Outline of the Talk

1. State of the Economy and Public PolicyByB. K. BhoiAdviser, MPDAtCollege of Agricultural Banking, Pune August 14, 2014

2. 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

3. Objectives of Public Policy • Objectives of FP • Full employment/growth • Reduction of inequality/poverty • Macroeconomic Balance • Financial stability • Instruments • Tax, Expenditure, Public Debt, • Openness, convertibility

4. 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.

5. Real GDP - Growth Rate

6. Agriculture & Allied Activities Growth Rate

7. Industry Sector - Growth Rate

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

9. Industry Sector – Growth Rate

10. Services Sector – Growth Rate

11. Services Sector – Growth Rate

12. Saving-Investment Ratio

13. Household (HH) Saving – As % of GDP

14. 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.

15. Inflationary Pressures

16. New CPI and WPI – Wedge

17. 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.

18. Monetary Policy Space – New CPI and Policy Rate

19. 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.

20. Impossible Trinity Fixed Exchange Rate Open Capital Account Monetary Policy Independence Corner solution is neither possible nor desirable.

21. 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.

22. 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.

23. Twin Deficits: GFD & CAD

24. CAD and GFD – As % of GDP

25. Exchange Rate Volatility for INR/USD: Recent Experience 25

27. Portfolio Investment by FIIs in India

28. Recent Policy Measures

29. 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.

30. 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.

31. 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.

32. 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.

33. 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.

34. 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.

35. 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.

36. Thank you