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Monetary policy: Four macroeconomic risks that RBI sees to economic growth

Maintaining a cautious stance, RBI Governor Subbarao cited various risks that are likely to hamper economic growth.

Updated: Jul 30, 2013, 12.39 PM IST
Credit policy: D Subbarao on risks to economic growth
NEW DELHI: Maintaining a cautious stance, the Reserve Bank of India (RBI) in its first quarter monetary policy review, not only kept key policy rates unchanged, but also cut the GDP growth forecast for FY14 to 5.5% from 5.7% earlier.

RBI Governor Subbarao cited various risks that are likely to hamper economic growth. Both domestic and global uncertainty were admitted to be a deterrent for economic recovery.

We take a look at the four risks that the central bank has highlighted:

External sector: By far, the biggest risk to the macroeconomic outlook stems from the external sector. "Financial markets around the world went into a flash turmoil on the perception of an earlier than expected tapering of QE by the US Fed. The rupee depreciated in nominal terms by as much as 5.8 per cent between May 22 (the day of the first 'announcement effect') and July 26, consequent on sudden stop and reversal of capital flows in reaction to the prospective change in the US monetary policy stance," RBI said.

"It is not clear if financial markets have factored in the full impact of the prospective tapering of QE or whether they will react to every future announcement of tapering," it added.

According to RBI, India, with its large CAD and dependence on external flows for financing it, will remain vulnerable to the confidence and sentiment in the global financial markets.

Large CAD: A Current Account Deficit (CAD), well above the sustainable level of 2.5 per cent of GDP for three years in a row, is a formidable structural risk factor, the bank says.

"It has brought the external payments situation under increased stress, reflecting rising external indebtedness and the attendant burden of servicing of external liabilities. Most external vulnerability indicators have deteriorated, eroding the economy's resilience to shocks," it said.

"The recent measures by the Reserve Bank to restore stability to the foreign exchange market should be used as a window of opportunity to put in place policies to bring the CAD down to sustainable levels. Furthermore, the growing vulnerability in the external sector reinforces the importance of credible fiscal consolidation with accent on both quantity and quality of adjustment," it added.

Investment climate: The investment climate remains weak and risk aversion continues to stall investment plans. "The outlook for investment is inhibited by cost and time overruns, high leverage, deteriorating cash flows, erosion of asset quality and muted credit confidence," it says.

Supply-side constraints: An environment of low and stable inflation and well-anchored inflation expectations is necessary to sustain growth in the medium-term. To engender this benign growth-inflation environment, it is critical to ease the supply constraints in the economy, particularly in the food and infrastructure sectors.

"Without policy efforts to address the deterioration in productivity and competitiveness, the pressures from wage increases and upward revisions in administered prices could weaken growth even further and exacerbate inflation pressures," it said.

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