RBI's Third Quarter Review of Monetary Policy 2011-12

RBI’s Third Quarter Review was announced on this Tuesday (i.e. 24.01.2012). The Press statement on the Policy Review stated that “Based on an assessment of the current macroeconomic situation, we have decided to:

Ø   Cut the cash reserve ratio (CRR) of scheduled banks by 50 basis points from 6.0 per cent to 5.5 per cent of their net demand and time liabilities (NDTL). This will be effective the fortnight beginning January 28, 2012.

Ø   This reduction in the CRR will inject around Rs. 320 billion of primary liquidity into the system.

There is no change in the policy interest rate. Accordingly, the repo rate under the liquidity adjustment facility (LAF) remains at 8.5 per cent.

          Consequently, the reverse repo rate under the LAF, determined with a spread of 100 basis point below the repo rate, will continue at 7.5 per cent, and the marginal standing facility (MSF) rate, determined with a spread of 100 bps above the repo rate, at 9.5 per cent.”

The Monetary Policy Stance said that three broad contours of our monetary policy stance. These are:

Ø   to maintain an interest rate environment to contain inflation and anchor inflation expectations;

Ø   to manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission;

Ø to respond to increasing downside risks to growth.

The RBI’s expected outcome from these policy move are as follows:

Ø First, liquidity conditions will ease.

Ø Second, downside risks to growth will be mitigated.

Ø Finally, medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation.

This time RBI had come with risks to our projections of growth and inflation for 2011-12 and it had listed Seven as follows:

1.  Sovereign debt concerns in the euro area pose a major downside risk to the overall growth outlook.

2.  Slowdown of capital flows in the face of a widening current account deficit.

3.  Global energy prices continue to pose a risk to growth and inflation due to geo-political factors and the global macroeconomic situation.

4.  There are signals of increasing risk aversion by banks, which could adversely affect credit flow to productive sectors of the economy.

5.  Inflation in respect of protein-based items remains high due to structural imbalances. In the absence of appropriate supply responses, risk to food inflation will continue to be on the upside.

6. There is a large element of suppressed inflation as domestic prices of some administered products do not reflect the underlying market conditions. Revision in domestic administered prices will add to inflationary pressures, although I should note that such revisions are necessary to maintain the balance between supply and demand. 

7. The fiscal deficit of the government could potentially crowd out credit to the private sector.  Moreover, slippage in the fiscal deficit has been adding to inflationary pressures and it continues to be a risk for inflation.

My Reflection:

          I am glad to see that RBI had finally found out some major risk factors to their Growth projections and Inflation. Hats off RBI!!!  At the same time, it’s surprised many people by cutting CRR rate by 50 basis points from 6.0 per cent to 5.5 per cent. Many people would have expected no action from RBI; but this move would have surprised many, if not many, at least me. I think it would have been better if RBI had not taken any policy measure at this juncture. The new injection of Rs. 320 billion in the economy may lead to increase in inflation again, which slowly cooling down. We need to wait and watch how the Economy reacts for this RBI's policy measure. I am also, looking Forward for the Annual Monetary Policy 2012-13 in order to know RBI’s Inflation Projections for the financial year 2012-13.