Mid-Term Review of the Annual Policy Statement for 2008-09, RBI Credit Policy, Reserve Bank of India: Banknet India

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Mid-Term Review of the Annual Policy Statement for 2008-09

Part A-Mid-term Review of the Annual Statement on Monetary Policy for the Year 2008-09

I. Assessment of Macroeconomic and Monetary Developments during the First Half of 2008-09

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Domestic Developments

21. During the second quarter of 2008-09, liquidity conditions were generally tight and, except in the first week of July, there were continuous injections of liquidity under the LAF. In addition, an amount of Rs.26,000 crore (net) was mopped up through the issuances of 91-day, 182-day and 364-day Treasury Bills during July-September, 2008. Net injections under the LAF increased from an average of Rs.8,622 crore in June 2008 to Rs.22,560 crore in August 2008. During September 2008, liquidity injections under the LAF ranged between Rs.1,025-90,075 crore, reaching a level of Rs.90,075 crore on September 29, 2008 with adverse developments in international financial markets coinciding with advance tax outflows and the half-yearly bank closing. To ease liquidity pressures, the Reserve Bank unwound the market stabilisation scheme (MSS) to the tune of Rs.3,105 crore during June 30-August 21, 2008. The Reserve Bank also cut the cash reserve ratio (CRR) by 250 basis points in October 2008 and expanded liquidity support to the market through additional facilities referred to later. During October 2008, liquidity injections under the LAF rose to Rs.91,500 crore on October 10, 2008, but there was a turnaround in liquidity conditions in the subsequent period and the Reserve Bank absorbed Rs.27,745 crore under the LAF on October 22, 2008. Banks’ dependence on export credit refinance (ECR) rose from a daily average of Rs.2,208 crore in June 2008 to Rs.3,110 crore in August 2008 and further to Rs.6,752 crore on September 29, 2008 before declining to Rs.91 crore on October 22, 2008. The Central Government’s cash balances declined from Rs.37,194 crore on June 30, 2008 to Rs.2,967 crore on August 2, 2008 and it took recourse to ways and means advances during August 4-6 and September 2-14, 2008 with a peak level of Rs.10,903 crore on September 5, 2008. In the subsequent period, the Central Government’s cash balances increased to Rs.29,753 crore on October 20, 2008.

22. On a net basis, average daily LAF absorption, which stood at Rs.9,881 crore in the first quarter of 2008-09 changed to a net injection of Rs.30,912 crore during the second quarter and Rs.53,259 crore in October 2008 (up to October 22). The balances under the MSS increased marginally from Rs.1,76,422 crore in June 30, 2008 to Rs.1,77,817 crore on September 25, 2008 before declining to Rs.1,71,317 crore on October 22, 2008. Cash balances of the Central Government with the Reserve Bank fell from an average of Rs.30,587 crore in the first quarter of 2008-09 to Rs.17,821 crore in the second quarter and Rs.36,599 crore in October 2008 (up to October 22). The total overhang of liquidity as reflected in the balances under the LAF, the MSS and the Central Government’s cash balances taken together declined from a daily average of Rs.1,93,726 crore in June 2008 to Rs.1,53,863 crore in September 2008 and further to Rs.1,22,182 crore on October 5, 2008. The total overhang of liquidity increased to Rs.2,17,415 crore on October 20, 2008.

23. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, increased to 11.4 per cent as on October 4, 2008 from 7.8 per cent as at end-March 2008 and 3.2 per cent a year ago. At a disaggregated level, prices of primary articles and manufactured products rose by 12.7 per cent and 9.7 per cent, respectively, as compared with the increase of 5.0 per cent and 4.5 per cent a year ago. During 2008-09 so far, inflation for primary articles has been driven mainly by the rising prices of foodgrains, vegetables, fruits, cotton, milk, condiment and spices and tea. Food articles prices, which had eased in June, firmed up in subsequent months. Elevated prices of cotton and oilseeds kept non-food articles inflation high. Manufacturing inflation was largely driven by three groups - basic metal and alloys, food products and chemical and chemical products.

24. Prices of the fuel group increased by 14.6 per cent on a year-on-year basis as against a decline of 1.8 per cent a year ago. The daily average price of the Indian basket of crude oil increased fromUS $ 99.4 per barrel in March 2008 to US $ 129.8 in June 2008 and further to a peak of US $ 141.5 on July 3, 2008 before declining to US $ 96.8 in September, 2008 and to US $ 74.4 in October so far up to October 22, 2008. Excluding the fuel group, year-on-year inflation rose to 10.6 per cent from 4.7 per cent a year ago. Similarly, excluding fuel and food articles, inflation rose to 10.8 per cent from 5.2 per cent a year ago. On an average basis, annual WPI inflation at 8.0 per cent was higher than 5.4 per cent a year ago.

25. Inflation, based on the consumer price index (CPI) for industrial workers, showed a sharp increase to 9.0 per cent on a year-on-year basis in August 2008 from 7.3 per cent a year ago. Year-on-year inflation based on the CPI for agricultural labourers (AL) and rural labourers (RL) increased to 11.0 per cent each in September 2008 from 7.9 per cent and 7.6 per cent, respectively, a year ago. Inflation based on the CPI for urban non-manual employees (UNME) rose to 8.5 per cent in August 2008 as compared with 6.4 per cent in the corresponding period of the previous year. The divergence between the inflation rates based on the WPI and CPIs is explained largely by the steep rise in prices of fuel items and metals which have a much higher weight in the WPI than in the CPIs.

26. Revenue receipts of the Central Government amounted to 26.8 per cent of the budget estimates (BE) during April-August 2008 as compared with 33.7 per cent in the corresponding period a year ago. As a proportion to the BE, tax and non-tax revenue receipts were 24.7 per cent and 37.7 per cent, respectively, as compared with 24.6 per cent and 78.4 per cent a year ago. Total expenditure at 37.2 per cent of the BE was lower than 39.9 per cent a year ago. The gross fiscal deficit (GFD) and revenue deficit increased to 87.7 per cent and 177.4 per cent of the BE, respectively, during April-August 2008 compared with 68.5 per cent and 74.9 per cent in the corresponding period last year. A notable feature of deficit financing this year so far has been the turnaround in mobilisation from small savings deposits and certificates after a decline in the previous year.

27. Gross market borrowings of the Central Government through dated securities at Rs.1,06,000 crore (Rs.1,07,000 crore a year ago) during 2008-09 so far (up to October 22, 2008) constituted 60.3 per cent of the BE. Net market borrowings at Rs.61,972 crore (Rs.74,875 crore a year ago) constituted 67.6 per cent of the BE. In addition, an amount of Rs.38,500 crore has been mobilised by the Central Government through issuance of additional treasury bills to finance the expenditure on the farm debt waiver scheme during the current year up to October 17, 2008. The weighted average yield and weighted average maturity of Central Government securities issued during 2008-09 so far (up to October 22, 2008) were higher at 8.81 per cent and 15.55 years, respectively, as compared with 8.12 per cent and 14.90 years for those issued during 2007-08 (full year). The borrowings were raised in accordance with the indicative calendar for the first half of 2008-09 except on two occasions. First, in the auction of July 24, 2008 a 10-year benchmark security was issued in place of a higher maturity security in view of uncertain market conditions. Second, after the Government of India completed the issuance of dated securities for the first half of the current fiscal year as per the indicative calendar covering the period April 1, 2008 to September 30, 2008, an unscheduled auction of dated securities amounting to Rs.10,000 crore was held on September 26, 2008 keeping in view the emerging requirements of the Government, market conditions and other relevant factors. On September 26, 2008 the issuance calendar for dated securities for the second half of 2008-09 (October-March) was released in consultation with the Government with planned issuances of Rs.39,000 crore. The announced auctions of Rs.10,000 crore each scheduled on October 10 and 20, 2008 were, however, cancelled by the Government of India in consultation with the Reserve Bank on a review of liquidity conditions. No special securities were issued to oil companies, fertiliser companies and the Food Corporation of India during the current year so far as against Rs.38,050 crore issued in 2007-08 and Rs.40,321 crore issued in 2006-07. On October 20, 2008 the Union Government sought Parliament approval for an additional cash outgo of Rs.1,05,613 crore to meet expenditure including towards the increased salaries of central government employees due to the implementation of the Sixth Pay Commission award, the farm debt waiver scheme, enhanced allocation towards rural employment schemes and the fertiliser subsidies among other. As against the estimated gross borrowings of Rs.62,658 crore (net Rs.48,287 crore), the State Governments raised a net amount of Rs.8,738 crore up to October 22, 2008.

28. Financial markets reflected the changes in liquidity conditions during the second quarter of 2008-09. The overnight rates in the call, market repo (outside the LAF) and collateralised borrowing and lending obligation (CBLO) hardened across the spectrum on account of tighter liquidity consequent upon increases in the CRR during April-August 2008 in six stages and in the LAF repo rate on June 12, June 25 and July 30, 2008. The weighted average call rate rose from 7.37 per cent in March 2008 to 9.10 per cent in August 2008 and moved up further to 10.52 per cent in September 2008. The call rate increased to 13.07 per cent on September 16, 2008 on account of advance tax outflows and disruptions in international money and stock markets. The average call rate touched a level of 14.70 per cent on September 29, 2008 following the half-yearly bank closing. During October 2008 (up to October 22), the weighted average call rate was 9.9 per cent, rising to a peak of 19.70 per cent on October 10, 2008, before declining to 6.09 per cent on October 22, 2008. Interest rates in the CBLO and market repo segments moved in tandem with call rates and increased from 6.37 per cent and 6.72 per cent, respectively, in March 2008 to 8.74 per cent and 8.87 per cent in September 2008 and further to 11.44 per cent and 11.77 per cent, respectively, on October 1, 2008 before declining to 5.38 per cent and 6.04 per cent, respectively, on October 22, 2008. The daily average volume (one leg) in the call money market, market repo and the CBLO segments moved from Rs.11,182 crore, Rs.14,800 crore and Rs.37,413 crore, respectively, in March 2008 to Rs.11,690 crore, Rs.10,659 crore and Rs.20,547 crore in September 2008 and increased to Rs.15,730 crore, Rs.13,275 crore and Rs.23,719 crore on October 22, 2008. Thus, the inter-bank money market has been working well throughout the period.

29. The primary yield on 91-day Treasury Bills, which had increased from 7.23 per cent at end-March 2008 to 9.36 per cent at end-July 2008, moderated subsequently to 7.19 per cent on October 22, 2008. Similarly, the primary yield on 364-day Treasury Bills increased from 7.35 per cent at end-March to 9.56 per cent at end-July before declining to 7.40 per cent on October 22, 2008. The weighted average discount rate on CPs increased to 12.28 per cent at end-September from 10.38 per cent as at end-March 2008 and the outstanding amount increased to Rs.52,038 crore from Rs.32,592 crore over this period. In the market for certificates of deposit (CDs) also, the weighted average discount rate increased from 10.00 per cent at the end of March 2008 to 11.56 per cent by end-September 2008 accompanied by an increase of 18.8 per cent in the outstanding amount from Rs.1,47,792 crore to Rs.1,75,522 crore.

30. The yields on Government securities with one-year, 10-year and 20-year residual maturity increased from 7.49 per cent, 7.93 per cent and 8.11 per cent, respectively, at end-March 2008 to a high of 9.25 per cent, 9.17 per cent and 9.72 per cent on July 14, 2008 and remained at elevated levels up to September 2008. The yields recorded a steady decline from 8.74 per cent, 8.63 per cent and 9.30 per cent, respectively, on September 29, 2008 to 7.40 per cent, 7.58 per cent and 8.31 per cent on October 22, 2008. The yield spread between 10-year and one-year Government security narrowed from 44 basis points in March 2008 to 18 basis points on October 22, 2008. The yield spread between 20-year and one-year Government securities declined from 82 basis points to 71 basis points during this period.

31. Increased activity in the foreign exchange market was reflected in a rise in the average daily turnover to US $ 64.9 billion in September 2008 from a level of US $ 50.5 billion a year ago. While the daily average turnover in the inter-bank segment increased from US $ 36.8 billion to US $ 46.4 billion, the merchant turnover increased from US $ 13.7 billion to US $ 18.5 billion during this period. The six-month forward premia increased from 2.5 per cent as at end-March 2008 to a high of 5.4 per cent by July 1, 2008 but eased subsequently to 2.5 per cent by September 12, 2008 and further to 0.24 per cent by October 22, 2008.

32. During April-October 22, 2008 SCBs increased their deposit rates for various maturities by 50-175 basis points. The range of interest rates offered by the public sector banks (PSBs) on deposits of above one-year maturity increased from 8.00-9.25 per cent in April 2008 to 8.50-10.60 per cent by October 22, 2008. The deposit rates of private sector banks on maturity of one to three years and above three years firmed up from the range of 7.25-9.25 per cent and 7.25-9.75 per cent to the range of 9.00-11.00 per cent and 8.25-11.00 per cent, respectively, during the same period. On the lending side, the benchmark prime lending rates (BPLRs) of PSBs increased by 125-150 basis points in April-October to a range of 13.75-14.75 per cent by October 22, 2008. The private sector banks and foreign banks also increased their BPLR from the range of 13.00-16.50 per cent and 10.00-15.50 per cent to the range of 13.75-17.75 per cent and to 10.00-17.00 per cent, respectively, during the same period.

33. Equity markets experienced a downturn in both the primary and secondary segments during the current financial year so far. In the primary market, resource mobilisation through public issues declined sharply to Rs.12,361 crore during the first half of 2008-09 in comparison with issuances of Rs.31,851 crore in the corresponding period last year. Resource mobilisation through private placement and euro issues also declined considerably when compared with the amounts raised a year ago. In the secondary market, the BSE Sensex (1978-79=100) was volatile with large two-way movements in response largely to movements in global equity markets. The Sensex continued its decline from the peak of 20,873 recorded on January 8, 2008 to reach a level of 10,170 by October 22, 2008.

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