabilise the growing credit.

Debt Ceiling: A Brief Note

Nowadays, we often hear the term “Debt Ceiling” in many newspapers when they try to describe about the Government policy. What is debt ceiling? A "debt ceiling" is the maximum amount of debt that a government can take. In simple term, there is a limit, where government freezes their debt.

Why there should be a Debt Limit? The Main purpose of the debt ceiling is to try to limit out-of-control spending of the Government. In other words, debt ceiling is required to encourage more thrift and to have economically sound fiscal management.


Debt Ceiling and India: After almost a two decade of large fiscal deficits, India has adopted a rules-based fiscal framework in 2003 called the Fiscal Responsibility and Budget Management Act (FRBMA), with the objective to ensure intergenerational equity in fiscal management and the fiscal sustainability necessary.


According to FRBM ACT 2003 there are 4 Annual targets:


1. By 31st March 2008, the Central government shall reduce revenue deficit by an amount equivalent of 0.5 per cent or more of the GDP at the end of each financial year, beginning with 2004-05.


2. The Central Government shall reduce the fiscal deficit by an amount equivalent of 0.3 per cent or more of the GDP at the end of each financial year, beginning with 2004-05, so that, the fiscal deficit is brought down to not more than 3% of GDP at the end of March 2008.


3. The Central Government shall not give guarantees aggregating to an amount exceeding 0.5 per cent of GDP in any financial year beginning with 2004-05.


4. The Central Government shall not assume additional liabilities (including external debt at current exchange rate) in excess of 9 % of GDP for the Financial Year 2004-05 and in each subsequent financial year, the limit 9% of GDP shall be reduced by at least 1 percentage point of GDP.

(Source: FRBM ACT, Ministry of Finance)


          India’s fiscal deficit for 2009-10 had increased to 6.6 per cent of the GDP due to Stimulus Package made by Government for recovery from Global Meltdown. The Government has projected that the fiscal deficit would come down to 5.5 per cent of GDP in 2010-11.