Since the Second Quarter Review of October 2012, the global economy has shown some signs of stabilisation although the situation remains fragile. While activity is picking up in the US and the UK, near-term prospects in the euro area are still weak. Moreover, there is no clarity as yet on how the US ‘fiscal cliff’ might be managed. While several emerging and developing economies (EDEs) are gradually returning to higher growth, weak external demand and contagion risks from advanced economies (AEs) render them vulnerable to further shocks.
On the domestic front, there are some incipient signs of pick-up though growth remains significantly below its recent trend. Also, though consumer price inflation remains stubborn, the pace of moderation in wholesale price inflation has been faster than anticipated. With food and manufacturing prices expected to edge down further, inflationary pressures may ease somewhat in the coming months.
With the step-up in oil imports persisting despite the moderation in crude prices, the cumulative trade deficit for April-November widened from its level a year ago indicating significant risks to the balance of payments from the adverse external environment. Even as capital inflows improved compared to Q2, there were downward pressures on the rupee reflecting the large trade and current account deficits.
On the domestic front, GDP growth is evolving along the baseline projection of 5.8 per cent for 2012-13 set out in the SQR. The recent policy initiatives by the Government and further reforms should help to boost business sentiment and improve the investment climate. As regards inflation, excess capacity in some sectors is working towards moderating core inflation. Furthermore, the easing of international commodity prices, particularly of crude, is expected to impart some softening bias to the evolving inflation conditions if it is not offset by the impact of rupee depreciation. The Reserve Bank is closely monitoring the evolving growth-inflation dynamic and will update the formal numerical assessment of its growth and inflation projections for 2012-13 as part of the third quarter review in January 2013.
Headline inflation has been below the Reserve Bank’s projected levels over the past two months. The decline in core inflation has also been comforting. These emerging patterns reinforce the likelihood of steady moderation in inflation going into 2013-14, though inflation may edge higher over the next two months. In view of inflation pressures ebbing, monetary policy has to increasingly shift focus and respond to the threats to growth from this point onwards. Liquidity conditions will be managed with a view to supporting growth as stated in the SQR, thereby preparing the ground for further shifting the policy stance to support growth. Overall, recent inflation patterns and projections provide a basis for reinforcing our October guidance about policy easing in the fourth quarter. However, risks to inflation remain and accordingly, even as the policy emphasis shifts towards growth, the policy stance will remain sensitive to these risks.