Mid-Term Review of the Annual Policy Statement for 2007-08, RBI Credit Policy, Reserve Bank of India: Banknet India

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Part I. Mid-term Review of Annual Statement on Monetary Policy for the Year 2007-08

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Domestic Developments

20. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, eased from its peak of 6.4 per cent on April 07, 2007 to 3.1 per cent by October 13, 2007. On an average basis, however, annual WPI inflation at 5.2 per cent was higher than 4.6 per cent a year ago.

21. At a disaggregated level, prices of primary articles (weight: 22.0 per cent in the WPI basket) and manufactured products (weight: 63.8 per cent) increased by 5.2 per cent and 4.1 per cent, respectively, by October 13, 2007 as compared with an increase of 8.1 per cent and 4.6 per cent a year ago. An analysis of constituent price movements indicates that the rise in prices of edible oils, oilseeds and oilcakes, which together have a weight of 6.9 per cent in the WPI, contributed nearly 40 per cent of the headline inflation, while 16 per cent of headline inflation came from increases in prices of primary food items especially rice, milk and vegetables. Excluding food, headline WPI inflation was 3.0 per cent as against 5.0 per cent a year ago. Other items that contributed to headline inflation included cement, drugs and medicines, iron and steel and electrical machinery.

22. Annual inflation of the ‘fuel, power, light and lubricants’ group (weight: 14.2 per cent) declined to 1.6 per cent as on October 13, 2007 as against 5.0 per cent a year ago. Excluding the fuel group, inflation was at 4.4 per cent (5.6 per cent a year ago). The average price of the Indian basket of international crude was at around US $ 72.1 per barrel during July-September 2007 higher than US $ 66.4 in April-June 2007 and US $ 56.6 in January-March 2007. Since the last revision of domestic retail prices of petrol and diesel in February 2007, the price of the Indian basket had increased by about 32 per cent in US dollar terms and about 21 per cent in rupee terms up to September 2007. Subsequently, there has been a further increase in crude oil prices in the international markets and the average price of the Indian crude basket has gone up to US $ 80 per barrel as on October 23, 2007. While the price of the Indian crude basket in rupee terms went up by an average of 22.4 per cent per annum between 2002-03 and 2006-07, the increase in prices of petrol and diesel and the freely priced products (such as aviation turbine fuel, furnace oil and naphtha) were 12.8 per cent and 16.5 per cent per annum, respectively. This suggests an average pass-through of around 57 per cent in the case of petrol and diesel and around 73 per cent in the case of the freely priced products. The subsidy schemes for kerosene and domestic LPG, which were available through public distribution system (PDS) until March 2007, have been extended till March 2010. Domestic retail prices of petrol and diesel have remained unchanged after two downward revisions in 2006-07, thereby increasing the magnitude of incomplete pass-through. The issue of oil bonds and burden sharing by upstream oil public sector units (PSUs) in the form of discounts on crude oil and products is expected to mitigate a part of the under-recoveries. Overall, inflation risks on account of oil prices remain incipient and it is possible that some increase in domestic prices of petroleum products would translate into some elevation in WPI inflation.

23. Inflation, based on the consumer price index (CPI) for industrial workers, showed a sharp increase to 7.3 per cent on a year-on-year basis in August 2007 from 6.3 per cent a year ago. Year-on-year inflation based on the CPI for urban non-manual employees, agricultural labourers and rural labourers in September 2007 increased to 5.7 per cent, 7.9 per cent and 7.6 per cent, respectively, from 6.6 per cent, 7.3 per cent and 7.0 per cent a year ago. A major portion of the differences between inflation rates based on the WPI and CPIs is explained by prices of food items which have a higher weight in the CPIs than in the WPI. Year-on-year CPI inflation for industrial workers was 9.6 per cent for food items and 5.2 per cent for non-food items in August 2007 whereas for urban non-manual employees and agricultural labourers, it was 7.7 per cent and 8.8 per cent for food items, respectively, and 4.0 per cent and 6.0 per cent for non-food items, in September 2007.

24. In drawing meaningful inferences from the data on fiscal developments during the year, it is necessary to take account of the one-time transaction relating to transfer of the Reserve Bank’s shareholding in the State Bank of India (SBI). On June 29, 2007 the Central Government paid Rs.35,531 crore to the Reserve Bank as consideration amount for the transfer. On August 9, 2007 the Reserve Bank transferred an amount of Rs.45,720 crore as its surplus for 2006-07 (July-June) to the Government which included an amount of Rs.34,309 crore on account of sale of SBI shareholding to the Government. Excluding the transactions relating to transfer of the Reserve Bank’s stake in the SBI to the Government, revenue receipts of the Central Government amounted to 26.7 per cent of the budget estimates (BE) in April-August 2007 as compared with 26.4 per cent in April-August 2006. Tax revenue and non-tax revenue were 24.6 per cent and 36.8 per cent of the BE, respectively, during April-August 2007 as compared with 24.9 per cent and 32.9 per cent a year ago. Total expenditure at 36.8 per cent of the BE in April-August 2007 was higher than 35.5 per cent a year ago. As a proportion to the BE, the gross fiscal deficit (GFD) and revenue deficit increased to 67.6 per cent and 122.9 per cent, respectively, during April-August 2007 as compared with 61.0 per cent and 93.7 per cent in the corresponding period last year. A notable feature of deficit financing this year so far has been the decline in net mobilisation from small savings deposits and certificates for the first time.

25. The gross market borrowings of the Central Government through dated securities at Rs.1,27,060 crore (Rs.1,17,548 crore a year ago) during 2007-08 so far (up to October 26, 2007) constituted 67.3 per cent of the BE. Net market borrowings at Rs.75,387 crore (Rs.65,951 crore a year ago) constituted 68.7 per cent of the BE. An additional amount of Rs.27,500 crore (net) was mobilised through issuance of Treasury Bills (TBs) over and above the rollover of TBs maturing during the period. The weighted average yield and weighted average maturity of Central Government securities issued during 2007-08 so far (up to October 26, 2007) were higher at 8.20 per cent and 14.41 years, respectively, as compared with 7.91 per cent and 14.08 years for those issued during the corresponding period last year. As against the provisional net allocation of Rs.28,206 crore (gross Rs.45,385 crore) for their market borrowing programme, the State Governments have raised a net amount of Rs.8,808 crore up to October 26, 2007. As in the past, an indicative issuance calendar for issue of dated securities for the second half of 2007-08 was issued on September 24, 2007 in consultation with the Central Government with a view to enabling institutional and retail investors to plan their investment in a better manner and also for providing transparency and stability in the Government securities market. In addition to the market borrowing programme, recapitalisation bonds amounting to Rs.12,001 crore were issued in August and September, 2007. Moreover, special securities amounting to Rs.7,500 crore with features similar to securities issued to oil companies and the Food Corporation of India in 2006-07, would be issued during the remaining part of 2007-08. Furthermore, it was announced on October 11, 2007 that the Central Government would bear 42.7 per cent (Rs.23,457 crore) of the total under-recoveries of the oil companies (estimated at Rs.54,935 crore for 2007-08) in the form of oil bonds. Thus, securities amounting to Rs.42,958 crore are planned to be issued by the Central Government (excluding MSS) in addition to the regular market borrowing programme for 2007-08 as against Rs.40,321 crore issued in 2006-07.

26. During the second quarter of 2007-08, financial markets remained generally stable with conditions of abundant liquidity. Reflecting this environment, interest rates moderated in almost all segments of the financial system. Overnight interest rates, which averaged 0.26 per cent in July, returned to the LAF corridor after the ceiling on reverse repo acceptance under the LAF was removed from August 6, 2007 and the CRR was increased from 6.5 per cent to 7.0 per cent with effect from the fortnight beginning August 4, 2007. Despite the overall stability, transient spikes in overnight rates were witnessed in August. Call money rates averaged 6.31 per cent in August 2007. Some hardening of overnight rates was also witnessed in the second half of September on account of reduction in liquidity with the banking system due to sizeable tax outflows and build-up of the Centre’s cash balances which was also reflected in reduced LAF reverse repo. The call money rate has declined from 14.07 per cent in March 2007 to 6.31 per cent in August and to 6.01 per cent on October 26, 2007. Overnight rates in other segments, viz., market repo and collateralised borrowing and lending obligations (CBLO) have moved in tandem with call money rates. Market repo (other than LAF) and CBLO rates declined from 8.13 and 7.73 per cent, respectively, in March 2007 to 5.66 and 6.00 per cent as on October 26, 2007. The daily average volume (one leg) in the call money market rose from Rs.11,608 crore in March 2007 to Rs.12,981 crore as on October 26, 2007. The corresponding volumes in the market repo were Rs.8,687 crore and Rs.27,075 crore, respectively. In the CBLO segment, the volumes were Rs.17,662 crore and Rs.25,090 crore, respectively. As on October 26, 2007 interest rates for CBLO, market repo and call money stood at 5.66 per cent, 6.00 per cent and 6.01 per cent, respectively.

27. The primary yield on 91-day Treasury Bills declined to 7.02 per cent on October 24, 2007 from 7.98 per cent on end-March 2007 whereas the yield on 364-day Treasury Bills declined to 7.36 per cent from 7.98 per cent over the same period. There was higher mobilisation from CPs as the outstanding amount of CP was Rs.33,614 crore by end-September 2007 as compared with Rs.17,688 crore at end-March 2007, with the weighted average discount rate on CP declining to 8.95 per cent from 11.33 per cent over this period. In the market for certificates of deposit (CDs) also, the weighted average discount rate declined from 10.75 per cent at the end of March 2007 to 8.57 per cent by end-September, accompanied by an increase of 27.0 per cent in the outstanding amount (from Rs.93,272 crore to Rs.1,18,481 crore). It may be noted that overnight and short-term money market rates had firmed up at the end of March 2007 reflecting liquidity tightening resulting from end-year tax outflows.

28. In the foreign exchange market, large surplus conditions in the spot market resulted in a sharp increase in average daily turnover to US $ 52.9 billion in mid-September 2007 from a level of US $ 27.5 billion a year ago. While the inter-bank turnover increased from US $ 20 billion to US $ 37.6 billion, the merchant turnover increased from US $ 7 billion to US $ 15.2 billion. According to the triennial central bank survey conducted by the Bank for International Settlements (BIS), India is among the fastest growing foreign exchange markets in terms of turnover. There has been a general softening in forward premia across all maturities. The six-month forward premia eased from 3.60 per cent in March 2007 to 2.53 per cent by end-June 2007 and further to 1.20 per cent as on October 26, 2007.

29. The yield on Government securities with one-year residual maturity declined from 7.55 per cent at end-March 2007 to 7.40 per cent as on October 26, 2007. The yield on Government securities with 10-year residual maturity also declined from 7.97 per cent to 7.88 per cent. The yield on Government securities with 20-year residual maturity rose from 8.23 per cent to 8.28 per cent. The yield spread between 10-year and one-year Government securities widened from 42 basis points to 48 basis points. The yield spread between 20-year and one-year Government securities also widened from 68 basis points to 88 basis points during the same period. 30. During April–October 2007, public sector banks (PSBs) decreased their deposit rates, particularly at the upper end of the range for various maturities, by 25-60 basis points. Deposit rates of PSBs increased by 25-75 basis points at the lower end for deposits of maturities of one year and above. Interest rates offered by the PSBs on deposits of above one year maturity moved from 7.25-9.75 per cent in April 2007 to 8.0-9.5 per cent in October 2007. Private sector banks’ deposit rates for up to one year maturity decreased from a range of 3.00-10.00 per cent to 2.5-9.25 per cent over the same period. Foreign banks’ deposit rates for up to one year maturity also declined from a range of 3.00-9.50 per cent to 2.00-9.00 per cent during the same period. The benchmark prime lending rates (BPLRs) of private sector banks moved from a range of 12.50-17.25 per cent to 13.00-16.50 per cent in the same period. The range of BPLRs for PSBs and foreign banks, however, remained unchanged at 12.50-13.50 per cent and 10.00-15.50 per cent, respectively, during this period.

31. During the second quarter of 2007-08, equity market activity recorded a pick-up in terms of issuances in the domestic primary segment as well as in international stock exchanges. The BSE Sensex (1978-79=100) increased from 13,072 at end-March 2007 to cross the 15,000 level on July 9, 2007, the 16,000 level on September 19, 2007, the 17,000 level on September 27, 2007, the 18,000 level on October 9, 2007, the 19,000 level on October 15, 2007 and closed at 19,243 on October 26, 2007. According to the Securities and Exchange Board of India (SEBI), net investments by foreign institutional investors (FIIs) in the equity market were significantly higher at Rs.62,139 crore (US $ 15.1 billion) during April-October 19, 2007 as compared with net investments of Rs.10,231 crore (US $ 2.2 billion) in the corresponding period last year. Mutual funds mobilised funds of the order of Rs.1,05,614 crore during April-September 2007 as against Rs.60,048 crore a year ago.

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