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Click here to return to main page of Annual Policy Statement 2007-08
Part I. Annual Statement on Monetary Policy for the Year 2007-08
I. Review of Macroeconomic and Monetary Developments during 2006-07
Domestic Developments
24.In terms of the year-on-year change in the consumer price index for industrial workers (CPI-IW), inflation was 7.6 per cent in February 2007 as compared with 5.0 per cent a year ago. On an annual average basis, CPI-IW inflation was 6.6 per cent as compared with 4.3 per cent a year ago. Inflation, based on the CPI for urban non-manual employees (CPI-UNME), for agricultural labourers (CPI-AL) and for rural labourers (CPI-RL) showed a sharp year-on-year increase to 7.8 per cent, 9.8 per cent and 9.5 per cent in February 2007, respectively, from 4.8 per cent, 5.0 per cent and 4.7 per cent a year ago. Elevated prices of primary food articles, which have a higher weightage in the CPI basket relative to the WPI, have been the main drivers of consumer prices and the major cause of the divergence between inflation rates based on the CPI and the WPI.
25.The revised estimates (RE) of the Central Government’s finances for 2006-07 indicate ongoing improvement in the fiscal position and lowering of the key deficit indicators as ratios of GDP, relative to budget estimates (BE). The revenue deficit estimated at Rs.83,436 crore or 2.0 per cent of GDP was lower than 2.1 per cent of GDP in the budget estimates for 2006-07 and 2.6 per cent in 2005-06. The gross fiscal deficit (GFD) for 2006-07 at Rs.1,52,328 crore constituted 3.7 per cent of GDP as against the budget estimates of 3.8 per cent and 4.1 per cent in the previous year. The improvement in key fiscal indicators was enabled by the sustained buoyancy in tax revenue and containment of growth in Plan expenditure.
26.During 2006-07, the Central Government’s net market borrowing at Rs.1,11,275 crore was 97.7 per cent of the budgeted amount of Rs.1,13,778 crore and gross market borrowing of Rs.1,79,373 crore was 98.6 per cent of the budgeted amount of Rs.1,81,875 crore. While the actual issuance of dated securities, in aggregate terms, matched the total quantum of issuances provided in the calendar for the first half (viz., Rs. 89,000 crore), there were four occasions when the actual issuance differed from the issuance calendar. For the second half, deviations were noted on two occasions, reflecting investor demand in favour of longer maturity instruments and buoyant revenue collections. Out of 33 issuances, 30 issues were reissuances, intended to impart liquidity while the remaining three securities were issued to provide benchmarks in the key segments of 10-15 year and 30-year maturity. The State Governments raised Rs.20,825 crore (gross) and Rs.14,274 crore (net) and under their market borrowing programme during 2006-07. The combined issuance (net) of Government securities of the Centre (excluding MSS) and States was Rs.1,25,549 crore as against Rs.1,13,691 crore in 2005-06, Rs.80,028 crore in 2004-05 and Rs.1,35,192 crore in 2003-04.
27.The weighted average yield on primary issuance of the Central Government’s dated securities rose by 55 basis points to 7.89 per cent in 2006-07 from 7.34 per cent in the previous year whereas the weighted average maturity of the dated securities issued during the year decreased to 14.72 years from 16.90 years in the previous year. Weighted average yields on securities issued by State Governments firmed up to 8.10 per cent in 2006-07 from 7.63 per cent in 2005-06 even though maturity of the issues has remained the same at 10.0 years.
28.Financial markets experienced generally stable conditions during the greater part of 2006-07, albeit with some volatility in the second half amidst heightened activity as volumes increased steadily and interest rates firmed up in all segments. The uncollateralised call/notice money market experienced occasional tightness during the last quarter of the year. While call money rates exceeded 10.0 per cent through the last week of December 2006, they declined subsequently but stayed above the LAF corridor on all the days from the second week of January to the first week of February 2007, with a peak at 8.35 per cent on January 8, 2007. Although average call rates eased to 6.72 per cent in the second week of February, they firmed up thereafter and reached 7.91 per cent in the third week. While easy liquidity returned in the subsequent period up to the third week of March, call rates rose markedly from March 16, 2007 following advance tax outflows. Call rates peaked at 54.32 per cent on March 30, 2007. With the easing of liquidity conditions in the banking system in April, call rates moved back within the corridor and even below in the second week of April. The call rate firmed up again from April 17, 2007 on account of enhanced reserve requirements and expectations surrounding the forthcoming Annual Policy Statement for 2007-08. The overnight rates in the call money segment went above the LAF corridor intermittently during December-March 2006-07 and ranged between 6.64–12.96 per cent in January 2007, between 6.08–8.08 per cent in February 2007 and between 5.31–54.32 per cent in March 2007.
29.The overnight rates in the market repo and collateralised borrowing and lending obligations (CBLO) segments, which were around the lower end of the LAF rate corridor till May 2006, started hardening in June in responce to underlying liquidity conditions. Over the rest of the year, quarterly advance tax outflows, the build-up of the Centre’s cash balances and changes in liquidity with the banking system on account of sustained credit demand resulted in sizeable shifts in liquidity conditions. Rates in the collateralised markets also moved towards the upper end of the LAF rate corridor. The interest rate in the call market moved up from an average of 5.69 per cent in April 2006 to 8.63 per cent in December 2006 and further to 14.07 per cent in March 2007. Interest rates in the CBLO and market repo segments rose from 5.23 per cent and 5.10 per cent, respectively, in April 2006 to 7.05 per cent and 7.47 per cent in December 2006 and further to 7.73 per cent and 8.13 per cent in March 2007. The daily average volume (one leg) in the call money market increased from Rs.7,890 crore in April 2006 to Rs.11,608 crore in March 2007. The corresponding volumes in the market repo (outside the LAF) were Rs.5,479 crore and Rs.8,687 crore, respectively, whereas in the CBLO segment, the volumes were Rs.16,327 crore and Rs.17,662 crore, respectively. As on April 20, 2007 the weighted average interest rate for CBLO, market repo and call rate stood at 9.80 per cent, 7.78 per cent and 7.85 per cent, respectively.
30.The weighted average discount rate on commercial paper (CP) increased from 8.6 per cent at end-March 2006 to 11.33 per cent at end-March 2007. The total outstanding amount of CPs increased from Rs.12,718 crore to Rs.17,333 crore during this period. The weighted average discount rate for certificates of deposit (CDs) increased from 8.62 per cent at end-March 2006 to 10.8 per cent in early-March 2007 accompanied by a significant increase in outstanding amounts from Rs.43,568 crore to Rs.92,468 crore.
31.In the Government securities market, the primary market yields of 91-day and 364-day Treasury Bills increased from 5.41 per cent and 5.90 per cent at end-April 2006 to 7.98 per cent each by March 2007. The 182-day Treasury Bill yield moved up from 5.61 per cent to 8.20 per cent during this period. The yield on Government securities with 1-year residual maturity in the secondary market increased from 6.22 per cent at end-April 2006 to 7.92 per cent by April 20, 2007. The yield on Government securities with 10-year residual maturity increased from 7.40 per cent in April 2006 to 8.09 per cent by April 20, 2007 while the yield on Government securities with 20-year residual maturity increased from 7.80 per cent to 8.34 per cent during the same period. Consequently, the yield spread between 10-year and 1-year Government securities came down from 118 basis points in April 2006 to 17 basis points on April 20, 2007. The yield spread between 20-year and 1-year Government securities also declined from 158 basis points to 42 basis points during this period. By mid-April 2007, the primary market yields of 91-day, 182-day and 364-day Treasury Bills stood at 7.48 per cent, 7.75 per cent and 7.70 per cent, respectively.
32.Interest rates on deposits of over one year maturity of public sector banks (PSBs) moved up from 5.75-7.25 per cent in April 2006 to 7.25-9.50 per cent in March 2007. Term deposits rates of up to one year for private sector banks moved from 3.50-7.25 per cent in April 2006 to 3.00-9.00 per cent in March 2007, while rates on deposits of one year and above moved from 6.00-7.75 per cent in April 2006 to 6.75-9.75 per cent in March 2007. The deposit rates of up to one year maturity for foreign banks increased from 3.00-5.75 per cent in April 2006 to 3.00-9.50 per cent in March 2007 and the deposit rates of more than one year maturity moved from 4.00-6.50 per cent to 3.50-9.50 per cent during the same period. In April 2007, PSBs and private sector banks increased their deposit rates at the longer end by 25-100 basis points for various maturities.
33.The benchmark prime lending rates (BPLRs) of PSBs and private sector banks increased from 10.25-11.25 per cent and 11.00-14.00 per cent to a range of 12.25-12.75 per cent and 12.00-16.50 per cent, respectively, during the same period. The BPLRs of foreign banks increased from 10.00-14.50 per cent in April 2006 to a range of 10.00-15.50 per cent in March 2007. The median lending rates for term loans (at which maximum business is contracted) in respect of PSBs moved from 8.00-11.63 per cent in March 2006 to 8.50-12.00 per cent in December 2006. In April 2007, PSBs and private sector banks increased their BPLRs by 25-75 basis points to the range of 12.50-13.50 per cent and 12.00-17.25 per cent, respectively.
34.Equity markets witnessed major swings during 2006-07. The BSE Sensex (1978-79=100) increased from 11,280 at end-March 2006 to the peak of 12,612 on May 10, 2006 after which it declined to a intra-year trough of 8,929 on June 14, 2006. It rebounded in subsequent months on institutional buying support, robust macroeconomic fundamentals and high private corporate profitability. The Sensex rallied with intermittent corrections to reach a high of 14,652 on February 8, 2007 but subsequently moderated to 13,072 by end-March 2007. As on April 20, 2007 the BSE Sensex stood at 13,897.
35.The Annual Policy Statement for the year 2006-07 had indicated that amendments to the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 were under consideration in order to provide greater flexibility in the conduct of monetary policy and to strengthen the regulatory powers of the Reserve Bank. The Reserve Bank of India Act, 1934 was amended in June 2006 with a view to enhancing the Reserve Bank’s operational flexibility and providing it with greater manoeuvrability in monetary management. The Reserve Bank of India (Amendment) Act, 2006 gives discretion to the Reserve Bank to decide the percentage of scheduled banks’ demand and time liabilities to be maintained as CRR without any ceiling or floor. Consequent to the amendment, no interest will be paid on CRR balances so as to enhance the efficacy of the CRR, as payment of interest attenuates its effectiveness as an instrument of monetary policy. The revised definition of "repo" and "reverse repo" provided under the amendment would facilitate transactions of market participants/banks in these instruments. The amendment also provides the Reserve Bank with the statutory backing for regulating the money market and also for regulating trading of over-the-counter derivatives.
36.Consequent to the amendment, the Reserve Bank announced the removal of the floor of 3 per cent and ceiling of 20 per cent in respect of the CRR. Furthermore, it was announced that no interest shall be payable on CRR balances with effect from the fortnight beginning June 24, 2006. The Extraordinary Gazette notification, however, notified January 9, 2007 as the date on which all the provisions, except Section 3, of the Reserve Bank of India (Amendment) Act, 2006 shall come into force. Section 3 of the Reserve Bank of India (Amendment) Act, 2006 provided for the removal of the ceiling and floor on the CRR to be prescribed by the Reserve Bank as also the provisions for interest payment on eligible CRR balances. Pending the notifications of the relevant provisions, the floor and ceiling on CRR were restored and the Reserve Bank decided to pay interest on eligible CRR balances but consistent with the monetary policy stance and measures at relevant periods of time. The Reserve Bank also exempted those banks from payment of penal interest which had breached the statutory minimum CRR level of 3.0 per cent during June 22, 2006 to March 2, 2007.
37.The Government of India notified Section 3 of the Reserve Bank of India (Amendment) Act, 2006 and appointed the first day of April 2007 as the date on which the related provisions shall come into force. Pursuant to the notification of the relevant section, the floor and ceiling on CRR to be prescribed by the Reserve Bank no longer exist and the Reserve Bank decided, in view of the prevailing monetary conditions, to maintain status quo on the existing provisions of CRR maintenance, including the CRR rate and extant exemptions which will be operative till further change. The Reserve Bank has also indicated that no interest will be payable on CRR balances of banks with effect from the fortnight beginning March 31, 2007 consistent with the amendment.
38.Consequent upon the promulgation of the Banking Regulation (Amendment) Ordinance, 2007 dated January 23, 2007 Section 24 of the Banking Regulation Act, 1949 has been amended, which inter alia removed the floor rate of 25 per cent for statutory liquidity ratio (SLR) to be prescribed by the Reserve Bank and empowered it to determine the SLR-eligible assets, giving it more flexibility in its monetary management operations. The Ordinance has subsequently been repealed and replaced by the Banking Regulation (Amendment) Act, 2007 which received the assent of the President on March 26, 2007 and is deemed to have come into force on January 23, 2007.
39.As a part of the recent changes in the institutional framework of monetary policy in India and with a view to strengthening the consultative process, the Reserve Bank of India had constituted the Technical Advisory Committee (TAC) on Monetary Policy with external experts in the areas of monetary economics, central banking, financial markets and public finance in July 2005. In its quarterly meetings, the TAC reviewed macroeconomic and monetary developments and contributed to enriching the inputs and processes of policy setting and advised on the stance of monetary policy. After its tenure ended in January 2007, the Reserve Bank of India reconstituted the TAC with a view to obtaining continued benefit of expert opinion from the external experts with a tenure up to January 31, 2009. The reconstituted TAC has five external members and two members of the Central Board of the Reserve Bank. The Committee is chaired by the Governor, with the Deputy Governor in charge of monetary policy as vice-chairman and other Deputy Governors as members. The Committee would meet at least once in a quarter to review macroeconomic and monetary developments and advise on the stance of monetary policy. It may be noted that the TAC is advisory and provides guidance to the making of policy from time to time. As such, the responsibility, accountability and time paths for decision making are not formally constrained by the meetings of the TAC.
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