Annual Report for 2010-11 by RBI highlighted RBI’s Response to Challenges to Indian Economy

The Reserve Bank of India in its Annual Report for 2010-11 released on 25 August 2011 included discussion on (i) the assessment of the macroeconomic performance during 2010-11 and the prospects for 2011-12, and (ii) the working and operations of the Reserve Bank and its financial accounts.

The central bank presented it great detail an analysis of the challenges faced by the Indian economy. The RBI considered that the immediate challenge to sustaining high growth lay in bringing down inflation, growth sustainability over medium-term depends on addressing the structural bottlenecks. Only by addressing the challenges the potential level of growth could be raised in the Indian economy.
The Annual Report for 2010-11 discussed the measures adopted by the RBI to deal with the challenges that threatented to lower the economic growth.

•    Lowering inflation and inflation expectations to acceptable levels was the most crucial challenge that demanded immediate attention. Monetary policy plays an important role in controlling inflation.The monetary can however successfully contain inflation when coupled with complementary policies. Such complementary policies could include, improved supply response for food and tackling food inflation by breaking the inertial element arising from rising real wages and MSP. Rural wage programmes noted the report needed to be linked with productivity.
•    Harnessing technology for agriculture productivity enhancements posed critical challenge to the economic growth. Harnessing technology for agriculture productivity would help tostep up agriculture growth from a trend of around 3 per cent per annum to 4 per cent. Substantial productivity enhancements would be possible through large scale introduction of Precision Farming Techniques, combined with local-specific fertigation practices, better cultivars, optimal use of biochemicals and water. According to the report, price incentives such as fertilizer subsidies have distorted its optimal use and led to suboptimal investments in its production. RBI therefore felt the need for extending the Nutrient Based Subsidy (NBS) scheme.
•    RBI also witnessed a challenge in maintaining right balance between consumption and investment. Aneed to rebalance demand from consumption to investment by stepping up savings in the economy was felt. In order to achieve a 9.0 per cent growth in Twelfth Five Year Plan (2012-17) the investment rate of 40.5 per cent would be required if ICOR remained unchanged from 4.5 realised during the Eleventh Plan. To achieve the 9.0% growth augmenting saving as well as bringing about technological and institutional improvements was needed to lower ICOR.
•    Facilitating energy security was to be ensured. India’s energy deficit was likely to be doubled by the end of the Twelfth Plan. Demand-supply gaps could be particularly large in coal and crude oil. RBI felt that the price increase would be necessary to incentivise energy conservation, curb demand and support capacity addition. New Exploraton Licensing Policy (NELP) strategy needed to be re-looked into and coal block auctions could be front-loaded. Given that a large amount of bank finance is locked in the infrastructure sector, the viability of new infrastructure projects need to be ensured.
•    Facilitating infrastructure finance was views as another challenge. India needs infrastructure investments of over US$ 1 trillion during the Twelfth Plan. The infrastructure project require to be funded by both, public and private sectors. Fiscal consolidation and reorientation of expenditure towards capital expenditure were needed to meet the target. Further measures were needed to improve the flow of resources to infrastructure sector on a commercial basis.
•    Promoting financial inclusion and inclusive growth presented a critical challenge to the economy. Long-term growth sustainability depended on achieving inclusive growth. Investments in agriculture, infrastructure, human capital formation through education, health and skill formation were needed. About one crore people sought to enter the workforce each year over the next decade thereby posing challenges for employment and skilling. Inclusive finance was deemed to be necessary for supporting the demand for these activities.

The Real Economy

The RBI in its Annual Report presented a broader picture of the real economic scenerio in Inida.
•    Following the US sovereign rating downgrade by S&P, oil prices fell. The August price of the Indian basket of crude was 25 per cent higher than its average during 2010-11. Empirical exercise revealed that a 10 percentage point increase in oil price would lead to a reduction in real GDP growth by about 0.3 percentage point. It would also raise WPI inflation by 1.0 percentage point through direct impact and 2.0 percentage points in total impact.
•    Preliminary estimates based on latest available information showed that financial savings of the household sector moderated to 9.7 per cent of GDP in 2010-11 from 12.1 per cent in 2010-11. The decline in the financial savings rate of the household sector reflected the lower growth in their bank deposits and life insurance as well as decline in investment in shares and debentures. Also, the households’ financial liabilities increased reflecting higher borrowings from commercial banks.
The report suggested that a holistic review of food management would be helpful in the backdrop of the National Food Security Bill (NFSB). The holistic review should cover procurement and pricing, production and food security, distribution and delivery mechanism.

Price Situation

•    Inflation became generalized since December 2010 with significant price pressures in non-food manufacturing commodities. Drivers of inflation were found to have changed during the course of 2010-11.
•    Global commodity prices recovered faster than the global economy as a result of surfeit of liquidity which resulted in creating pressure on headline inflation in India during 2010-11. Empirical estimates of short run and long run elasticities suggest that despite some softening in global commodity prices in recent months, upside risks to India’s inflation could persist.

Money and Credit

•    Money growth was moderate during 2010-11, but it had picked up during the last quarter of 2010-11. Currency expansion was strong during 2010-11. The growth in currency demand was explained by high GDP growth, high inflation and low deposit rates initially. Increase in number of ATMs, higher social expenditures in rural areas, tax evasions were the other factors that led to the growth in currency demands. The relationship of demand for currency with real income and prices was found to be very strong.

The RBI had observed that the rate of decline in velocity had accelerated. Accentuated liquidity preference and slack credit demand in the aftermath of the crisis were reflected in sharp fall in velocity.

Financial Markets

•    International financial markets witnessed frequent re-pricing of risks during 2010-11, reflecting persisting uncertainties. Sovereign risk concerns, particularly in the Euro Area, affected the financial markets. Monetary policy transmission across the various segments of the financial markets strengthened during 2010-11 and till mid 2011-12 with liquidity condition shifting to a deficit mode from June 2010.

Government Finance

•    Combined GFD/GDP for Centre and States fell from 9.3 per cent in 2009-10 to 7.7 per cent in 2010-11. The budgets of the Central and State governments envisaged further fiscal consolidation during 2011-12. The report reccomended concerted efforts to avoid fiscal slippages in 2011-12, especially arising from higher expenditure on subsidies if global commodity and fuel prices continue at an elevated level. The sustainability of lower deficits required substantial new measures leading to expenditure compression and revenue raising.

External Sector-an Overview

India’s balance of payments improved to 2.6 per cent of GDP during 2010-11 from 2.8 per cent during 2009-10 led by a pick-up in exports during the second half and a higher invisibles surplus.
Capital flows to India improved during 2010-11. However the composition and volatility of capital flows posed concern. Capital flows at the aggregate level were only weakly sensitive to the interest rate differential between India and the rest of the world.
Financing of CAD for 2011-12 would not pose a problem unless the public debt fragilities in the Euro Zone and the growth slowdown in the US significantly impact capital flows.
Overall, the BoP situation was believed to manageable, though continuous monitoring due to the global uncertainties would be required for the same.

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