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Click Here For Highlights of RBI's Annual Policy Statement for 2005-06
Part I. Annual Statement on Monetary Policy for the Year 2005-06
I. Review of Macroeconomic and Monetary Developments during 2004-05
Domestic Developments
19. In addition to the normal market borrowings, the Central Government raised Rs.65,481 crore (face value) under MSS for sterilisation purposes. Overall, the net resources raised through government securities (Centre, States and MSS) amounted to Rs.1,45,510 crore during 2004-05 as compared with Rs.1,35,192 crore (Centre and States) in the previous year.
20. The weighted average cost of Central Government borrowing through primary issuance of dated securities rose by 40 basis points to 6.11 per cent in 2004-05 from 5.71 per cent in the previous year. The weighted average maturity of the dated securities issued during 2004-05 was lower at 14.13 years as compared to 14.94 years in the previous year.
21. The persistence of a large government borrowing programme has implications for efficient monetary and debt management. With a pick up in credit demand, the banking system reduced its holding of government securities as a share of its net demand and time liabilities (NDTL) from 41.3 per cent in March 2004 to 38.5 per cent in March 2005. Such holdings of government securities, however, continue to be in excess of the statutory minimum requirement of 25 per cent of NDTL. In terms of volume, such holdings above the statutory liquidity ratio (SLR) amounted to Rs.2,60,582 crore in March 2005.
22. During 2004-05, there was a slippage in the key deficit indicators for 2004-05 from their budgeted levels. Moreover, the Union Budget sets a 'pause' for deficit indicators in 2005-06 as envisaged in the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 keeping in view the impact of implementation of the recommendations of the Twelfth Finance Commission (TWFC) which implies substantially higher devolution to States. It is, however, essential to pursue fiscal consolidation with resolve to realise the long-term potential of the economy. In this context, the parameters set out in FRBM Act coupled with the recommendations of TWFC provide a basis for fiscal consolidation within the federal structure.
23. During 2004-05, financial markets remained generally stable, though interest rates showed some intra-year upward movement. At the shorter end of the market, the weighted average call money rate increased by 40 basis points from 4.37 per cent in March 2004 to 4.77 per cent by March 2005. Similarly, the cut-off yields on 91-day and 364-day Treasury Bills also increased by 95 and 122 basis points from 4.37 per cent and 4.44 per cent to 5.32 per cent and 5.66 per cent, respectively, by March 2005. The yields on government securities with 1-year residual maturity increased by 97 basis points from 4.54 per cent to 5.51 per cent by March 2005. The weighted average discount rate on commercial paper (CP) of 61 to 90-days maturity increased by 73 basis points from 5.11 per cent to 5.84 per cent by March 2005.
24. An interesting development in the money market during 2004-05 was the increase in the relative size of the collateralised segment vis-à-vis the uncollateralised segment. The combined average daily transactions of market repo and collateralised borrowing and lending obligation (CBLO) was proportionately higher than those in the uncollateralised call/notice money market. The spread between call money rates and market repo rates narrowed from around 60 basis points in April 2004 to around 10 basis points by February 2005. The spread, however, widened to around 40 basis points in March 2005 on account of increase in market liquidity. Institutional and technological changes such as operationalisation of Clearing Corporation of India Limited (CCIL), negotiated dealing system (NDS), real time gross settlement (RTGS), delivery versus payment (DvP) III mode of settlement in government securities and rollover of repo have lowered transaction costs, reduced settlement risks, enhanced transparency and facilitated the ease of transaction. This is reflected in increasing collateralisation of transactions and better alignment of interest rates in the money market.
25. The yield on government securities with 5-year residual maturity increased by 158 basis points from 4.78 per cent in March 2004 to 6.36 per cent in March 2005. The yield on securities with 10-year maturity increased by 150 basis points from 5.15 per cent to 6.65 per cent in March 2005. Similarly, the yield on securities with 20-year residual maturity increased by 114 basis points from 5.85 per cent to 6.99 per cent during the same period.
26. As the longer-term yields exhibited sharper movements, the tenor spread in the government securities revealed intra-year variations. The spread between securities with residual maturities of 1-year and 10-year widened from 61 basis points in March 2004 to 114 basis points in March 2005. Similarly, the spread between government securities with residual maturities of 1-year and 20-year widened from 131 basis points in March 2004 to 148 basis points in March 2005.
27. While the yield curve steepened during 2004-05, the interest rate movement was orderly notwithstanding the sharp upward movement noticed during the third quarter of the financial year. For example, the average call money rates had peaked to 6.30 per cent and the yield on 10-year government securities had touched 7.31 per cent in November on account of adverse expectations emanating from uncertainties on the inflation front but the rates moderated in the subsequent period. Overall, despite large excess liquidity in the system, interest rates moved upwards reflecting uncertainties in oil prices, upward trend in global interest rates and increasing domestic demand for credit.
28. In line with the trend in yields in the government securities market, the yields on corporate papers also increased. The yield on 5-year AAA-rated corporate bond increased from 5.60 per cent in March 2004 to 7.14 per cent by March 2005. The spread between yields of AAA-rated corporate bond and government securities for 5-year residual maturity, however, narrowed from 82 basis points in March 2004 to 76 basis points by March 2005.
29. The term deposit rates offered by the public sector banks for maturities up to one year moved from a range of 3.75-5.25 per cent in March 2004 to 2.75-6.0 per cent in March 2005. The interest rates on term deposits over one year moved from a range of 5.00-6.00 per cent to 4.75-7.00 per cent during this period. The spread between typical deposit rates of 15-29 days and over 3-year tenor offered by public sector banks widened to 200 basis points in March 2005 from 175 basis points a year ago.
30. The benchmark prime lending rates (BPLRs) of public sector banks moved from a range of 10.25-11.50 per cent in March 2004 to 10.25-11.25 per cent in March 2005. BPLRs of foreign and private sector banks moved from a range of 11.00-14.85 per cent and 10.50-13.00 per cent in March 2004 to 10.00-14.50 per cent and 11.00-13.50 per cent, respectively, in March 2005.
31. During 2004-05, a substantial part of banks' lending was at sub-BPLR rates given the competitive conditions in the credit market. The share of sub-BPLR lending in total lending of commercial banks, excluding export credit, increased from about 50 per cent in March 2004 to over 60 per cent by March 2005. As at end-March 2005, public sector banks' median (representative) lending rate for the demand and term loans (at which maximum business is contracted), in the range of 9.00-12.50 per cent and 8.35-12.00 per cent, respectively, exhibited moderation as compared with their corresponding levels of 11.00-12.75 per cent each in March 2004. The movement in lending rates was in the desired direction keeping in view the concern expressed in the mid-term Review of November 2003 regarding the observed rigidities in the downward movement of lending rates.
32. The Reserve Bank has been persistently drawing the attention of banks to interest rate risks. Accordingly, banks were advised in January 2002 to build up investment fluctuation reserves (IFR) to a minimum of 5 per cent of their investment portfolio under the 'held for trading' (HFT) and 'available for sale' (AFS) categories, by transferring the gains realised on sale of investments within a period of five years. As at end-February 2005, banks have built up IFR up to 3.9 per cent. In September 2004, RBI allowed banks to exceed the ceiling of 25 per cent of investments included under 'held to maturity' (HTM) category by shifting some of their investments in SLR securities from the HFT/AFS categories to HTM category at the lowest of the acquisition cost or prevailing market value or book value, subject to a maximum of 25 per cent of NDTL. Further, in the mid-term Review of October 2004, banks were advised to prepare themselves to implement the capital charge for market risk as envisaged under Basel norms in a phased manner by end-March 2006.
33. The equity market during 2004-05 passed through its peak and trough, moving from a low on May 17 to record its all-time high in March.A strong macroeconomic outlook, positive investment climate, continued investment support by foreign institutional investors (FIIs), and encouraging corporate financial results were the main factors driving the market sentiment during 2004-05. However, an intra-year rise in inflation, deficient monsoon rainfall, outlook in the global financial markets and volatility in international oil prices were the main factors that led to some uncertainties.
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