In line with our expectations, the Reserve Bank has kept the key benchmark rates unchanged.

The volatility in the exchange rate and the attendant implications for macro-economic stability have come to the forefront; this is as against growth-inflation dynamics and concerns regarding the funding of the current account deficit (CAD) that have dominated the setting of monetary policy in the recent past.

The downward revision in GDP forecast for 2013-14 to 5.5 per cent (from the earlier indicated levels of 5.7 per cent) factors in the weaker-than-expected performance of the IIP and the merchandise exports, following tepid global growth in Q1 of FY-14. It also takes into account the delay in monetary easing and transmission relative to what was anticipated previously.

In case the current situation persists for a longer period, the growth estimates may need to be further moderated.

Key concern

Despite easing wholesale inflation, inflationary expectations remain elevated, as retail inflation persists at close to 10 per cent.

While the inflationary pressures related to food prices may ease, with the favourable monsoons so far, the rupee depreciation and the rising global price of crude oil have increased the suppressed inflation component in the economy.

While continuing to reinforce the importance of structural measures to bring CAD down to sustainable levels, the RBI again urged the Government to ease supply-side constraints to improve the productivity and competitiveness of Indian companies; this will engender a benign growth-inflation environment.

Moreover, with business sentiments likely to remain cautious prior to the parliamentary elections, private sector capital spending is unlikely to revive in 2013-14.

In our view, the subdued outlook for economic growth and likely stickiness of interest rates suggests that consumer demand may not display a broad-based uptick in FY-14.

This is even as the favourable monsoon may improve consumption demand from the rural sector.

Given these incipient risks, the RBI is likely to remain cautious, to prevent inflationary pressures from resurfacing.

At the same time, the accommodative stance of the central bank to roll back the recent liquidity tightening measures introduced in July 2013 is welcome.

But the same will be pushed back given the heightened external sector risks.

Welcome rollback

Further, the guidance provided by the RBI — that monetary policy focus would revert to supporting growth only after calibrated rollback of the recent liquidity measures as stability is restored in the foreign exchange market — is likely to keep interest rates sticky at elevated levels, which would weigh upon consumption and investment decisions.

Accordingly, we anticipate that the RBI will ease its stance in the second half of the fiscal.

The current deposit and credit growth remains weak. With a pause in the monetary easing cycle it is likely to remain moderate in this fiscal; a meaningful revival in industrial and investment activity is required for an improvement in credit growth from the levels registered in FY13.

Following weak credit off-take in Q1 of FY-14, the structural wedge between deposit and credit growth narrowed from 1.1 per cent at the end of March 2013 to 0.6 per cent(excess of credit growth over deposit growth) on July 12, 2013.

This could narrow further, as lending rates are likely to remain high, following the liquidity tightening measures introduced earlier this month.

With the moderate growth witnessed till date, sizeable credit and deposit growth would be required in the second half of the fiscal to meet the RBI estimates for the year.

(The author is MD and CEO, ICRA Ltd.)

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