04-09-2012, 12:06 PM
RBI and its ineffective Monetary Policy
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Introduction
The Annual Policy for 2011-12 is set in conditions significantly different than they were a year ago. Last year’s policy was made in an environment of incipient domestic recovery amidst uncertainty about the state of the global economy, a perception that was reinforced with the precipitation of the Greek sovereign debt crisis a few weeks later. While signs of inflation were visible, they were driven primarily by food. However, food price pressure spilling over into more generalised inflation was clearly a risk as the recovery consolidated and domestic resource utilisation rose to levels which stretched capacities. Throughout the year, the goal of monetary policy was to nurture the recovery in the face of persistent global uncertainty while trying to contain the spillover of supply-side inflation.
The trend of moderating inflation and consolidating growth in the second and third quarters of 2010-11 justified the calibrated policy approach of the Reserve Bank. However, the resurgence of inflation in the last quarter of 2010-11 was a matter of concern. Although the trigger was the sharp uptrend in international commodity prices, the fact that these were quickly passing through into the entire range of domestic manufactured goods indicated that pricing power is significant. In other words, demand has been strong enough to allow significant pass-through of input price increases. Significantly, this is happening even as there are visible signs of moderating growth, particularly in capital goods production and investment spending, suggesting that cumulative monetary actions are beginning to have an impact on demand.
The State of the Economy
Global Economy
The global economy during the first quater of 2011 continued with the momentum of late 2010. The global manufacturing purchasing managers’ index (PMI) for February 2011 was close to a record high, while the global services PMI recorded its fastest pace of expansion in almost five years. Although these indices slipped somewhat in March 2011, they signalled continuing expansion. However, consumer confidence in major countries, which improved during January-February 2011, moderated in March 2011 on the back of higher oil prices.
GDP growth in the US, which was strong at 3.1 per cent (q-o-q seasonally adjusted annualised rate) in Q4 of 2010, slipped to 1.8 per cent reflecting a decline in government spending, deceleration in private consumption and increase in imports. Clearly, a number of weaknesses persist. The US housing market remains weak. More generally, unemployment rates continue to remain elevated in major advanced economies, albeit with some improvement in the US. Concerns about sovereign debt in the euro area have now been reinforced by developments in the US. Finally, and most importantly, commodity price increases have accelerated, engendering global inflationary fears and posing downside risks to growth.
Report of the Working Group on Operating Procedure of Monetary Policy
Following the First Quarter Review of Monetary Policy for 2010-11 (July 2010), the Reserve Bank constituted a Working Group to Review the Operating Procedure of Monetary Policy in India (Chairman: Shri Deepak Mohanty). The Report of the Group was placed in public domain on March 15, 2011 for feedback and comments.
Based on the Group’s recommendations and in the light of the feedback received, it has been decided to make the following changes in the extant operating procedures of monetary policy:
(i) The weighted average overnight call money rate will be the operating target of monetary policy of the Reserve Bank.
(ii) There will henceforth be only one independently varying policy rate and that will be the repo rate. The transition to a single independently varying policy rate is expected to more accurately signal the monetary policy stance.
(iii) The reverse repo rate will continue to be operative but it will be pegged at a fixed 100 basis points below the repo rate. Hence, it will no longer be an independent rate.
(iv) A new Marginal Standing Facility (MSF) will be instituted from which SCBs can borrow overnight up to one per cent of their respective NDTL. The rate of interest on amount accessed from this facility will be 100 basis points above the repo rate. A notification is being issued separately providing for a general waiver of default from SLR compliance