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State of the Economy and Public Policy

By

B. K. BhoiAdviser, MPD

At

College of Agricultural Banking, Pune August 14, 2014

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Outline of the Talk• Objectives of Public Policy• Growth• Savings-Investment • Inflation• Fiscal Situation• External Sector• Challenges of Monetary Policy

Formulation• Recent Policy Initiatives • Concluding Observations

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Objectives of Public Policy

Objectives of MP•Price stability•Sustainable growth•External balance•Financial stability

Instruments•Money: quantity and Price, exchange rate•Regulatory & supervisory tools

Objectives of FP• Full

employment/growth• Reduction of

inequality/poverty• Macroeconomic

Balance• Financial stability

Instruments• Tax, Expenditure,

Public Debt,• Openness,

convertibility

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Ideal Combination of MP and FP

• Public Policy should be counter-cyclical;

• Fiscal Policy in EMDEs is generally pro-cyclical;

• Monetary Policy is generally counter-cyclical;

• Combination of public policy depends on circumstances;

• Financial stability is not possible without coordination.

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Real GDP - Growth Rate

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Agriculture & Allied Activities Growth Rate

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Industry Sector - Growth Rate

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IIP Growth Rate (y-o-y): 2014-15 (up to June)

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Industry Sector – Growth Rate

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Services Sector – Growth Rate

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Services Sector – Growth Rate

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Saving-Investment Ratio

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Household (HH) Saving – As % of GDP

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Downside Risks to Growth

Recovery of global growth is tepid;Global uncertainty in respect of

capital flows persists;Global trade volume growth is

uncertain; Strains on profit margin; weak pricing

power of the corporates;Slowdown of domestic investment; Uneven monsoon; andCompositional shift in household

savings.

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Inflationary Pressures

(Avg. Inflation, %)

Item 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15*

WPI 4.11 8.04 9.36 7.95 6.43 6.24

CPI – IW 10.37 12.45 9.14 9.17 10.57 10.22

CPI – RL 13.70 10.13 8.38 10.16 11.41 10.72

CPI - AL 13.85 10.12 8.23 10.00 11.60 10.74

New CPI - - - 10.21 9.49 9.00 @

*: Up to June 2014. @: Up to July 2014.

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New CPI and WPI – Wedge

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Upside Risks to Inflation

International prices of crude, food and metals are still at elevated levels;

Domestic wage-price spiral continues;

Large social sector expenditure by the

Govt.;

Increase in the input cost;

High food inflation; and

Uneven and below average monsoon.

Monetary Policy Space – New CPI and Policy Rate

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Medium-term Challenges of Monetary Policy Formulation

Impossible Trinity; Complex Growth-Inflation Dynamics; Unsustainable CAD (decline in 2013-14); Large Fiscal Deficit; Volatile Govt. Cash Balances; and Global Uncertainties.

Conducting monetary policy in a globalised environment is difficult.

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Impossible Trinity

Fixed Exchange Rate

Open Capital Account Monetary Policy

Independence

Corner solution is neither possible nor desirable.

Growth-Inflation Dynamics in India

• Sharp slowdown in growth;

• Persistence of inflation (but pace is weakening?); and

• Inflation harms growth if it persists above a threshold level.

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High Inflation Harms Growth• Reduces purchasing power of fixed

income earners;

• Reduces inflation adjusted returns on assets/deposits;

• Causes compositional shift in savings towards real estate/physical assets;

• Causes real appreciation in domestic currency (CAD comes under stress); and

• Creates uncertain policy environment.

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Twin Deficits: GFD & CAD

(Per cent to GDP)

Year GFD/GDP CAD/GDP

2003-08 (Avg.) -3.6 -0.3

2008-09 -6.0 -2.3

2009-10 -6.5 -2.8

2010-11 -4.8 -2.8

2011-12 -5.7 -4.2

2012-13 -4.8 -4.7

2013-14 -4.6 (RE) -1.7

2014-15 -4.1 (BE) -

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CAD and GFD – As % of GDP

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Exchange Rate Volatility for INR/USD: Recent Experience

Portfolio Investment by FIIs in India

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Recent Policy Measures

Period Repo Rate (bps) CRR (bps) SLR (bps)2011-12: Q4 - -125 -2012-13

Q1 -50 - -Q2 - -25 -100Q3 - -25 -Q4 -50 -25 -

2013-14Q1 -25 - -Q2 50 - -Q4 25 - -

2014-15Q1 - - -50

Q2 (Aug 5) - - -50

Policy Response to Capital Outflows/ Exchange Market Pressures

• Interest Rate Hikes - MSF, FCNR(B) Deposit for 3 years and above;

• Liquidity Tightening;• Restrictions on Gold Imports;• Measures to Curb Speculation;• Capital Account Management;• Swap Arrangements - Oil Marketing

Companies, FCNR(B) Deposits, etc.; and• Limited Forex Market Interventions.

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Impact of Recent Policy Measures

• Rupee Yield Curve Inverted,

• Depreciation of Rupee Arrested,

• Gold Import Moderated;

• Speculative Activities Reduced;

• Improvement in the CAD; and

• Early Signs of Capital Flows.

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Calibrated Roll Back since Sept. MQR

• MSF Rate reduced by 125 bps to 9%;• Repo Rate raised by 75 bps to 8%; • CRR maintenance on a daily basis reduced from

99% to 95% of the requirement, and• MSF Rate is now 100 bps higher than Repo Rate.• Interest rates ceiling on FCNR(B) deposits and also

NRE deposits, for above 3 year maturity, restored to position prior to August 14, 2013.

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1st Bi-Monthly Monetary Policy (April 1, 2014)

• Liquidity facility through 7-day and 14-day term repos increased from 0.5 per cent of NDTL to 0.75 per cent; and

• Liquidity provided through LAF window reduced from 0.5 per cent of NDTL to 0.25 per cent.

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2nd Bi-Monthly Monetary Policy (June 3, 2014)

• SLR reduced by 50 bps to 22.5 per cent.

• ECR limit reduced to 32 per cent of eligible export credit outstanding from 50 per cent.

• Introduction of special term repo facility of 0.25 per cent of NDTL to compensate for reduction in access to liquidity under ECR facility.

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3rd Bi-Monthly Monetary Policy (Aug 5, 2014)

• SLR further reduced by 50 bps to 22 per cent.

• Continue to provide liquidity under LAF at 0.25 per cent of NDTL and under 7-day/14-day term repos at 0.75 per cent of NDTL;

• Ceiling for banks’ holdings of SLR securities in the HTM category reduced by 50 bps to 24 per cent.

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Concluding Observations• Downside risks to growth are high;• Fiscal consolidation path indicated in Union

Budget 2014-15 may help in improving sentiments and also investment environment, going forward;

• Upside risks to inflation persist and difficult to support growth as inflation expectations remain elevated; and

• Easing of inflationary pressure may provide some space for monetary easing to support growth in due course.

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Thank you