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

3. Estimates released by the Central Statistical Organisation (CSO) at the end of August 2007 placed real GDP growth during April-June 2007 at 9.3 per cent as against 9.6 per cent in the corresponding quarter last year. Real GDP growth originating in agriculture, industry and services sectors was 3.8 per cent, 10.6 per cent and 10.6 per cent, respectively, in the first quarter of 2007-08 as against 2.8 per cent, 10.6 per cent and 11.6 per cent a year ago.

4. The pace of the broadening expansion of economic activity appears to have been sustained in the second quarter of 2007-08. Lead indicators point to congenial conditions for a pick-up in agricultural activity on the back of the higher than expected growth recorded in the preceding quarter. Rainfall during the 2007 south-west monsoon season was five per cent above the long-period average (LPA) for the country as a whole according to the India Meteorological Department (IMD). Of the 36 meteorological subdivisions across the country, rainfall was excess/normal in as many as 30 sub-divisions as against 26 in the 2006 season. On the other hand, six sub-divisions which have received deficient rainfall in the 2007 season include Punjab, Haryana, Himachal Pradesh, western Uttar Pradesh and eastern Madhya Pradesh which are major foodgrains producing regions. As on October 18, 2007 live storage in 81 major reservoirs was 81 per cent of designated capacity which is 19.3 per cent higher than the last 10 years’ average but 3.1 per cent lower than the level a year ago. The water storage level supports the prospects for rabi production.

5. Benefiting from favourable south-west monsoon conditions, the area sown under kharif rice, pulses and oilseeds increased to 37.3 million hectares, 12.5 million hectares and 17.8 million hectares, respectively, up to October 19, 2007 as against 37.1 million hectares, 11.4 million hectares and 16.8 million hectares in the 2006 season. Acreage under cash crops such as cotton, jute and sugarcane was also higher than a year ago. First advance estimates released by the Ministry of Agriculture place kharif foodgrains production at 112.2 million tonnes, below the target of 114.2 million tonnes, but higher than 110.5 million tonnes recorded last year. As per these initial estimates, production of nine major oilseeds during the kharif season is placed at 16.1 million tonnes which is lower than the target of 18.5 million tonnes, but significantly higher than the output of 13.9 million tonnes in 2006-07. Production of cotton, jute and sugarcane is also expected to register an increase in 2007-08.

6. The index of industrial production (IIP) rose by 9.8 per cent during April-August 2007 as against 11.0 per cent in the corresponding period last year. Manufacturing output increased by 10.3 per cent (12.2 per cent a year ago) while mining activity and electricity generation rose by 5.4 per cent (3.0 per cent) and 8.3 per cent (5.7 per cent), respectively. Manufacturing activity was led by food products, wood products, chemicals, basic metals and alloys and non-transport machinery and equipments which together constituted 53.9 per cent of the manufacturing sector and contributed 71.5 per cent of its growth during April-August 2007. On the other hand, deceleration in the production of textiles and transport equipment, and decline in the production of metal products and parts which have a combined share of 22.3 per cent in the manufacturing sector, had a moderating effect on manufacturing activity as well as on overall industrial growth during this period. The use-based classification indicates sustained investment demand as reflected in an increase of 21.3 per cent (19.5 per cent) in capital goods production. Production of basic goods and intermediate goods increased by 10.0 per cent (8.3 per cent) and 9.3 per cent (10.4 per cent), respectively. Consumer goods growth decelerated to 6.2 per cent (11.4 per cent), mainly due to a decline of 2.3 per cent in the consumer durables. The six infrastructure industries, which together comprise nearly 27 per cent of the IIP, posted a growth of 6.6 per cent during April-August 2007 as against 8.3 per cent a year ago. Except for electricity generation, all other sectors of core infrastructure recorded decelerated growth.

7. Information on corporate activity indicates that sales of selected companies had risen by 19.2 per cent during April-June 2007, lower than 25.6 per cent in the corresponding quarter a year ago. The rise in other income, lower interest burden, improvements in operational efficiency, higher capacity utilisation and economies of scale appear to have contributed substantially to overall financial performance and high profit margins especially for larger companies, despite an increase of 18.1 per cent in depreciation provision. Net profits rose by 33.9 per cent in the first quarter of 2007-08 as against 34.7 per cent during the corresponding period last year. Buoyant equity markets enabled higher mobilisation of resources by the private corporate sector through public issues and private placements than in the corresponding period of 2006-07. Early results for the second quarter of 2007-08 (July-September) for a truncated sample of companies indicate continuing moderation in sales and profitability growth relative to the corresponding quarter a year ago as well as the preceding quarter, especially for manufacturing companies. On the other hand, some decline in the interest burden on a year-on-year basis, reflecting the relatively higher recourse of corporates to external commercial borrowings (ECBs) and consequently lower interest payments relative to domestic borrowings as well as gains thereon in rupee terms due to exchange rate appreciation boosted other income and helped to shore up net profit margins.

8. The Reserve Bank’s Industrial Outlook Survey conducted mainly during August 2007, which covers private manufacturing companies, indicates stable business conditions. Half of the respondent companies reported increase in production and a better overall business situation; over 40 per cent indicated no change in these characteristics. A majority of respondents felt that capacity utilisation would remain unchanged. The overall assessment of working capital requirement, availability of finance and overall financial situation was positive for July-September 2007. The assessment of moderation in export and import growth that started in the beginning of the year continued to prevail. On a net basis, respondents reported a higher increase in input cost than in selling prices. The business expectation index for July-September 2007 improved by 3.1 percentage points from its level in the previous quarter; however, it was lower by 1.8 percentage points from its level a year ago. For October-December 2007, the business expectation index rose by 3.3 percentage points from its level in the previous quarter though lower by 0.9 percentage points on a year-on-year basis. Over a fifth of respondents expect increase in employment level in their companies during July-December 2007. While 60 per cent did not expect any change in profit margins, a fourth of the respondents expected increase in profitability.

9. Other business confidence surveys which also cover services sector companies present a somewhat mixed picture. According to one survey, business confidence shows a fall of 8.9 percentage points in July-December 2007 relative to its level in the previous round, reflecting some increase in the cost of finance and rising prices of raw materials. A lower level of confidence in overall economic conditions and industry/firm level performance is also reflected in some other surveys. On the other hand, some surveys report optimism on value of production, new orders and utilisation of capacity for the second half of 2007-08. In this view, seasonally adjusted purchasing managers’ indices, which cover only manufacturing companies, point to a robust improvement in operating conditions with marked increase in output and new orders, underpinned by favourable domestic market conditions. Price increases for both inputs and outputs were stated to be high by respondents but were not expected to impede the step-up in purchasing activity and hiring of additional staff due to higher production requirements.

10. Lead indicators suggest that the pace of expansion in the services sector activity has been sustained during April-August 2007. The communication sector has recorded robust growth with 34 million telephone connections (fixed plus cellular) in April-August 2007 which is 55.4 per cent higher than 22 million connections provided in the corresponding period last year. Cargo handled at major ports increased by 14.2 per cent, whereas handling of import cargo and export cargo in the civil aviation sector increased by 23.5 per cent and 5.4 per cent, respectively. Railway revenue earnings from freight traffic increased by 7.0 per cent which was lower than the growth of 9.9 per cent in the corresponding period last year, mainly due to lower traffic for carriage of foodgrains and raw materials for steel plants. Passengers handled at domestic and international terminals increased by 27.8 per cent and 12.4 per cent, respectively, as against 40.1 per cent and 12.9 per cent a year ago.

11. According to the CSO’s end-August 2007 release, there are indications of underlying shifts in the constituents of aggregate demand. As a proportion to GDP, real private final consumption expenditure declined to 58.8 per cent during the first quarter of 2007-08 from 60.8 per cent a year ago. On the other hand, real gross fixed capital formation (GFCF) increased to 29.6 per cent of GDP from 27.9 per cent, indicative of the investment led acceleration of growth in the Indian economy. As regards external demand, net exports are placed at (-)1.0 per cent of GDP in April-June 2007 vis-à-vis 0.8 per cent a year ago.

12. On a year-on-year basis, total credit extended by scheduled commercial banks (SCBs) increased by Rs.3,81,333 crore (23.3 per cent) up to October 12, 2007 as compared with an increase of Rs.3,66,463 crore (28.8 per cent) a year ago. On a financial year basis, credit extended by SCBs increased by Rs.90,262 crore (4.7 per cent) up to October 12, 2007 as compared with the increase of Rs.1,30,764 crore (8.7 per cent) in the corresponding period last year. Food credit declined by Rs.9,501 crore as against a decline of Rs.7,246 crore in the previous year. Non-food credit registered an increase of Rs.99,763 crore (5.3 per cent) as compared with an increase of Rs.1,38,010 crore (9.4 per cent) in the corresponding period of the previous year.

13. Provisional information available from select SCBs up to August 2007 indicates that credit to industries expanded by 24.6 per cent up to August on a year-on-year basis, slowing from 25.7 per cent in March 2007. Credit to agriculture expanded by 24.4 per cent (32.4 per cent in March 2007). On the other hand, bank credit to services and personal loans at 24.5 per cent (31.0 per cent) and 19.8 per cent (26.5 per cent), respectively, recorded a sizeable slowdown. Within the industrial sector, credit off-take by infrastructure, chemicals and vehicles and auto parts picked up to 32.1 per cent (26.8 per cent), 16.1 per cent (14.2 per cent) and 28.5 per cent (11.0 per cent), respectively. On the other hand, credit disbursed decelerated in the case of textiles to 28.0 per cent (34.2 per cent), metals to 19.6 per cent (26.7 per cent), engineering to 24.0 per cent (24.5 per cent) and petroleum to 35.7 per cent (41.0 per cent). In the services sector, all constituents barring computer software, tourism and hotels and non-banking financial companies recorded deceleration in credit off-take. In particular, growth in credit to real estate decelerated to 52.9 per cent from 69.8 per cent in March 2007, but still remained high. Under personal loans, sizeable deceleration in credit occurred under housing (to 16.6 per cent in August 2007 from 24.6 per cent in March 2007), consumer durables (to 4.1 per cent from 28.9 per cent) and other personal loans (to 22.5 per cent from 30.3 per cent). Credit to industry recorded the highest share of 41.1 per cent in total incremental non-food bank credit by August 2007, followed by services (23.8 per cent), personal loans (22.4 per cent) and agriculture (12.7 per cent). The shares of infrastructure, engineering and chemical industries in incremental credit to industry increased from 21.4 per cent, 6.0 per cent and 4.9 per cent, respectively, in March 2007 to 26.7 per cent, 6.2 per cent and 5.5 per cent in August 2007. The share of metals, textiles, petroleum and food processing declined from 12.4 per cent, 14.1 per cent, 7.3 per cent and 6.1 per cent, respectively, to 10.0 per cent, 12.4 per cent, 6.2 per cent and 6.0 per cent. The share of the priority sector in incremental non-food gross bank credit declined marginally to 31.0 per cent from 31.2 per cent. Priority sector advances rose by 20.2 per cent up to August 2007, lower than 24.0 per cent in March 2007. While the share of agriculture declined to 12.7 per cent in August 2007 from 14.4 per cent in March 2007, the share of small scale industries (SSIs) increased to 8.3 per cent from 6.6 per cent. There has been a greater deceleration in credit disbursements in respect of the services and retail sectors as compared with industry.

14. On a year-on-year basis, commercial banks’ investments in shares, bonds/debentures and commercial paper (CP) declined by Rs.5,514 crore (6.7 per cent) up to October 12, 2007 as compared with a decline of Rs.895 crore (1.1 per cent) a year ago. On a financial year basis, such investments by banks fell by Rs.6,930 crore (8.5 per cent) during 2007-08 so far (up to October 12), as against an increase of Rs.2,514 crore (3.2 per cent) in the corresponding period of 2006-07. Banks’ investments in instruments issued by all-India financial institutions and mutual funds, however, increased by Rs.49,847 crore as against an increase of Rs.11,526 crore in the corresponding period of the previous year. The year-on-year growth in total resource flow from SCBs to the commercial sector was 22.1 per cent, over and above the growth of 28.0 per cent a year ago. In addition, during the first quarter of the current financial year, corporates raised additional resources in the form of external commercial borrowings (ECBs) amounting to Rs.29,498 crore as against Rs.18,882 crore in the first quarter last year.

15. On an annual basis, the growth in aggregate deposits at 24.9 per cent (Rs.5,69,061 crore) was higher than that of 20.4 per cent (Rs.3,88,528 crore) a year ago. On a financial year basis, aggregate deposits of SCBs increased by 9.6 per cent (Rs.2,49,724 crore) up to October 12, 2007 as compared with an increase of 8.5 per cent (Rs.1,79,923 crore) in the corresponding period of the previous year. Reflecting high profitability and internal generation of resources by the corporate sector, its share in total deposits with the banking system has been increasing, mainly in the form of short-term deposits. On the other hand, the share of savings deposits in total deposits has been declining. The incremental annual non-food credit-deposit ratio declined to 66.4 per cent on October 12, 2007 from 95.3 per cent a year ago.

16. In view of the lower credit growth, banks undertook incremental investment in statutory liquidity ratio (SLR) securities. SCBs’ investment in SLR securities at Rs.1,52,488 crore during the current financial year up to October 12, 2007 was higher than that of Rs.49,717 crore in the corresponding period of the previous year. The ratio of such investments to aggregate deposits on an incremental basis was 30.9 per cent as against 6.1 per cent in the corresponding period last year. It needs to be mentioned that a part of this increase was due to bank recapitalisation bonds (amounting to Rs.5,270 crore) being considered as approved securities for SLR, and part due to subscription to SLR bonds issued under the market stabilisation scheme (MSS). Even after adjusting for banks’ repo/reverse repo with the Reserve Bank under the Liquidity Adjustment Facility (LAF), SLR investments at Rs.86,758 crore during 2007-08 so far were much higher than the increase of Rs.38,727 crore in the corresponding period last year. Consequently, on an outstanding basis, commercial banks’ holdings of Government and other approved securities increased to 30.0 per cent of their net demand and time liabilities (NDTL) as on October 12, 2007 from 28.0 per cent at end-March 2007. While these investments exceeded the required SLR by Rs.1,56,851 crore (Rs.84,223 crore at end-March 2007), the excess SLR investment adjusted for LAF holdings amounted to Rs.1,20,306 crore or 3.8 per cent of NDTL.

17. Year-on-year money supply (M3) at 21.8 per cent as on October 12, 2007 was higher than 18.9 per cent a year ago and above the range of 17.0-17.5 per cent indicated in the Annual Policy Statement of April 2007. On a financial year basis, M3 increased by 8.2 per cent (Rs.2,72,010 crore) up to October 12, 2007 as compared with the increase of 7.7 per cent (Rs.2,11,279 crore) in the corresponding period of the previous year.

18. Reserve money increased by 24.4 per cent on a year-on-year as on October 19, 2007 as compared with 20.2 per cent a year ago. On a financial year basis, reserve money increased by 8.0 per cent (Rs.57,060 crore) up to October 19, 2007 as compared with the increase of 7.5 per cent (Rs.42,932 crore) in the corresponding period of the previous year. The large increase in reserve money in the current financial year so far reflects in part the initial impact of recent increases in the cash reserve ratio (CRR). Among the components of reserve money, therefore, bankers’ deposits with the Reserve Bank increased by 18.7 per cent (Rs.36,984 crore) during the current year so far as compared with an increase of 5.2 per cent (Rs.7,047 crore) in the corresponding period last year. Currency in circulation, however, registered a lower growth of 4.5 per cent (Rs.22,589 crore) as compared with 8.7 per cent (Rs.37,319 crore). Among the sources of reserve money, Reserve Bank’s net credit to the Central Government declined by Rs.1,43,116 crore as compared with an increase of Rs.15,029 crore in the corresponding period last year. Adjusted for transactions under the LAF, Reserve Bank’s credit to the Central Government showed a decline of Rs.81,981 crore mainly on account of increased MSS issuance in 2007-08 so far. The Reserve Bank’s net foreign exchange assets (NFEA) increased by Rs.1,71,080 crore as against an increase of Rs.77,310 crore during the corresponding period of the previous year. Adjusted for revaluation, NFEA increased by Rs.2,17,201 crore as compared with an increase of Rs.42,544 crore during the corresponding period of the previous year. The ratio of NFEA to currency increased from 171.8 per cent on March 31, 2007 to 196.9 per cent by October 19, 2007.

19. Movements in the key monetary and banking aggregates in the second quarter of 2007-08 were reflected in generally easy conditions of liquidity, except for some short-lived episodes of tightness. The banking system experienced conditions of surplus liquidity on account of substantial deposit mobilisation relative to credit demand as well as capital augmentation through several large IPOs. Consequently, banks made sizeable investments in Government securities/Treasury bills issued under the MSS. With effect from August 6, 2007 the daily ceiling of Rs.3,000 crore on reverse repo under the LAF stipulated since March 5, 2007 was removed. During August 6-31, 2007 average daily net absorption under the LAF was Rs.25,333 crore, despite an additional amount of Rs.13,500 crore absorbed under the MSS. On August 9, 2007 the Reserve Bank transferred its annual profit to the Central Government which included a one-time payment of Rs.34,309 crore on account of profit on sale of the Reserve Bank’s stake in the State Bank of India (SBI) which augmented the Central Government’s cash balances with the Reserve Bank. Large absorption of liquidity under the LAF and the MSS continued till the third week of September when quarterly advance tax outflows and build-up of the Centre’s cash balances led to a sharp drop in the daily volumes of funds offered at the LAF auctions, and the Reserve Bank had to inject liquidity under the LAF on September 21 and 28. In view of large capital inflows, an additional amount of Rs.68,685 crore was sterilised during September and October under the MSS with the outstanding sterilisation under the MSS increasing to Rs.1,77,155 crore by October 26, 2007. The overhang of liquidity as reflected in the sum of LAF, MSS and the Central Governments’ cash balances increased from Rs.85,770 crore at end-March 2007 to Rs.1,24,632 crore on August 6, 2007 and further to Rs.2,22,582 crore by October 24, 2007. The Government of India, in consultation with the Reserve Bank, revised the ceiling under MSS for the year 2007-08 from Rs.1,10,000 crore to Rs.1,50,000 crore on August 8, 2007 and further to Rs.2,00,000 crore on October 4, 2007.

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