State of the Economy and

Public Policy
By

B. K. Bhoi
Adviser, MPD

At

College of Agricultural Banking, Pune

August 14, 2014
1
 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 Objectives of FP
Price stability Full
Sustainable growth employment/growth
External balance Reduction of
Financial stability inequality/poverty
Macroeconomic
Instruments Balance
Money: quantity and
Financial stability
Price, exchange rate
Regulatory & Instruments
supervisory tools Tax, Expenditure,
Public Debt,
Openness,
convertibility 3
 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

5
Agriculture & Allied Activities
Growth Rate

6
Industry Sector - Growth Rate

7
IIP Growth Rate (y-o-y):
2014-15 (up to June)

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Industry Sector Growth Rate

9
Services Sector Growth Rate

10
Services Sector Growth Rate

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Saving-Investment Ratio

12
Household (HH) Saving As % of GDP

13
 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; and
Compositional 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.

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Monetary Policy Space
New CPI and Policy Rate

18
 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. 19
 Impossible Trinity
Fixed Exchange Rate

Open Capital Account Monetary Policy

Independence

Corner solution is neither possible

nor desirable. 20
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) - 23
CAD and GFD As % of GDP

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Exchange Rate Volatility for INR/USD:
Recent Experience

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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 -100
Q3 - -25 -
Q4 -50 -25 -
2013-14
Q1 -25 - -
Q2 50 - -
Q4 25 - -
2014-15
Q1 - - -50
Q2 (Aug 5) - - -50
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 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.

32
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.

33
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

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