Saturday, September 4, 2010

Cause Enough for RBI to Pause?

RBI’s tightening cycle was almost unanimously presumed to continue in its September policy review, however, the global economic scenario has clouded considerably recently and though the Indian economy seems to be steaming on there are a few warning signs which ought to be heeded before it is too late.

Growth in the world's largest economy decelerated to a pace of 1.6 percent, signaling a more pronounced slowdown in the recovery from recession. July consumer spending a key driver of US economic growth, usually accounting for two-thirds of output rose 0.4% and incomes rose a mere 0.2%, with spending outpacing income. The US Unemployment rate for August came in higher as forecasted at 9.6%, while the Change in Nonfarm Payrolls for the same period showed a better than predicted shed of 54 thousand jobs. However, the Change in Manufacturing Payrolls showed a shed of 27 thousand jobs, which is actually worse than the predicted outcome, and also Change in Private Payrolls showed that jobs added were lower than expected. Europe looked better; economic confidence in the 16 countries that use the euro rose to its highest level in nearly two-and-a-half years during August, as unemployment concerns eased somewhat. The UK economy expanded at 1.6% year-on-year, faster than previously estimated in the second quarter in the biggest growth spurt since 2001 as companies rebuilt stocks and construction work surged.

Japan's government and the central bank had to throw the economy a double lifeline; accompanied by an unanimous vote to keep its key interest rate at a 0.1 percent the central bank unveiled a new six-month low-interest loan program to financial institutions to boost liquidity, combined with an existing three-month funds-supplying operation worth 20 trillion yen ($236 billion) so that banks would have access to a total of 30 trillion yen ($355 billion).

India's economy grew 8.8 percent in the first quarter of the current fiscal, its best performance since 2007, led by a 12.4 percent year-on-year surge in manufacturing, a 9.7 percent leap in services and an 8.9 percent jump in construction and was also boosted by agricultural output expansion of 2.8 percent. Yet many economists suggest that the central bank, which has hiked rates four times since the start of the year to curb inflation, should pause its monetary tightening — the most aggressive in the Asia-Pacific region — in the face of the shaky global outlook. If that is not cause enough RBI should possibly heed the warning signals emitted from the slowdown in domestic investment; not only has manufacturing growth slowed from 16.3% in the previous quarter to 12.4%, essential supplies and construction outputs have also shrunk as compared to the previous quarter, while services growth in important sectors have not really picked up. More concerning is the fact that gross fixed capital formation has decelerated compared to the last 2 quarters at a time that it ought to be rising with a need for vast infrastructure spending both for physical and human resources development. Should inflation control measures delinked from monetary policy and targeted at select necessary commodities now be evaluated instead?

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