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Wednesday, January 25, 2012

Third Q Monetary Policy of RBI

Economics is difficult to understand and strange are the ways of the Press when it comes to publishing it in their own perspective !  The Third quarter Monetary Policy of Reserve Bank of India is being hotly debated upon.  Though I do not understand it in is depth, we for sure know that it is to impact us in the months to come, especially on the financial side.

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interestfor the purpose of promoting economic growth and stability.  In India, it is done by Reserve Bank of India.  The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It could be by increasing the total supply of money or constricting other things. 

You know this condition as also the term – but perhaps may not relate them with ease.  In Economics, Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.  A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.  To put it simply “inflation means that your money won’t buy as much today as you could yesterday. ”

RBI wanted the Govt to deregulate diesel prices in order to contain the trade deficit, which is expected to widen to $160 billion during the current fiscal.   The petrol prices are market-linked, the government decides the rates of LPG, kerosene and diesel, which usually results in a large budgetary expenditure on subsidies.  Largely the response for the 3rd Quarter review of Monetary policy appears to be not so welcome.    As RBI wants to put is, the  Annual Policy for 2011-12 is set in conditions significantly different from those a year ago. Last year’s policy was made in an environment of incipient domestic recovery and uncertainty about the state of the global economy. While signs of inflation were visible, they were driven primarily by food items. Nonetheless, there was a clear risk of food price pressures spilling over into more generalised inflation, as the recovery consolidated and domestic resource utilisation rose to levels which stretched capacities. Throughout last year, the goal of monetary policy was to nurture the recovery in the face of persistent global uncertainty, while trying to contain the spill-over of supply side inflation.

This suggests growth will slow down even more if investment activity, that has already slowed significantly , stays depressed. The signs are ominous. Corporate investment in new projects fell sharply on a sequential basis during the second quarter of 2011-12 . The resultant impact on growth could have been mitigated had government stepped in with higher capital spending.   The Govt. would struggle as there is likely to be a mounting revenue deficit and constrain the capacity for capital spending. 

First Post reports that 79 is the number of times the  RBI  mentions “inflation” in the press release and in  contrast, “growth” is mentioned 68 times (10 times in reference to global, not local, growth). – this is sought to be exhibited as a clue on where the focus of RBI lies !!

In his statement, RBI Governor D Subbarao acknowledged that declining food prices are a seasonal trend and unlikely to last. The sharp decline in food prices in the past few weeks could be attributed to sharp declines in onion, potato and vegetable prices, which account for less than 3 percent of the WPI.   Fuel inflation came in at a high 14.9 percent in December. Currently, oil marketing companies have refrained from hiking fuel prices because of upcoming state assembly elections and the prices could be hiked immediately after the elections.   When the government’s fiscal deficit (the gap between government revenues and expenditure) widens, it has to resort to borrowings from the capital markets, which reduces the level of funds for the private sector and increases the cost of capital as well.

The expectation of RBI is fall in inflation to 7% by March from the 7.47$ present and there may not be much easing of monetary policy.   The reduction in CRR by 50 bps to 5.5% is not greatly welcomed though; the Repo and Reverse Repo remain unchanged.  The interpretation of the monetary policy is sought to be represented as no reining of inflation but squeezing of demand which could be painful for the growth.

With regards – S. Sampathkumar.


  1. It is not easy to deregulate, as there are other large Govt. sector consumers - defence & rail, also road transport another large area to be affected, which in turn can raise inflation...!

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