Second Quarter Review of Monetary Policy 2012-13
By Dr. D. Subbarao
Over the last quarter, policymakers around the world have confronted increasingly difficult challenges. Globally, even as the growth momentum has slowed, governments have had to manage the balance between fiscal consolidation and growth stimulus amidst visible signs that the two objectives are in conflict with each other. As the advanced economies (AEs) deal with these tensions and global demand conditions weaken, emerging and developing economies (EDEs) are also slowing down.
2. Liquidity infusions by central banks in AEs during the quarter have contributed to some stability in global financial markets. These measures cannot, however, substitute for robust structural solutions that can return the AEs to the path of recovery. At this stage, growth risks have risen and could well overwhelm the positive effects of enhanced liquidity. Moreover, with commodity prices still at elevated levels, notwithstanding some muted softening recently, risks of liquidity-driven price increases remain significant. Even as this process moves forward, the months ahead will be a period of heightened uncertainty for the global economy.
3. Amidst this global slowdown and uncertainty, the Indian economy remains sluggish, held down by stalled investment, weakening consumption and declining exports. However, recent policy initiatives undertaken by the Government have begun to dispel pervasive negative sentiments. As the measures already announced are implemented and further reforms are initiated, they should help improve the investment climate further.
4. Meanwhile, the persistence of inflationary pressures even as growth has moderated, remains a key challenge. In this respect, India is an exception to the global trend, which underscores the role of domestic structural factors. Of particular concern is the stickiness of core inflation, mainly on account of supply constraints and the cost-push of rupee depreciation. Consequently, managing inflation and inflation expectations must remain the primary focus of monetary policy. A central premise of monetary policy is that low and stable inflation and well-anchored inflation expectations contribute to a conducive investment climate and consumer confidence, which is key to sustained growth on a higher trajectory in the medium-term.
5. Accordingly, over the past few quarters, monetary policy had to focus on inflation, even as growth risks have increased. As recent policy initiatives by the Government start yielding results in terms of revitalising activity, they will open up space for monetary policy to work in concert to stimulate growth. However, in doing so, it is important not to lose sight of the primary