ECONOMIC REVIEW II THE ANNUAL REPORT ON THE WORKING OF THE RESERVE BANK OF INDIA For the Year July 1, 2009 to June 30, 2010* PART ONE: THE ECONOMY – REVIEW AND PROSPECTS The Indian economy exhibited broad based recovery in the second half of 2009-10 from the slowdown that had started in the second half of 2008-09. Despite deficient monsoon and the fragile global recovery, India achieved 7.4 per cent growth in GDP in 2009-10, one of the highest in the world. The focus of macroeconomic policies was on management of the recovery. The expansionary fiscal stance helped offset the impa ct of sluggish private consumption and invest ment demand on economic growth. The accommodative monetary policy stance of the Reserve Bank, besides ensuring non-disruptive financing of the fiscal plans, created an overall liquidity and interest rate condition that was conducive for growth. The stable financial system of India continue d to have a favourable impact on th e overall business confidence, while also ensuring availability of resources from banks, non-banks and markets to meet the financing needs of the r ecovery. However , inflationary conditions changed significantly during the course of the year. After remaining subdued during the first half of the year, headline inflation spiked in the second half, initially driven by high food prices, but turning more generalised thereafter over successive months. The policy dilemma of containing inflation while supporting growth warranted reprioritisation of the policy goals. Stronger and broad -based recovery in growth provided nece ssary headroom for the gradual unwinding of monetary policy stimulus. In the second half, the need for faster return to the path of fiscal consolidation was generally recognised in view of the potential adverse implications of high fiscal deficit for medium-term growth, inflation and financial market conditions. The Union Budget for 2010-11, accordingly, announced plans for the beginning of the process of gradual fiscal exit. By the end of the year , developments in the Euro area following the sovereign debt crisis in Greece underscored the need for and significance of timely fiscal exit, with an emphasis on the quality of adjustment, for ensuring sustainable robust growth in the medium-run. II.1.1 The Indian economy exhi bited accel erat ion in the momentum of recovery during the course of the year and registered a growth of 7.4 per cent in 2009-10. The expansionary monetary and fiscal stance adopted in response to the global crisis contributed to the recovery. With the pickup in private investment demand, particularly by the last quarter of 2009-10, the recovery gradually became self-sustaining. This created the precondition for beginning of the policy exit. Moreover, the headline inflation path changed course significantly in the second half of the year, spurting to 11 per cent towards the end of the year, from near zero or negative in most of the months in the first half of the year. The changing output-inflation path, thus, warranted withdrawal of monetary policy stimulus. Accordingly, the focus of policy attention shifted gradually from “responding to the crisis” to “management of recovery”. II.1.2 The timing and stance of monetary pol icy actions had to be calibrated carefully during the year because of the uncertainty about the strength of the recovery in domestic private consumption