The Policy Stance

Keeping in view the slowdown in growth, the Reserve Bank front-loaded the policy rate reduction in April with a cut of 50 basis points. Subsequent developments suggested that even as growth moderated, inflation remained sticky. Keeping in view the heightening risks to inflation, the Reserve Bank decided to pause in the Mid-Quarter Review (MQR) of June 2012, even in the face of slowing growth.

Against the backdrop of global and domestic macroeconomic conditions, outlook and risks, the policy stance in this review is shaped by three major considerations.

First, after moderating for a short period during December-January, headline WPI inflation edged up again beginning February 2012 and has remained sticky, above 7 per cent, on account of increase in food prices, increase in input costs, and upward revision in prices of some administered items such as coal. Headline inflation has persisted even as demand has moderated and the pricing power of corporates weakened. Non-food manufactured products inflation has also not declined to the extent warranted by the growth moderation. This reflects severe supply constraints and entrenchment of inflation expectations.

Second, growth decelerated significantly to 6.5 per cent in 2011-12. Although more recent data suggest some pick up, overall economic activity remains subdued. Importantly, the current growth performance has to be seen in reference to the trend rate of growth in order to assess its inflationary implications. In this context, investment activity has remained subdued over the last two years. External demand has also remained weak due to the slowdown in global growth. Consequently, the post crisis trend rate of growth, which was earlier estimated at 8.0 per cent, has dropped to 7.5 per cent. While the current rate of growth is clearly lower than trend, the output gap will remain relatively small. Under these conditions, demand pressures on inflation can re-emerge quite quickly, exacerbating the existing supply pressures.

Third, liquidity conditions play an important role in the transmission of monetary policy signals. Although the situation has eased significantly in the recent period, it is necessary to ensure that liquidity pressures do not constrain the flow of credit to productive sectors of the economy.

Against this backdrop, the stance of monetary policy is intended to:

- contain inflation and anchor inflation expectations;
- support a sustainable growth path over the medium-term; and
- continue to provide liquidity to facilitate credit availability to productive sectors.

Monetary and Liquidity Measures

On the basis of the current assessment and in line with the policy stance outlined in Section III, the Reserve Bank announces the following policy measures.

Repo Rate
It has been decided to retain the repo rate under the liquidity adjustment facility (LAF) at 8.0 per cent.

Reverse Repo Rate
The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands at 7.0 per cent.

Marginal Standing Facility (MSF) Rate
The MSF rate, determined with a spread of 100 basis points above the repo rate, stands at 9.0 per cent.

Bank Rate
The Bank Rate stands at 9.0 per cent.

Cash Reserve Ratio
The cash reserve ratio (CRR) of scheduled banks has been retained at 4.75 per cent of their net demand and time liabilities (NDTL).

Statutory Liquidity Ratio

It has been decided to:

- reduce the statutory liquidity ratio (SLR) of scheduled commercial banks from 24.0 per cent to 23.0 per cent of their NDTL with effect from the fortnight beginning August 11, 2012.

Guidance

The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium-term. While monetary actions over the past two years may have contributed to the growth slowdown – an unavoidable consequence – several other factors have played a significant role. In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately.

Meanwhile, managing liquidity within the comfort zone remains an objective and the Reserve Bank will respond to liquidity pressures, including by way of OMOs.

In a turbulent global environment, the risks of external shocks are high and the Reserve Bank stands ready to respond to any such shocks swiftly, using all available instruments.

Expected Outcomes

The policy actions taken are expected to:

- anchor inflation expectations based on the commitment of monetary policy to inflation control

- maintain liquidity to facilitate smooth flow of credit to productive sectors to support growth

Mid-Quarter Review of Monetary Policy 2012-13

The next Mid-Quarter Review of Monetary Policy for 2012-13 will be put out through a press release on Monday, September 17, 2012.

Second Quarter Review of Monetary Policy 2012-13

The Second Quarter Review of Monetary Policy for 2012-13 is scheduled for Tuesday, October 30, 2012.

Source: RBI