92.
At the end of July 2007, risks to the outlook for global growth and financial
markets had become accentuated by adverse developments in the US sub-prime mortgage
market. Regulators and monetary authorities were expressing concern about the
global financial system in the context of rising levels of widely diffused risks.
Accordingly, banks, financial institutions and corporates in India were advised
to be vigilant and well-prepared with appropriate risk mitigation strategies to
deal with significantly higher volatility than before and to monitor various types
of exposures with appropriate hedging of risks to balance sheets. In view of the
continuing uncertainty regarding the full dimensions and characteristics of the
crisis in developed financial markets, banks, financial institutions and corporates
are urged to enhance their vigilance with respect to the possibility of unfolding
risks arising from global developments. In this context, they should ensure hedging
of risks embedded in various types of exposure and put in place appropriate risk-management
strategies to protect their balance sheets and preserve asset quality. Furthermore,
banks need to step up their monitoring of similar risks that could affect corporates
that have international market exposure. 93.
With domestic economic activity seen as expanding strongly and inflation expectations
well anchored, the First Quarter Review noted that monetary policy in India would
continue to be vigilant and pro-active in the context of any accentuation of global
uncertainties that pose threats to growth and stability in the domestic economy.
It was also indicated that while the stance of monetary policy would continue
to reinforce the emphasis on price stability and well-anchored inflation expectations
and thereby sustain the growth momentum, contextually, financial stability may
assume greater importance in the months to come. The First Quarter Review reiterated
the stance of the Annual Policy Statement for 2007-08 of reinforcing the emphasis
on price stability and well-anchored inflation expectations while ensuring a monetary
and interest rate environment that supports export and investment demand in the
economy so as to enable continuation of the growth momentum. Credit quality and
orderly conditions in financial markets for securing macroeconomic and, in particular,
financial stability were re-emphasised while simultaneously pursuing greater credit
penetration and financial inclusion. A readiness to respond swiftly with all possible
measures as appropriate to the evolving global and domestic situation impinging
on inflation expectations, financial stability and the growth momentum was also
reiterated. 94.
Developments in global financial markets in the immediate aftermath showed that
several risks associated with global developments that were indicated in the First
Quarter Review have materialised, vindicating the emphasis on vigilance and preparedness
in the context of global uncertainties. First, the sudden fall in credit market
confidence brought on by the spread of the sub-prime loan risks into higher quality
debt unsettled financial markets across the world. The response of monetary authorities
provides an indication of the threat to growth and financial stability. Second,
a sympathetic and sustained surge in international crude prices has added to the
building uncertainty; despite alternating movements, the volatility of crude prices
around elevated levels may crystallise into potential second round effects impacting
inflation expectations. Third, food prices have continued to rule at historically
high levels with no immediate relief from improvement in global supply conditions.
Consequently, consumer price inflation has hardened in a number of countries,
with food importers being most adversely affected. The persistence of inflationary
pressures presents a dilemma for monetary authorities in the context of the immediate
need for assuaging liquidity and solvency stress in the context of financial stability. 95.
Domestic macroeconomic developments have exhibited enduring strength and resilience.
First, growth has been sustained and has broadened. In particular, the improvement
in agricultural supply conditions in conjunction with the sustained pace of industrial
and service sector activity is indicative of an acceleration in the underlying
momentum of the economy above the projected trajectory. Second, considerable success
has been achieved in lowering inflation and in anchoring inflation expectations.
The environment of price stability has entrenched the foundations of a higher
growth path for the economy. Third, financial markets have, by and large, exhibited
orderliness in the face of the turmoil in global markets. Fourth, while the merchandise
trade deficit has widened, the strength of invisible earnings has kept the current
account deficit at a level that is modest in comparison with the net capital flows.
As a consequence, there has been a sizeable accretion to the foreign exchange
reserves as in the preceding year. 96.
The First Quarter Review of July 2007 had indicated that potential uncertainties
in global markets and recent developments in domestic financial markets warrant
a higher priority for managing appropriate liquidity conditions in the policy
hierarchy. By and large, the combination of measures that were put in place has
worked satisfactorily in terms of returning overnight interest rates to the LAF
corridor and ensuring that they generally evolve in an orderly manner. Nevertheless,
financial markets continue to experience conditions of surplus liquidity, warranting
an appropriate response in order to ensure orderly market conditions on an enduring
basis. 97. Real
GDP growth originating in agriculture and allied activities has risen above trend
in the first quarter of 2007-08 and is poised to maintain this performance over
the rest of the year on the back of a favourable south-west monsoon and improvement
in sown acreage. Recent developments indicate some slackening of momentum in the
industrial and services sectors. Moreover, global uncertainties may have some
moderating influence on the performance of manufacturing as well as services.
Overall, these sectors are expected to sustain the momentum of growth. Accordingly,
real GDP growth in 2007-08 is placed at 8.5 per cent for policy purposes, as set
out in the Annual Policy Statement of April 2007 and reiterated in the First Quarter
Review, assuming no further escalation in international crude prices and barring
domestic or external shocks. 98.
The gains achieved in reining in inflation in the first quarter of 2007-08 have
been extended into the second quarter and currently headline inflation appears
to be emerging out of a prolonged trough. At this juncture, however, rising and
volatile international crude prices and the heightened levels of food prices pose
risks to the inflation outlook. In view of the persisting high levels of the price
of the Indian crude basket, some pass-through to domestic petroleum product prices
appears reasonable. A key issue going forward in this regard is the timing of
the pass-through in the context of the expected path of headline inflation. The
policy resolve going forward should be to consolidate the success in lowering
inflation on an enduring basis so that an environment of stability prevails to
nurture and protect the transition to higher growth. There are indications that
the publics perceptions on inflation are increasingly converging with the
policy preference for price stability. Accordingly, in view of the lagged and
cumulative effects of monetary policy on aggregate demand and assuming that supply
management would be conducive, capital flows would be managed actively and in
the absence of shocks emanating in the domestic or global economy, the policy
endeavour would be to contain inflation close to 5.0 per cent in 2007-08. In recognition
of Indias evolving integration with the global economy and societal preferences
in this regard, the resolve, going forward, would be to condition expectations
in the range of 4.0-4.5 per cent so that an inflation rate of around 3.0 per cent
becomes a medium-term objective consistent with Indias broader integration
into the global economy. 99.
Money supply has so far been expanding well above the indicative trajectory of
17.0 -17.5 per cent set in the Annual Policy Statement of April 2007. Fiscal spending
and exchange market interventions have mainly driven this acceleration as reflected
in sizeable reserve money growth. Deposit growth has been running ahead of the
projection of Rs.4,90,000 crore for 2007-08 as a whole. Non-food credit (inclusive
of non-SLR investments) has decelerated and is currently close to the projection
of 24.0-25.0 per cent given in the Annual Policy Statement. However, moderating
the expansionary effects of net capital flows is warranted so that money supply
is not persistently out of alignment with the indicative projections set out in
the Annual Policy Statement. 100.
The Reserve Bank will continue with its policy of active demand management of
liquidity through appropriate use of the CRR stipulations and open market operations
(OMO) including the MSS and the LAF, using all the policy instruments at its disposal
flexibly, as and when the situation warrants. 101.
In sum, barring the emergence of any adverse and unexpected developments in various
sectors of the economy and keeping in view the current assessment of the economy
including the outlook for inflation, the overall stance of monetary policy in
the period ahead will broadly continue to be:
To reinforce the emphasis on price stability and well-anchored inflation expectations
while ensuring a monetary and interest rate environment that supports export and
investment demand in the economy so as to enable continuation of the growth momentum.
To re-emphasise credit
quality and orderly conditions in financial markets for securing macroeconomic
and, in particular, financial stability while simultaneously pursuing greater
credit penetration and financial inclusion.
To respond swiftly with all possible measures as appropriate to the evolving global
and domestic situation impinging on inflation expectations, financial stability
and the growth momentum.
To be in readiness to take recourse to all possible options for maintaining stability
and the growth momentum in the economy in view of the unusual heightened global
uncertainties, and the unconventional policy responses to the developments in
financial markets.
also see : I. Assessment of Macroeconomic and
Monetary Developments during the First Half of 2007-08; III.
Monetary Measures.
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