RBI lukewarm to rate cut demand

The Reserve Bank of India (RBI) today released an assessment of the macroeconomic and monetary situation in the country in 2012-13 that still posed significant risks to the economy, denting hopes of any big reduction in its policy rates at the monetary policy review due tomorrow.

Releasing the document, which serves as a backdrop to the monetary policy statement for 2013-14, RBI said it has "very limited" space for further easing of monetary policy in view of the still-very-significant financial risks.

RBI governor Duvvuri Subbarao was widely expected to announce a minimum 25 basis points reduction in interest rates, for the third time this year.

'' With headline inflation remaining above the threshold and consumer price inflation remaining high, the space for action for 2013-14 remains very limited,'' the report noted, adding, ''If some of the risks come to fore, policy re-calibration may become necessary in either direction.''

RBI said while there could be a slow-paced recovery in 2013-14, contingent on improved governance and concerted action to resolve structural bottlenecks, especially in infrastructure sector, the gap in output would still remain negative.

While the wholesale price-based inflation would remain range-bound in 2013-14 due to subdued producers' pricing power and falling global commodity prices, it could still increase somewhat in the second half of the current fiscal due to base effects, RBI said.

An RBI survey of professional forecasters showed anticipation of a modest recovery with 6 per cent growth in 2013-14 against the 5 per cent growth of the previous fiscal while the WPI inflation could moderate to 6.5 per cent from 7.3 per cent.

''Inflation expectations have moderated slightly, while business expectations remain subdued,'' the survey stated.

During 2012-13, mining and manufacturing activity stalled, agriculture output was affected by deficiency in rains and the services sector witnessed moderation, forcing overall growth in the fourth quarter of 2012-13 to low levels.

Growth has been hamstrung by structural bottlenecks, shortages of power, coal and natural gas and stoppage of mining activity in some states following legal enforcements on illegal mining, the report noted.

Core sector industries like coal, oil power etc also underperformed in this backdrop.

The RBI survey of order books, inventory and capacity utilisation shows that the slack capacity utilisation persisted in Q3 of 2012-13. New orders picked up marginally. Inventory as a ratio of sales, reached its lowest for finished goods, but remained high for raw materials in the past five quarters.

Savings, investments decline
Aggregate demand remained sluggish with inflation adversely impacting real consumption and cyclical and structural factors impeding investment. Both investment and household savings declined as persistent inflation eroded financial savings of households.

Corporate sales growth moderated in Q3 of 2012-13 to its lowest level since Q3 of 2009-10 although operating profits grew at a positive rate.

Planned corporate investment moderated sharply in Q3 of 2012-13, thus continuing with the downturn that began in H2 of 2010-11. For growth to return, RBI said, the bottlenecks in coal, power, road and telecommunication sectors need to be addressed.

While the government's fiscal consolidation measures have gained momentum since middle of 2012-13, fiscal risks have come down although not waned. There is a lurking risk of a further slowdown in growth resulting in revenue shortfalls and a resurgence of fiscal risks, RBI noted.

Removing structural impediments and public investment stimulus would need to be balanced by offsetting reductions in government's current expenditures, the report said.

Liquidity conditions
While the present monetary conditions allow little space for policy intervention, RBI said conditions might evolve with macroeconomic developments and shifting growth-inflation dynamic.

RBI had eased monetary policy during 2012-13 in a calibrated manner by cumulatively reducing policy rates by 100 basis points and injecting Rs1,50,000 crore of primary liquidity through outright open market operations.

Besides, it injected Rs1,30,000 crore of primary liquidity through reductions in cash reserve ratio since January 2012.

During 2012-13, broad money growth remained on the indicative trajectory and reserve money adjusted for CRR changes grew at a reasonable pace.

However, non-food credit growth remained below the indicative trajectory, reflecting growth slowdown and risk aversion among banks from deteriorating asset quality.

High current account deficit
On the external front RBI said, the risk of high current account deficit (CAD) remained very high for the Indian economy despite the fall in global commodity prices bringing in temporary respite.

A modest increase in exports in Q4 of 2012-13 and some deceleration in imports are likely to help moderate current account deficit (CAD) in Q4 of 2012-13 after a record high of 6.7 per cent of GDP in Q3. Despite this, the CAD/GDP ratio for the year 2012-13 is expected to be around 5.0 per cent, twice the sustainable level, it added.

High CAD in Q3 of 2012-13 was adequately financed by capital inflows, without any reserves depletion. CAD in 2013-14 is likely to benefit from moderation in global commodity prices. Yet, its sustainability continues to face risk from event shocks that may cause a sudden stop or reversal of capital inflows.

Meanwhile, India's external debt also rose in Q3 of 2012-13, reflecting continued dependence on ECBs and short-term borrowings to meet the widening CAD. Short-term debt on a residual maturity basis increased to 44 per cent of total debt and 56 per cent of the foreign exchange reserves by end-December 2012.

Financial markets
Strong FII inflows, especially in H2 of 2012-13 augured well for the Indian equity markets and the rupee. Money markets remained orderly, despite year-end liquidity pressures. G-sec yields softened during Q4 of 2012-13, although with some increase at the year-end.

Primary markets remained subdued during 2012-13, though resource mobilisation through mutual funds and Qualified Institutional Placements gathered some momentum during the year.

The RBI's House Price Index increased 26 per cent y-o-y during Q3 of 2012-13, with annual increase hovering around 20 per cent for the past eight quarters. Transaction volumes registered a growth of 14 per cent during Q3.

Inflation risks remain
Headline inflation and demand-side pressures have moderated, but inflation risks remain reflected in double-digit consumer price inflation, food supply constraints and suppressed inflation in energy segment, including diesel, coal and electricity, RBI noted.

Persistent pressures from wages remain a major risk to inflation moderation. Although the pace of increase in rural wages moderated a bit, it remains high.

Divergence between WPI and CPI inflation has widened on account of higher food inflation and other factors such as increase in housing rents and transportation costs.

RBI said global economic growth, which remained weak in 2012, is expected to stay sluggish in 2013 as well. Fiscal adjustments will drag growth down in advanced economies and delay cyclical recovery in emerging market and developing economies.