Fiscal slippages pose significant risk to inflation, policy stability

The Reserve Bank of India, on Tuesday, left key interest rates untouched but cut cash reserve ratio or CRR by 0.5 per cent to 5.5 per cent.

Here are the highlights

Key points

• RBI cuts CRR by 50 bps to 5.5 per cent 
• CRR cut effective beginning 28th Jan 2012 
• CRR cut will infuse Rs 32,000 crore liquidity in system
• Repo Rate retained at 8.5 per cent 
• Reverse Repo rate remains unchanged at 7.5 per cent  
• Marginal Standing Facility stands at 9.5 per cent  
• Bank Rate retained at 6 per cent 

Growth Outlook

• FY12 GDP growth revised downward from 7.6 per cent  to 7 per cent 
• Downside risks have increased since October even as inflation remains elevated 
• There is increased global uncertainty, weak industrial growth, slowdown in investment 
• Agricultural prospects look buoyant
• Slower industrial growth will impact services sector growth 
• Economy will exhibit modest recovery in 2012-13

Guidance

• Growth – Inflation balance of monetary policy stance shifted to growth
• Cut in CRR to address structural pressures on liquidity
• Based on current inflation, premature to begin reducing policy rates 
• RBI will be constrained from lowering policy rate in absence of fiscal consolidation
• Reduction will be conditioned by signs of sustainable moderation in inflation 
• CRR reduction reinforces guidance that future rate actions will be towards lowering them 
• Timing and magnitude of future actions contingent on various factors
• Policy actions to induce investment & address supply bottlenecks critical 
• Fiscal slippage poses significant threat to inflation management 
• Fiscal slippage poses significant threat to macroeconomic stability 
• Union budget must begin process of fiscal consolidation 
• Prudent to fully deregulate diesel prices to contain aggregate demand & trade deficit

Inflation

• Food inflation has moderated more than anticipated 
• Benefit offset by lower moderation in manufactured goods inflation
• Baseline projection for WPI inflation retained at 7 per cent 
• Rupee depreciation, suppressed inflation in preventing downward revision of inflation
• Inflation will remain vulnerable to variety of upside risks

Fiscal Worries

• Gross fiscal deficit for FY12 will overshoot budget estimate substantially
• Fiscal deficit could potentially crowd out credit to the private sector 
• Fiscal slippages adding to inflationary pressures & continue to pose a risk

Liquidity

• Liquidity conditions have remained beyond comfort zone
• Structural deficit in the system has increased significantly
• Structural deficit could hurt credit flow to productive sectors 
• Structural deficit presents a strong case for injecting permanent liquidity

Global Risks

• Sovereign debt concerns in Eurozone pose a major downside risk to growth 
• Uncertainty will adversely affect Indian growth through trade 
• Slowing capital flows raises concerns about current account deficit

Credit & Deposit Growth

• Credit offtake has been below projected trajectory 
• Nonfood credit growth scaled down to 16 per cent  versus 18 per cent 
• Money supply growth projection for FY12 retained at 15.5 per cent