1. 1 State of the Economy and Public Policy By B. K. Bhoi Adviser, MPD At College of Agricultural Banking, Pune August 14, 2014

2. 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. 3 Objectives of Public Policy Objectives of MP Price stability Sustainable growth External balance Financial stability Instruments Money: quantity and Price, exchange rate Regulatory & supervisory tools Objectives of FP Full employment/growth Reduction of inequality/poverty Macroeconomic Balance Financial stability Instruments Tax, Expenditure, Public Debt, Openness, convertibility

4. 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. 5 Real GDP - Growth Rate

6. 6 Agriculture & Allied Activities Growth Rate

7. 7 Industry Sector - Growth Rate

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

9. 9 Industry Sector – Growth Rate

10. 10 Services Sector – Growth Rate

11. 11 Services Sector – Growth Rate

12. 12 Saving-Investment Ratio

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

14. 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. 15 Inflationary Pressures (Avg. Inflation, %) Item2009-102010-112011-122012-132013-142014-15* WPI4.118.049.367.956.436.24 CPI – IW10.3712.459.149.1710.5710.22 CPI – RL13.7010.138.3810.1611.4110.72 CPI - AL13.8510.128.2310.0011.6010.74 New CPI---10.219.499.00 @ *: Up to June 2014. @: Up to July 2014.

16. 16 New CPI and WPI – Wedge

17. 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 18

19. 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. 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. 21

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. 22

23. 23 Twin Deficits: GFD & CAD (Per cent to GDP) YearGFD/GDPCAD/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)-

24. 24 CAD and GFD – As % of GDP

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

27. Portfolio Investment by FIIs in India 27

28. 28 Recent Policy Measures PeriodRepo 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-- Q250-- Q425-- 2014-15 Q1---50 Q2 (Aug 5)---50

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. 29

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. 30

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. 31

32. 1 st 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

33. 2 nd 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

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. 34

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. 35

36. 36 Thank you