Monday, May 15, 2017

Some Pointers to India’s Revised IIP and WPI 

In recent times, IIP, the high-frequency indicator of factory output, has been showing far more muted and volatile growth than the manufacturing component of GDP. The WPI (wholesale price index) measure of inflation has also shown unusual divergence from the CPI (consumer price index), differing not only in magnitude but also in direction. The composition of the basket of goods is decided, in the case of the IIP, which tracks production, based on traded volumes of goods in the base year. In the case of WPI, it is based on the volume of goods consumed in the base year. Weights are also assigned to individual items as well as the groups, based on the net traded value (the total transactions in a product) in the base year.  The government has released the new series of WPI and IIP under which the base year for calculating the macroeconomic indicators has been revised to 2011-12, from the 2004-05 earlier. The new series is expected to capture the deep structural change in the Indian economy and better reflect contemporary market realities. The revisions are based on the recommendations of a working group headed by Saumitra Chaudhuri (then Member of the Prime Minister’s Economic Advisory Council constituted by Manmohan Singh as well as Member, Planning Commission).  
The new IIP now measures output for the basket of goods produced in base year 2011-12 instead of 2004-05. It has been updated by introducing 149 new items into manufacturing, while removing 124 obsolete ones. The number of items in the basket of goods is now 809 (in 407 item groups) against 620 items (in 399 item groups) in the old series. The index is now more broad-based, includes renewable energy, and introduces a new sub-group — infrastructure and construction, reflecting the growing importance of the infrastructure and construction sector in the economy. This will significantly trim the weight of consumer products in the IIP and add to the weight of industrial goods. The capital goods, data will capture ‘work in progress’, on the recommendation of the Chaudhuri working group, which had noted that in the case of heavy machinery and other capital goods, the production may take several months and is reported only in the month when it is completed, causing high volatility in reported data. The decision to count work in progress is expected to smooth out the wild swings in this sub-index. The switch to a new base year and basket of goods are expected to reduce the dissonance with GDP data; however, divergences will remain as IIP by definition measures production in the organised sector, while GDP tracks value added and also covers the unorganised sector.
The revised WPI basket has 697 items against 676 earlier. The updating of base year to 2011-12 from 2004-05 has led to 199 new items being added to and 146 deleted from the basket. So far, the WPI was calculated as producer price plus indirect taxes minus trade discount. A major alteration is the exclusion of indirect taxes while compiling WPI. This exclusion removes the impact of fiscal policy on prices and brings it closer to a producer price index (PPI) in line with global best practices. This would also ensure that no further changes are required during the soon-to-be introduced GST regime. The dissemination of a new food index should be of considerable utility to households, agriculturists and policymakers. Both the IIP and WPI items will now be reviewed on an annual basis by a technical review committee.
Though the new series of GDP, IIP, WPI and CPI are expected to better reflect the true trends in the economy academicians have expressed severe doubts on the quality of data given the nature of ground staff employed in gathering data and the approximations made from small samples lacking use of modern sources in the era of big data.

Tuesday, May 9, 2017

Budget 2017-18 highlights

Following are the Highlights of the Union Budget for 2017-18
Introductory Remarks
Budget 2017-18 contains 3 major reforms: advancement of date of presentation, merger of railway budget with general budget, abolition of Plan and non-Plan expenditure.
Pace of remonetization will soon reach comfortable levels; effect of demonetization not expected to spill over into next year. Surplus liquidity in banking system will raise access to credit, leading to multiplier effect on economic activity.
Agenda for 2017-18 is “Transform, Energise and Clean India” through 10 themes:
Farmers : committed to double the income in 5 years;  Rural Population : providing employment & basic infrastructure;  Youth : energising them through education, skills and jobs;  The Poor and the Underprivileged : strengthening the systems of social security, health care and affordable housing;  Infrastructure: for efficiency, productivity and quality of life;  Financial Sector : growth & stability by stronger institutions;  Digital Economy: for speed, accountability and transparency;  Public Service : effective governance and efficient service delivery through people’s participation;  Prudent Fiscal Management: to ensure optimal deployment of resources and preserve fiscal stability;  Tax Administration: honouring the honest.

Fiscal situation
*       Total expenditure is Rs. 21, 46,735 crore.
*       Plan, non-plan expenditure to be abolished; focus will be on capital expenditure, which will be 25.4 %.
*       Rs. 3,000 crore under the Department  of Economic Affairs for implementing the Budget announcements.
*       The defence sector gets an allocation of Rs. 2.74,114 crore.
*       Expenditure for science and technology is Rs. 37,435 crore.
*       Total resources transferred to States and Union Territories is Rs 4.11 lakh crore.
*       Revenue deficit is 1.9 %
*       Fiscal deficit of 2017-18 pegged at 3.2% of the GDP. Will remain committed to achieving 3% in the next year.
*       Net market borrowing of Government restricted to Rs. 3.48 lakh crores after buyback in 2017-18, compared with Rs. 4.25 lakh crores of the previous year.
*       Food subsidy estimated at 1.45 lakh crore rupees in 2017-18 versus 1.35 lakh crore rupees revised estimate for 2016-17.
*       Fuel subsidy seen at 25,000 crore rupees in 2017-18 versus 27,500crore rupees revised estimate for 2016-17.
*        Fertiliser subsidy seen unchanged in 2017-18 at 70,000 crore rupees.
*        Federal government's pension liabilities seen at 1.31 lakh crore rupees in 2017-18 versus 1.28 lakh crore rupees revised estimate for 2016-17.
*        Budget allocation to health seen at 48,900 crore rupees in 2017-18 versus revised estimate of 39,900 crore rupees in 2016-17.
*       Interest payments at Rs. 523078 crore in 2017-18 against Rs. 483069 crore in 2016-17.

Tax proposals
*       India’s tax to GDP ratio is not favourable and there are several anomalies: Out of 13.14 lakh registered companies, only 5.97 lakh firms have filed returns for 2016-17; individuals numbering 1.95 crore showed an income between Rs. 2.5 lakh to Rs. 5 lakh; out of 76 lakh individual assessees declaring income more than Rs. 5 lakh, 56 lakh are salaried; only 1.72 lakh people showed income of more than Rs. 50 lakh a year; between November 8 to December 30, deposits ranging from Rs. 2 lakh and Rs. 80 lakh were made in 1.09 crore accounts.
*       Proportion of direct tax to indirect tax is not optimal.
*       Under the corporate tax, in order to make MSME companies more viable, there is a proposal to reduce tax for small companies with a turnover of up to Rs 50 crore to 25%. About 67 lakh companies fall in this category. 96% of companies to get this benefit.
*       The government proposes to reduce basic customs duty for LNG to 2.5% from 5%.
*      Proposal to have a carry-forward of MAT for 15 years.
*      Holding period for long-term capital gains tax on immovable property reduced from 3 to 2 years; base year indexation shifted from 1.4.1981 to 1.4.2001.
*       Capital gains tax to be exempted for persons holding land from which land was pooled for creation of the state capital of Andhra Pradesh.
*       The limit of cash donation by charitable trusts is reduced to Rs 2,000 from Rs 10,000.
*       Actual revenue loss on tax proposals Rs 22,700 crore; gain from additional resource mobilisation is Rs 2,700 crore 
*       Net revenue loss in direct tax could be Rs. 20,000 crore.

Personal income tax
*       Existing rate of tax for individuals between Rs.  2.5- Rs 5 lakh is reduced to 5% from 10%.
*       All other categories of tax payers in subsequent brackets will get a benefit of Rs 12,500.
*       10 % surcharge on individual income above Rs. 50 lakh and up to Rs 1 crore to make up for Rs 15,000 crore loss due to cut in personal I-T rate.
*       15 surcharge on individual income above Rs. 1 crore to remain.
*       Rate of growth of advance tax in Personal I-T is 34.8% in the last three quarters of this financial year.
*       The Income Tax Act to be amended to ensure that no transaction above Rs 3 lakh is permitted in cash.

Infrastructure and Railways   
Ø  A total allocation of Rs. 39,61,354 crore has been made for infrastructure.
Ø  For transportation sector as a whole, including rail, roads, shipping, provision of Rs. 2,41,387 crore has been made in 2017-18.
Ø  Total allocation for Railways is Rs. 1,31,000 crore.
Ø  No service charge on tickets booked online through IRCTC.
Ø  Corpus of Rs. 1 lakh crore for five years for passenger safety.
Ø  Railways to partner with logistics players for front-end and back-end solutions for select commodities.
Ø  Railways will offer competitive ticket booking facility.
Ø  New Metro rail policy will be announced with new modes of financing.
Ø  Rs. 64,900 crore allocated for highways.
Ø  A DigiGaon initiative will be launched to provide tele-medicine, education and skills through digital technology.
Ø  Trade Infrastructure for Export Scheme (TIES) will be launched in 2017-18.
Ø  A strategic policy for crude reserves will be set up.

Agriculture, Poverty and Health
*       A sum of Rs. 10 lakh crore is allocated as agricultural credit. Farmers to also benefit from 60 days interest waiver announced on 31 Dec 2016. Agriculture sector is expected to grow at 4.6%.
*       Long Term Irrigation Fund already set up in NABARD to be augmented by 100% taking the total corpus to Rs. 40,000 crores. A dedicated micro irrigation fund will be set up for NABARD with Rs 5,000 crore initial corpus.
*       National Agricultural Market (e-NAM) to be expanded from 250 markets to 585 APMCs. Assistance up to Rs. 75 lakhs will be provided to every e-NAM.
*       Dairy processing infrastructure fund wlll be initially created with a corpus of Rs. 2000 crore.
*       Over Rs 3 lakh crore will be spent for rural India. MGNREGA to double farmers' income.
*       MGNREGA allocation to at Rs. 48,000 crores in 2017-18.
*       Technology will be used in a big way to ensure MGNREGA works.
*       During 2017-18, five lakh farm ponds will be be taken up under the MGNREGA.
*       The government targets to bring 1 crore households out of poverty by 2019.
*       The government proposes to complete 1 crore houses for those without homes.
*       Affordable housing will be given infrastructure status.
*       Will allocate Rs. 19,000 crore for Pradhan Mantri Gram Sadak Yojana in 2017-18.
*       The country well on way to achieve 100% rural electrification by March 2018.
*       Swachh Bharat mission has made tremendous progress; sanitation coverage has gone up from 42% in Oct 13 to 60% now.
*       Allocation of  Rs. 4000 crores  for Skill Acquisition and Knowledge Awareness for Livelihood Promotion programme (SANKALP) to provide market relevant training to 3.5 crore youth.
*       Allocation of Rs. 500 crores to provide support services for empowering rural women with opportunities for skill development, employment, digital literacy, health and nutrition.
*       Total allocation for Rural, Agriculture and Allied sectors is Rs. 187223 crores.

Financial sector
Ø  FDI policy reforms - more than 90% of FDI inflows are now automated.
Ø  Foreign Investment Promotion Board will be abolished.
Ø  An expert committee for creation of an operational and legal framework to integrate spot market and derivatives market in the agricultural sector, for commodities trading. e- NAM to be an integral part of the framework.
Ø  A new ETF with diversified CPSE stocks and other Government holdings will be launched in 2017-18.
Ø  Shares of Railway PSE like IRCTC will be listed on stock exchanges.
Ø  Bill on resolution of financial firms will be introduced in this session of Parliament.
Ø  Revised mechanism to ensure time-bound listing of CPSEs.
Ø  Computer emergency response team for financial sector will be formed.
Ø  Rs 10,000 crore for recapitalisation of banks will be providedin 2017-18.
Ø  Pradhan Mantri Mudra Yojana lending target fixed at Rs 2.44 lakh crore for 2017-18.
Ø  Digital India The government will introduce two schemes to promote BHIM App - referral bonus for the users and cash back for the traders.
Ø  Negotiable Instruments Act might be amended.
Ø  For big-time offences - including economic offenders fleeing India, the government will introduce legislative change or introduce law to confiscate the assets of these people within the country.
Ø  No transaction above Rs. 3 lakh would be permitted in cash subject to certain exceptions.
Ø  A Mission will be set up with a target of 2,500 crore digital transactions for 2017-18 through UPI, USSD, Aadhar Pay, IMPS and debit cards.
Ø  The maximum amount of cash donation for a political party will be Rs. 2,000 from any one source. Political parties will be entitled to receive donations by cheque or digital mode from donors. An amendment is being proposed to the RBI Act to enable issuance of electoral bonds .A donor can purchase these bonds from banks or post offices through cheque or digital transactions. They can be redeemed only by registered political parties.

Thursday, April 27, 2017

Highlights of RBI’s First Bi-monthly Monetary Policy Statement, 2017-18

Policy Measures
  • The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.25%.
  • With a view to ensuring finer alignment of the weighted average call rate (WACR), the operating target of monetary policy, with the repo rate it has been decided to further narrow the policy rate corridor around the policy repo rate to +/-25bps from +/- 50bps with immediate effect. Consequently, the reverse repo rate under the LAF is at 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.50%.
  • The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth. 
Indicators of global growth suggest signs of stronger activity in most AEs and easing of recessionary conditions in commodity exporting large emerging market economies (EMEs). For EMEs, the outlook is gradually improving, with indications that the slowdown characterising 2016 could be bottoming out. Inflation is edging up in AEs to or above target levels on the back of slowly diminishing slack, tighter labour markets and rising commodity prices. Among EMEs, there is a generalised softening of inflation pressures. 
International financial markets have been impacted by policy announcements in major AEs, geo-political events and country-specific factors. Equity markets in AEs were driven up by reflation trade, stronger incoming data and currency movements. Equity markets in EMEs had a mixed performance, reflecting domestic factors amidst a cautious return of investor appetite and capital flows.
The CSO released its second advance estimates for 2016-17 on February 28, placing India’s real GVA growth at 6.7% for the year, down from 7% in the first advance estimates released on January 6. Agriculture expanded robustly; in the industrial sector, there was a significant loss of momentum across all categories, barring electricity generation; and the services sector also slowed, pulled down by most categories of services.
Several indicators are pointing to a modest improvement in the macroeconomic outlook. Foodgrains production has touched an all-time high. Industrial output, measured by the index of industrial production (IIP), recovered in January from a contraction in the previous month, helped by a broad-based turnaround in manufacturing as well as mining and quarrying. The manufacturing purchasing managers’ index (PMI) remained in expansion mode in February and rose to a five month high in March on the back of growth of new orders and output. The 77th round of the Reserve Bank’s industrial outlook survey indicates that overall business sentiment is expected to improve in Q1 of 2017-18 on the back of a sharp pick up in both domestic and external demand. Coincident indicators such as exports and non-oil non-gold imports are indicative of a brighter outlook for industry, although the sizable under-utilisation of capacity in several industries could operate as a drag on investment.
 After moderating continuously over the last six months to a historic low, retail inflation measured by year-on-year changes in the CPI turned up in February to 3.7%. While food prices bottomed out at the preceding month’s level, base effects pushed up inflation in this category. Fuel inflation increased as the continuous hardening of international prices lifted domestic prices of petroleum. Kerosene prices have also been increasing since July with the programmed reduction of the subsidy. Both three months ahead and a year ahead households’ inflation expectations, reversed in the latest round of the Reserve Bank’s survey. The 77th round of the Reserve Bank’s industrial outlook survey indicates that pricing power is returning to corporates as profit margins get squeezed by input costs. Excluding food and fuel, inflation moderated in February by 20 basis points to 4.8%, essentially on transient and specific factors in items like clothing and gold.
With progressive remonetisation, the surplus liquidity in the banking system declined from a peak of Rs.7,956 billion on January 4, 2017 to an average of Rs. 6,014 billion in February and further down to Rs. 4,806 billion in March. Currency in circulation expanded during this period. Its impact on the liquidity overhang was, however, partly offset by a significant decline in cash balances of the Government up to mid-March which released liquidity into the system. Thereafter, the build-up of Government cash balances on account of advance tax payments and balance sheet adjustment by banks reduced surplus liquidity to Rs. 3,141 billion by end-March. Issuances of cash management bills (CMBs) under the MSS ceased in mid-January and existing issues matured, with the consequent release of liquidity being absorbed primarily through variable rate reverse repo auctions of varying tenors. Accordingly, the average net absorption by the Reserve Bank increased from Rs. 2,002 billion in January to Rs. 4,483 billion in March. The weighted average call money rate (WACR) remained within the LAF corridor. The maturing of CMBs and reduced issuance of Treasury bills leading up to end-March has also contributed to Treasury bill rates being substantially below the policy rate.
Merchandise exports rose strongly in February 2017 from a subdued profile in the preceding months. Growth impulses were broad-based.  The surge in imports in January and February 2017 largely reflected the effect of the hardening of commodity prices such as crude oil and coal. With imports outpacing exports, the trade deficit widened in January and February from its level a year ago, though it was lower on a cumulative basis for the period April-February 2016-17. Balance of payments data for Q3 indicate that the current account deficit for the first three quarters of the financial year narrowed to 0.7% of GDP, half of its level a year ago. For the year as a whole, the current account deficit is likely to remain muted at less than 1% of GDP.
Foreign direct investment (FDI) has dominated net capital inflows during April-December, with manufacturing, communication and financial services being the preferred sectors. FPI flows turned positive in February and welled up into a surge in March, especially in debt markets. This reversal appears to have been driven by stable domestic inflation, better than expected domestic growth, encouraging corporate earnings, clarity on FPI taxation, pro-reform budget proposals and state election results. The level of foreign exchange reserves was US$369.9 billion on March 31, 2017.
GVA growth is projected to strengthen to 7.4% in 2017-18 from 6.7% in 2016-17, with risks evenly balanced. The pace of remonetisation will continue to trigger a rebound in discretionary consumer spending. Significant improvement in transmission of past policy rate reductions into banks’ lending rates post demonetisation should help encourage both consumption and investment demand of healthy corporations. Various proposals in the Union Budget should stimulate capital expenditure, rural demand, and social and physical infrastructure all of which would invigorate economic activity. The imminent materialisation of structural reforms in the form of the roll-out of the GST, the institution of the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board will boost investor confidence and bring in efficiency gains. The upsurge in IPOs in the primary capital market augurs well for investment and growth. External demand should support domestic growth. Downside risks to the projected growth path stem from the outturn of the south west monsoon; ebbing consumer optimism on the outlook for income, the general economic situation and employment as polled in the March 2017 round of the Reserve Bank’s consumer confidence survey; and, commodity prices, other than crude, hardening further.
Headline CPI inflation is set to undershoot the target of 5.0% for Q4 of 2016-17 in view of the sub-4% readings for January and February. For 2017-18, inflation is projected to average 4.5% in the first half of the year and 5% in the second half. Aggregate demand pressures could build up, with implications for the inflation trajectory.
Developmental and Regulatory Policies
The RBI also sets out new measures for further refining the liquidity management framework (Management of Surplus Liquidity, Narrowing of the Monetary Policy Rate Corridor, Substitution of Collateral under the LAF Term Repos); strengthening the banking regulation and supervision (Revised Prompt Corrective Action (PCA) Framework for Banks, Raising the Minimum Level of Net Owned Funds for ARCs, Partial Credit Enhancement, Banking Outlets in underserved areas, banks’ participation in Real Estate Investment Trust (REITS) and Infrastructure Investment Trusts, Countercyclical Capital Buffer); broadening and deepening financial markets (Draft Guidelines on Simplified Hedging Facility for Forex Exposure, Introduction of Tri-party Repo, Introduction of Additional Settlement Batches for NEFT, Merchant Discount Rate rationalization, Issuance and Operation of Pre-paid Payment Instruments); and extending the reach of financial services by enhancing the efficacy of the payment and settlement systems (Pilot Project on Financial Literacy).

Thursday, February 2, 2017

The Global Economy: A Rough Ride into 2017

Year 2016 ended on a rather low note for the global economy with low output and employment growth, stagnant global trade, subdued investment, and heightened policy uncertainty marking another difficult year. Global growth in 2016 is estimated at a post-crisis low of 2.3 per cent by the World Bank, while the IMF estimate is at a slightly higher 3.1 per cent (See: or World trade growth for 2016 is estimated by World Bank to have fallen from 2.8 per cent in 2015 to 2.5 per cent, while the IMF estimate for 2016 is at an even lower 1.9 per cent. In the second half of the year growth did rebound in the US after a weak first half of 2016. Output remains below potential in a number of other advanced economies, notably in the Euro area, though growth figures were somewhat stronger than previously forecast in some economies, such as Spain and the UK, where domestic demand held up better than expected in the aftermath of the Brexit vote. The growth rate in China was slightly stronger than expected, supported by continued policy stimulus, though deep concerns remain over imbalances caused by the country’s reliance on credit and its high savings rate. But activity was weaker than expected in some Latin American countries currently in recession, such as Argentina and Brazil, as well as in Turkey, which faced a sharp contraction in tourism revenues. Activity in Russia was slightly better than expected, in part reflecting firmer oil prices.
While slowing investment growth is partly a correction from high pre-crisis growth rates in some EMDEs, it also reflects a range of obstacles holding back investment, including terms-of-trade shocks for oil exporters, slowing foreign direct investment inflows, as well as private debt burdens and political risks. Commodity prices have stabilized and are projected to increase moderately during 2017-19, providing support for commodity-exporting EMDEs. The rise in US yields since early November has led to a notable tightening of financing conditions for EMDEs, in some cases resulting in significant currency depreciation and portfolio outflows. High corporate debt, declining profitability, weak bank balance sheets, and thin policy buffers in several economies add to concerns. Fiscal stimulus, if implemented in key economies, could result in stronger growth. Monetary policy has so far remained mostly accommodative across the globe; however fiscal space remains inadequate in several economies, both advanced and emerging, because of already high public debts.
Risks to the global growth outlook are assessed to be skewed to the downside. A projected stabilization in energy and commodity prices may provide a small tailwind for resource rich economies in 2017, but the medium-term trend continues to be dominated by weak investment growth. Adding to the inertia is a wait-and-watch attitude among corporates and governments. Going into 2017, businesses have to prepare for more disruptions from geopolitical tensions, policy uncertainty, and financial market volatility. Lingering uncertainty about the course of US economic policy could have a significantly negative effect on global growth prospects as the new US government’s policies take shape. Accelerating inflation and a soaring US dollar are among the risks to the economic balance. Even more alarming is the fact that recent political developments highlight a fraying consensus about the benefits of cross-border economic integration. Major policy shifts along these lines are seen to lead to potential widening of global imbalances coupled with sharp exchange rate movements and in response could further intensify protectionist pressures. Increased restrictions on global trade and migration would hurt productivity and incomes, and take a toll on market sentiment as well, leading to a vicious circle of growth debilitating outcomes.

Sunday, January 22, 2017

RBI’s fifth bi-monthly monetary policy statement, 2016-17

Policy Measures
  • Repo rate unchanged at 6.25%, consequently, the Reverse repo rate remains at 5.75% and the MSF rate at 6.75%. All the six members of the RBI panel voted in favour of status quo in policy.
  • Cash reserve ratio or CRR unchanged at 4%. RBI withdraws the temporary 100% hike in the CRR in the fortnight beginning 10 December.
  • Foreign exchange reserve rose to all-time high of $364 billion on December 2.
  • RBI injected  liquidity worth Rs. 1 trillion through OMO purchases this fiscal.
Global growth picked up modestly in the second half of 2016, after weakening in the first half. Activity in AEs improved, led by a rebound in the US. In the EMEs, growth has moderated, but policy stimulus in China and some easing of stress in the larger commodity exporters shored up momentum. World trade is beginning to emerge out of a trough that bottomed out in July-August and shows signs of stabilising. Inflation has ticked up in some AEs, though well below target, and is easing in several EMEs. Expectations of reflationary fiscal policies in the US, Japan and China, and the waning of downward pressures on EMEs in recession are tempered by still-prevalent political risks in the euro area and the UK, emerging geo-political risks and the spectre of financial market volatility.
International financial markets were strongly impacted by the result of the US presidential election and incoming data that raised the probability of the Federal Reserve tightening monetary policy. As bouts of volatility fuelled a risk-off surge into US equities and out of fixed income markets, a risk-on stampede pulled out capital flows from EMEs, plunging their currencies and equity markets to recent lows even as bond yields hardened in tandem with US yields. The surge of the US dollar from late October intensified after the election results and triggered sizable depreciations in currencies around the world. Commodity prices firmed up across the board from mid-November on an improvement in the outlook for demand following the US election results, barring gold which lost its safe haven glitter to the ascendant US dollar. Crude prices have firmed after the OPEC’s decision to cut output.
GVA in Q2 of 2016-17 turned out to be lower than projected on account of a deeper than expected slowdown in industrial activity. Manufacturing slowed down both sequentially and on an annual basis, with weak demand conditions and the firming up of input costs dragging down the profitability of corporations. Gross fixed capital formation contracted for the third consecutive quarter. Although government final consumption expenditure slowed sequentially, it supported private final consumption expenditure, the mainstay of aggregate demand. The contribution of net exports to aggregate demand remained positive, but on account of a sharper contraction in imports relative to exports. CPI eased more than expected for the third consecutive month in October, driven down by a sharper than anticipated deflation in the prices of vegetables. Underlying this softer reading, however, was an upturn in momentum as prices rose month-on-month across the board.
Liquidity conditions have undergone large shifts in Q3 so far. Surplus conditions in October and early November were overwhelmed by the impact of the withdrawal of notes from November 9. Currency in circulation plunged by ₹7.4 trillion up to December 2; consequently, net of replacements, deposits surged into the banking system, leading to a massive increase in its excess reserves. The RBI scaled up its liquidity operations through variable rate reverse repo auctions of a wide range of tenors from overnight to 91 days, absorbing liquidity (net) of ₹5.2 trillion. From the fortnight beginning November 26, an incremental CRR of 100 per cent was applied on the increase in net demand and time liabilities (NDTL) between September 16, 2016 and November 11, 2016 as a temporary measure to drain excess liquidity from the system. Liquidity management was bolstered by an increase in the limit on securities under the market stabilisation scheme (MSS) from ₹0.3 trillion to ₹6 trillion on November 29. 
Growth forecast cut to 7.1%, from 7.6% for this fiscal. Downside risks in the near term could travel through two major channels: (a) short-run disruptions in economic activity in cash-intensive sectors such as retail trade, hotels & restaurants and transportation, and in the unorganised sector; (b) aggregate demand compression associated with adverse wealth effects.
Inflation target remains 5% for March 2017. Demonetisation to lower prices of perishables, could reduce inflation by 10-15 basis points by December; however, crude price volatility, surge in financial market turbulence could put March-end inflation target at risk.
The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. The RBI’s cautious approach comes amidst a volatile global environment, which saw the rupee sink to a record low last month as part of a sell-off in emerging market assets. Pressure on the RBI to act has grown since November 8 when a drastic plan to abolish Rs 500 and Rs 1,000 notes was put in place, removing 86 percent of the currency in circulation in a bid to crack down on black money.