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Click here to return to main page of Annual Policy Statement 2006-07
Part I. Annual Statement on Monetary Policy for the Year 2006-07
I. Review of Macroeconomic and Monetary Developments during 2005-06
Domestic Developments
22. Consistent with the monetary policy stance of ensuring appropriate liquidity, daily net injections of liquidity under the LAF averaged Rs.11,686 crore during January-March, 2006. In addition to the unwinding of funds held under the MSS, the Reserve Bank’s open market operations, private placement of Government securities and foreign exchange operations also augmented market liquidity. On the other hand, the cash balances of the Centre with the Reserve Bank increased from an average of Rs.19,693 crore in March 2005 to Rs.40,981 crore during January-March 2006, which added to the tightness in liquidity. Pressures began to ease in the last week of February 2006 with the call rate returning to the level of the repo rate and settling within the LAF corridor from mid-March 2006. Daily average injections fell to Rs.6,319 crore under the LAF in March 2006. On March 31, 2006 there was, in fact, net absorption of liquidity under the LAF of Rs.7,250 crore. The liquidity conditions eased considerably in April 2006 and the Reserve Bank absorbed an average daily amount of Rs.31,532 crore during the first 13 days of April. As on April 13, 2006 the LAF reverse repo amount was Rs.57,050 crore. Thus, there has been a significant shift in the liquidity conditions between the second half of March 2006 and the first half of April 2006.
23. Reserve money increased by 17.2 per cent (Rs.83,900 crore) during 2005-06, higher than the increase of 12.1 per cent (Rs.52,623 crore) in the previous year. As regards the components of reserve money, currency in circulation rose by 16.8 per cent (Rs.61,879 crore) as compared with the increase of 12.7 per cent (Rs.41,633 crore). Among the sources of reserve money, the Reserve Bank’s foreign currency assets (adjusted for revaluation) increased by Rs.68,834 crore as compared with an increase of Rs.1,15,044 crore. Net Reserve Bank’s credit to the Central Government (adjusted for the Government’s deposit balances including the MSS proceeds) increased by Rs.35,830 crore against a decline of Rs.60,177 crore. The increase in net Reserve Bank’s credit to the Central Government during 2005-06 mainly comprised acquisition of securities against liquidity injections through LAF of Rs.12,684 crore, MSS unwinding of Rs.35,149 crore and private placement of government securities with the Reserve Bank of Rs.10,000 crore, partly offset by the increase of Rs.13,195 crore in the Central Government cash balances (other than MSS) with the Reserve Bank. The Reserve Bank’s credit to banks and the commercial sector increased by Rs.534 crore as compared with a decline of Rs.833 crore in the previous year. The ratio of net foreign exchange assets (NFEA) to currency declined from 166.2 per cent in March 2005 to 156.3 per cent by March 31, 2006. As on April 7, 2006 the year-on-year growth in reserve money was 16.9 per cent.
24. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, was 4.0 per cent at end-March 2006 and 3.5 per cent as on April 1, 2006 after receding from a peak of 6.0 per cent on April 23, 2005. Prices of primary articles (weight: 22.0 per cent) rose by 5.2 per cent as against 1.1 per cent a year ago, largely on account of prices of food articles. Prices of manufactured products (weight: 63.8 per cent), however, remained benign through the year, rising by 1.0 per cent as compared with 5.5 per cent in the previous year. Prices of the ‘fuel, power, light and lubricants’ group (weight: 14.2 per cent) increased by 8.3 per cent as against 11.1 per cent a year ago.
25. The incomplete pass-through to the prices of domestic petroleum products, particularly kerosene, liquefied petroleum gas (LPG), and to a smaller extent in petrol and diesel, appropriate timing of administered price increases into the retreating phase of inflation during the first half of 2005-06 and some burden sharing by oil companies as well as through customs/excise duty reductions mitigated the immediate cost push impact of international crude prices. The average price of the Indian basket of international crude varieties (comprising Brent and Dubai Fateh) ruled at around US $ 60.1 per barrel in January-March, 2006 higher by 5.7 per cent than in the preceding quarter and by 30.2 per cent than a year ago. By April 13, 2006 the Indian crude basket price increased to US $ 65.5 per barrel. In the event, mineral oils accounted for 13.2 per cent of inflation in 2005-06. Excluding mineral oils, the WPI inflation works out to 2.3 per cent on April 1, 2006. In terms of the year-on-year change in the consumer price index (CPI) for industrial workers, inflation was 5.0 per cent in February 2006 as compared with 4.2 per cent a year ago. On an annual average basis, the CPI inflation was 4.3 per cent during 2005-06 as compared with 3.8 per cent a year ago.
26. Financial markets remained generally stable during 2005-06 although interest rates firmed up in all segments and the uncollateralised overnight call market experienced persistent tightness during the last quarter of the year. A noteworthy and desirable development during the year was the substantial migration of money market activity from the uncollateralised call money segment to the collateralised market repo and collateralised borrowing and lending obligations (CBLO) markets. The daily average volume (one leg) in the call money market increased from Rs.8,607 crore in April 2005 to Rs.9,145 crore in March 2006. The corresponding volumes in the market repo (outside the LAF) were Rs.3,958 crore and Rs.7,783 crore, respectively, whereas in the CBLO markets, the volumes were Rs.5,185 crore and Rs.17,299 crore, respectively. Thus, the share of the uncollateralised call market in the total overnight market transactions declined from 48.5 per cent in April 2005 to 26.7 per cent in March 2006. Increasingly, the CBLO market has emerged as the preferred overnight segment in 2005-06. The shift of activity from uncollateralised to collateralised segments of the market has largely resulted from measures relating to limiting the call market transactions to banks and primary dealers only. This policy-induced shift is in the interest of financial stability and is yielding results.
27. The overnight rates in the call money, market repo and CBLO segments, which were around the lower end of the LAF rate corridor till October 2005, started hardening in November as the shift in liquidity conditions from surplus to deficit rendered a few market participants short of both liquidity and collateral securities. The overnight rates, which were around the LAF reverse repo rate, registered a steep rise responding to the underlying liquidity conditions. While the overnight rates in the call money segment went above the LAF corridor during the third quarter of 2005-06, rates in the collateralised markets moved towards the upper end of the LAF rate during the same quarter. The interest rate in the call market moved up from an average of 5.12 per cent in October 2005 to 6.93 per cent in February 2006, but moderated thereafter to 6.58 per cent in March 2006. The overnight interest rate in the CBLO and market repo segments also rose from 5.01 per cent and 4.98 per cent, respectively, in October 2005 to 6.43 per cent and 6.41 per cent in February 2006, before moderating to 6.22 per cent and 6.17 per cent in March 2006. Reflecting the easy liquidity conditions, the call, market repo and CBLO rates (average for the first 13 days) declined to 5.69 per cent, 5.20 per cent and 5.24 per cent, respectively, in April 2006.
28. The weighted average discount rate on commercial paper (CP) of 61 to 90-day maturity increased from 5.80 per cent in April 2005 to 8.72 per cent by end-March 2006 and the total outstanding amount declined from Rs.15,214 crore to Rs.12,693 crore. The typical interest rate on 3-month CDs increased from 5.87 per cent in April 2005 to 8.56 per cent by mid-March 2006 accompanied by a significant increase in outstanding amounts from Rs.14,975 crore to Rs.36,931 crore.
29. In the Government securities market, the primary market yields of 91-day and 364-day Treasury Bills increased from 5.12 per cent and 5.60 per cent at end-April 2005 to 6.11 per cent and 6.42 per cent, respectively, at end-March 2006. The 182-day Treasury Bill yield moved up from 5.29 per cent to 6.61 per cent during this period. The primary market yields of 91-day, 182-day and 364-day Treasury Bills were 5.49 per cent, 6.14 per cent and 6.06 per cent, respectively, in the auctions held in April 2006. The yield on Government securities with 1-year residual maturity in the secondary market increased from 5.77 per cent as at end-April 2005 to 6.52 per cent at end-March 2006 but subsequently declined to 6.29 per cent as on April 13, 2006. The yield on Government securities with 10-year residual maturity increased from 7.35 per cent at end-April 2005 to 7.52 per cent at end-March 2006 and further to 7.55 percent as on April 13, 2006 while the yield on Government securities with 20-year residual maturity marginally declined from 7.77 per cent to 7.72 per cent but increased subsequently to 7.80 per cent during the same period. Consequently, the yield spread between 10-year and 1-year Government securities came down from 158 basis points in April 2005 to 100 basis points in March 2006 but increased to 126 basis points on April 13, 2006. The yield spread between 20-year and 1-year Government securities, however, declined from 200 basis points to 120 basis points as at end-March 2006 but subsequently increased to 151 basis points as on April 13, 2006.
30. The interest rates on deposits of over one year maturity of public sector banks (PSBs) moved up from 5.25-6.50 per cent in April 2005 to 5.75-7.25 per cent in March 2006. During the same period, the benchmark prime lending rates (BPLRs) of public sector banks and foreign banks remained unchanged in the range of 10.25-11.25 per cent and 10.00-14.50 per cent, respectively. The BPLRs of private sector banks moved to a range of 11.00-14.00 per cent from 11.00-13.50 per cent in the same period. The median lending rates for term loans (at which maximum business is contracted) in respect of major PSBs stood at 8.50-12.50 per cent in March 2006 as against 8.00-12.50 per cent in December 2005.
31. The equity market witnessed strong rallies with intermittent corrections and the BSE Sensex (1978-79=100) increased from an average of 6,379 in April 2005 to 10,857 in March 2006. The steep rise in stock prices during the year was largely driven by domestic mutual funds and foreign institutional investors (FIIs) who were responding to optimistic market sentiments as well as ample liquidity. As on April 13, 2006 the BSE Sensex was at 11,237.
32. The revised estimates (RE) of the Central Government’s finances for 2005-06 indicate some improvement in the fiscal position. Reduction in non-plan expenditure and in non-defence capital outlay enabled a lowering of the key deficit indicators relative to budget estimates (BE). The revenue deficit, at Rs.91,821 crore or 2.6 per cent of GDP, was lower than 2.7 per cent of GDP in the budget estimates (BE) for 2005-06. This was enabled by some increase in tax revenue and containment of growth in several items of non-plan expenditure like interest payments, grants to States and subsidies. The revised gross fiscal deficit (GFD) for 2005-06 at Rs.1,46,175 crore constituted 4.1 per cent of GDP as against the budgeted 4.3 per cent, contributed by a reduction in the revenue deficit, a decline in capital outlay and the availability of disinvestment proceeds.
33. During 2005-06, the Central Government’s net market borrowings at Rs.95,370 crore were 86.5 per cent of the budgeted amount of Rs.1,10,291 crore and gross market borrowings of Rs.1,58,000 crore were 88.5 per cent of the budgeted amount of Rs.1,78,487 crore. Issuances were broadly in accordance with the indicative semi-annual calendar except for rejection/cancellations of Rs.10,000 crore in October 2005 and Rs.5,000 crore in February 2006. As against this, the Government privately placed dated securities for an amount of Rs.10,000 crore with the Reserve Bank on March 6, 2006 which was outside the issuance calendar. All issuances, except one, were reissuances imparting liquidity to the securities. The State Governments raised Rs.15,455 crore (net) and Rs.21,729 crore (gross). During 2005-06, the combined issuance (net) of Government securities of the Centre (including MSS) and States was, however, only Rs.74,344 crore due to the unwinding of MSS securities to the tune of Rs.36,481 crore as against Rs.1,45,510 crore in 2004-05 and Rs.1,35,192 crore in 2003-04. It is noteworthy that the aggregate net issuance of Centre and States in 2005-06 was at its lowest level in the last seven years.
34. The weighted average yield on primary issuance of the Central Government’s dated securities rose by 123 basis points to 7.34 per cent in 2005-06 from 6.11 per cent in the previous year. The weighted average maturity of the dated securities issued during the year increased to 16.90 years from 14.13 years in the previous year.
35. Commercial banks’ holdings of Government and other approved securities remained in excess of the statutory minimum requirement of 25.0 per cent of net demand and time liabilities (NDTL). Such holdings, however, declined from 38.2 per cent of the banking system’s NDTL in March 2005 to 31.9 per cent in March 2006. While the excess SLR holdings amounted to Rs.1,56,504 crore in March 2006, several banks seem to be operating their SLR portfolios close to the statutory minimum level.
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