RBI's Annual Policy Review

As expected today RBI reduced the repo rate [rate at which RBI lends to banks] & reverse repo rate [rate at which banks lends/deposit to/with RBI] by 25 basis points to 4.75% from 5% & 3.25% from 3.5% respectively.

Apart from these few other important things from RBI policy reviews are as follows...

After clocking annual growth of 8.9 per cent on an average over the last five years (2003-08), India was headed for a cyclical downturn in 2008-09. But the growth moderation has been much sharper because of the negative impact of the crisis. In fact, in the first two quarters of 2008-09, the growth slowdown was quite modest; the full impact of the crisis began to be felt post-Lehman in the third quarter, which recorded a sharp downturn in growth. The services sector, which has been our prime growth engine for the last five years, is slowing, mainly in construction, transport and communication, trade, hotels and restaurants sub-sectors. For the first time in seven years, exports have declined in absolute terms for five months in a row during October 2008-February 2009. Recent data indicate that the demand for bank credit is slackening despite comfortable liquidity in the system. Dampened demand has dented corporate margins while the uncertainty surrounding the crisis has affected business confidence. The index of industrial production (IIP) has been nearly stagnant in the last five months (October 2008 to February 2009), of which two months registered negative growth. Investment demand has also decelerated. All these indicators suggest that growth will moderate more than what had been expected earlier.

You can see how the 3rd quarter has become disaster due to NEGATIVE growth in Agriculture & heavy slowdown in the industry sectors. You can click on the image for enlargement.




Business Confidence:

The Industrial Outlook Survey of the Reserve Bank for January-March 2009 indicates a further worsening of perception for the Indian manufacturing sector. The overall business and financial sentiment, which touched a seven-year low in the preceding quarter, slid below the neutral 100 mark, for the first time since the compilation of the index began in 2002. According to the survey, the demand for working capital finance during January-March 2009 from external sources dropped due to slowdown in business, even as the availability of finance eased. The business confidence surveys conducted by other agencies are also consistent with these findings.

Inflation



The analysis of the last four years suggests that WPI inflation and CPI inflation moved, by and large, in tandem till April 2007. Thereafter, inflation measured in WPI and CPI tended to diverge. However, the divergence in the recent period has been unusually high reflecting the volatilities in commodity prices which have a higher weight in WPI. With the decline in WPI inflation, CPI inflation is expected to moderate in the coming months. For its overall assessment of inflation outlook for policy purposes, the Reserve Bank continuously monitors the full array of price indicators.

Monetary Conditions

Growth in key monetary aggregates – reserve money (RM) and money supply (M3) – in 2008-09 reflected the changing liquidity positions arising from domestic and global financial conditions and the monetary policy response.

Reduction in the CRR has three inter-related effects on reserve money. First, it reduces reserve money as bankers’ required cash deposits with the Reserve Bank fall. Second, the money multiplier rises. Third, with the increase in the money multiplier, M3 expands with a lag. While the initial expansionary effect is strong, the full effect is felt in 4-6 months.

Bottom line:

Growth Projection

The India Meteorological Department in its forecast of South-West monsoon expects a normal rainfall at 96 per cent of its long period average for the current year. The fiscal and monetary stimulus measures initiated during 2008-09 coupled with lower commodity prices could cushion the downturn in the growth momentum during 2009-10 by stabilising domestic economic activity to some extent. However, any upturn in the growth momentum is unlikely in view of the projected contraction in global demand during 2009, particularly decline in trade. While domestic financing conditions have improved, external financing conditions are expected to remain tight. Private investment demand is, therefore, expected to remain subdued. On balance, with the assumption of normal monsoon, for policy purpose, real GDP growth for 2009-10 is placed at around 6.0 per cent.