The Reserve Bank of India today released its Annual Report for 2010-11. This is a statutory Report of the Central Board of the Reserve Bank that covers (i) the assessment of the macroeconomic performance during 2010-11 and the prospects for 2011-12, and (ii) the working and operations of the Reserve Bank and its financial accounts. The highlights of the Report are as follows:
Assessment for 2010-11
The Indian economy returned to a high growth path. However, challenges emerged as investment activity slowed, fiscal consolidation was led by cyclical and one-off factors, leaving its sustainability in question and inflation remained sticky on the back of new pressures.
- In response, cumulative monetary tightening by raising operational policy rates by 475 bps since mid-March 2010 has been one of the sharpest around the world. The policy was tightened aggressively as high inflation would have brought down growth by itself. Trade off for higher inflation for lower unemployment or higher growth does not work if inflation is high. The threshold inflation at which this change occurs has been empirically estimated in 4-6 per cent range for India. The inflation objective of monetary policy is lower than the threshold keeping in view the welfare costs for the poor and the open nature of the economy. As such, the Reserve Bank’s medium-term inflation objective has been 3 per cent. Reserve Bank’s emphasis on containing perceptions of inflation in the range of 4.0-4.5 per cent
- Fiscal deficit ratios in 2010-11 turned out to be better than envisaged in the Union budget. A qualitative assessment of fiscal correction during 2010-11, however, raises concerns. Capital outlay-GDP ratio fell. Improved fiscal position had a large temporary component. Clearly, a more enduring fiscal consolidation strategy is needed.
- The improvement in the current account gap came about by cyclical upswing in global trade and turnaround in invisibles. This was on back of a strong pick-up in exports from November 2010 aided by diversification of trade in composition and direction. Trade policy supported exports through schemes such as DEPB.
- Financial markets across the world witnessed significant deleveraging in the post-crisis period. However, balance sheet risks still remain. In India, post-Lehman crisis, regulators have taken several measures for risk mitigation, but areas of concerns remain.
- A series of stress tests conducted by the Reserve Bank showed that banks remained reasonably resilient. However, risks of asset quality deterioration in infrastructure sector needs to be averted by quickly resolving the pricing and input supply issues. The gross NPA ratio of scheduled commercial banks which increased marginally to 2.52 per cent by end-June 2011 still remains low. Based on unaudited results of these banks, the CRAR at 13.86 per cent as at end-June 2011 was well above the minimum requirement.
Prospects for 2011-12
Going ahead, global uncertainty, sticky inflation, hardening interest rates and high base, especially for agriculture, could moderate growth in 2011-12. On the other hand, though global commodity prices appear to have plateaued, inflation is likely to be elevated in near term and fall only towards the later part of the year as monetary transmission works through further.
Growth Outlook for 2011-12
- After above trend growth during 2010-11, growth is expected to decelerate but remain close to the trend of about 8.0 per cent in 2011-12. If global financial problems amplify and slow down global growth markedly, it would impart a downward bias to the growth projection of around 8.0 per cent indicated in the Monetary Policy.
- Growth prospects for the year 2011-12 seem to be relatively subdued compared with the previous year. Global uncertainties, high global oil and commodity prices, persistent inflationary pressures, rising input costs, rise in cost of capital due to monetary tightening and slow project execution are some of the factors that are weighing on growth.
- Crop prospects remain good, though on a high base the growth is likely to turn out to be less than last year. The monsoon up to August 17, 2011 was 1 per cent below the Long Period Average. RBI’s overall foodgrains production weighted rainfall index was 101 till August 17, 2011 (88 in the corresponding period last year). Sowing up to August 12, 2011 was marginally higher than in corresponding period of the previous year.
- Downside risks to the industrial growth in 2011-12 may arise from falling business confidence, but robustness of the services sector would continue to support the growth process. There is a very strong structural dimension to services sector growth in India.
- Investment may remain soft in the near term, while private consumption may decelerate. In face of moderating demand, expenditure-switching from government consumption expenditures to public investments would help.
Inflation Outlook for 2011-12
- Inflation is likely to remain high and moderate only towards the latter part of the year to about 7 per cent by March 2012. The decline in global commodity prices has not been very significant. Should the global recovery weaken ahead, commodity prices may decline further, which should have a salutary impact on domestic inflation.
- The Fed has indicated that it will pursue its near zero rate policy at least till mid-2013. It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated. The pass-through of the rise in global commodity prices till had been incomplete, especially in the minerals and oil space. As such, the benefit of a moderate fall in global commodity prices on domestic price level would also be limited.
- If global oil prices stay at current level, further increase in prices of administered oil products will become necessary to contain subsidies. Fertiliser and electricity prices will also require an upward revision in view of sharp rise in input costs.
- The high and persistent inflation over the last two years has brought to the fore the limitation in arresting inflation in absence of adequate supply response. However, monetary policy still has an important role to play in curbing the second round effects of supply-led inflation. In face of nominal rigidities and price stickiness, there are dangers of accepting elevated inflation level as the new normal.
Outlook on twin deficits for 2011-12
- In the context of weakening global economy and the likelihood of some spillovers to the domestic economy, the twin deficits require close monitoring.
- On current assessment, the fiscal deficit in 2011-12 is likely to overshoot the budgeted projections. If the economy slows down beyond what is currently anticipated, the resultant revenue erosion could magnify the fiscal slippage. At the same time, the fiscal space to support any counter-cyclical policies is more limited than what existed at the time of the global crisis of 2008.
- On the other hand, in the baseline scenario, the CAD would remain at a sustainable level in 2011-12. Estimates of sustainable CAD suggest a threshold of 2.7-3.0 per cent of GDP. Prospects for external sector for 2011-12 remain somewhat uncertain as global uncertainties could impinge on commodity prices and exchange rate movements.
- The continuance of robust performance of exports in 2010-11 and 2011-12 so far faces downside risks. The impact of growth slowdown in the advanced economies could partly be mitigated by continued diversification of exports. The impact could, nevertheless, turn material in case the slowdown in global growth is sharp and widespread.
- With the US and Europe constituting the bulk of Indian software exports, some impact from a slowdown in advanced economies can be expected. Several pointers suggest that a growth could still be in line with NASSCOM target. Any downside impact can become perceptible with a lag if crisis assumes severe proportions.
- As regards capital flows, the impact is more difficult to gauge. Capital flows could surge or diminish, depending upon the degree of risk aversion. If global crisis turns deep, capital flows are more likely to moderate. On the other hand, capital flows to India could increase in spells on relative returns basis and due to large interest differentials. FDI to India in Q1 of 2011-12 has doubled.
Medium-term Challenges for the Indian Economy
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