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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

4.Real gross domestic product (GDP) growth for 2006-07 was placed at 9.2 per cent in the advance estimates of the Central Statistical Organisation (CSO) released in February 2007, over and above 9.0 per cent in 2005-06. These estimates have vindicated the overall optimism building around the performance of the Indian economy which was also reflected in successive upward revisions in growth projections by various agencies during the course of 2006-07, including in the Reserve Bank’s quarterly reviews.

5.Real GDP originating from agriculture and allied activities is estimated to have registered a growth of 2.7 per cent in 2006-07, closer to the trend growth but lower than 6.0 per cent in the previous year. According to the estimates of the Ministry of Agriculture released in April 2007, total foodgrains production is expected to have increased marginally to 211.8 million tonnes in 2006-07 from 208.6 million tonnes in 2005-06, with rabi production having compensated for the decline of 1.4 per cent in kharif foodgrains production. Among the commercial crops, production of sugarcane is estimated to have increased by 14.9 per cent in 2006-07, making India one of the top producers of sugar in the world, along with Brazil. Cotton production also recorded a sizeable increase of 13.7 per cent. Production of jute and mesta increased by 4.6 per cent whereas oilseeds production declined by 16.9 per cent. The combined value-added by horticulture and plantation crops, livestock and fisheries contributed to growth in real GDP originating from agricultural and allied activities in recent years.

6.Industrial activity expanded strongly, with real GDP originating in industry estimated to have risen by 10.2 per cent in 2006-07 as compared with 8.0 per cent in the previous year. The index of industrial production (IIP) recorded an increase of 11.1 per cent during April-February 2006-07 vis-à-vis 8.1 per cent a year ago. All constituent sub-sectors shared in the acceleration. While manufacturing, the prime mover, recorded a growth of 12.1 per cent as compared with 9.1 per cent a year ago, growth in mining and electricity generation were also higher at 4.9 per cent and 7.2 per cent, respectively, as compared with 0.9 per cent and 5.3 per cent a year ago.

7.The production of consumer and capital goods increased by 9.5 per cent and 17.8 per cent, respectively, during April-February 2006-07 over and above the increase of 12.0 per cent and 16.3 per cent a year ago. The basic and intermediate goods segments registered a high growth of 10.1 per cent and 11.6 per cent, respectively, as against 6.5 per cent and 2.4 per cent a year ago. The output of the six key infrastructure industries (with a weight of 26.7 per cent in the IIP) increased by 8.3 per cent as against 6.1 per cent in the corresponding period of the previous year.

8.Corporate sector performance continued to remain buoyant, supported by favourable domestic and export demand conditions during 2006-07. During April-December 2006, sales and net profits of selected non-financial private companies increased by 28.9 per cent and 48.7 per cent, respectively, as against 16.1 per cent and 36.8 per cent in the corresponding period of the preceding year. Profitability ratios were 1.5 to 2.0 percentage points higher than a year ago, reflecting both sales growth and operational efficiency gains. Strong capacity enhancement was also reflected in the increase of 16.7 per cent in depreciation provision. While the momentum of economic activity and the turnaround in the interest rate cycle resulted in an increase of 17.7 per cent in interest payments in contrast to the decline recorded in the preceding two years, higher growth in sales and gross profits in relation to interest payments ensured a lower interest burden (i.e., interest payments relative to gross profits) and interest cost to sales at 12.9 per cent and 2.1 per cent, respectively, as against 16.4 per cent and 2.3 per cent in April-December 2005. Early results for the fourth quarter of 2006-07 indicate that the underlying strength of corporate performance as reflected in sales and earnings growth has been sustained.

9.The Reserve Bank’s Industrial Outlook Survey conducted during February 2007 reflects higher confidence and continued optimism surrounding corporate business activities. During January-March 2007, the overall business situation was assessed to be better than in the preceding quarter as well as in the corresponding period a year ago, though there was a moderation in expectations about output growth. While demand conditions as well as export and import growth were perceived to be better than in the corresponding quarter of the previous year, some decline was expected in the availability of finance in relation to the preceding quarter. Capacity utilisation improved over the previous quarter and the inventory of raw material and finished goods was reported to be at average levels. Nearly half the respondents reported increases in the cost of raw materials and a third expected selling prices to go up. Over 55 per cent of respondents expect further improvements in the overall business situation in April-June 2007. The business expectations index for April-June 2007 is higher than in the corresponding quarter a year ago, in spite of the seasonal decline vis-à-vis January-March 2007. The quarter-to-quarter seasonal decline in April-June 2007 is, however, expected to be less steep than a year ago in respect of demand, order books, production, working capital requirement and availability of finance. Capacity utilisation and employment growth are expected to go up in relation to the preceding quarter. Over 80 per cent of respondents reported normal levels of pending orders and expected higher capacity utilisation with improvement in expectations of both exports and imports. Above 90 per cent felt that existing capacity would not be a constraint over the next 6-9 months. Nearly one-fourth of the respondents expected some increase in their profitability and nearly 60 per cent more did not perceive any change in their profit margins.

10.Business confidence surveys conducted by other agencies present a somewhat mixed picture. The overall confidence level appears to have been positive on the back of higher macroeconomic activity, enhanced foreign direct investment (FDI) flows, new orders, high capacity utilisation and falling crude prices, although a seasonal decline in activity levels and shortages of some raw materials were expected to put pressure on prices. According to one survey, the confidence level reported in October 2006-March, 2007 increased in respect of ex-factory output prices and employment growth, outweighing a marginal decline in expectations on production/sales, exports, profit margins and selling prices. Seasonally adjusted purchasing managers’ indices for the manufacturing sector showed some decline during October 2006-March 2007, despite a marked increase in new orders.

11.Real GDP originating in the services sector increased by 11.0 per cent during 2006-07 as against 10.3 per cent a year ago. The growth of trade, hotels and restaurants, transport, storage and communication accelerated to 13.0 per cent in 2006-07 from 10.4 per cent in 2005-06. The construction sector registered a lower growth of 9.4 per cent as compared with 14.2 per cent in the previous year. The growth in activity in financing, insurance, real estate and business services, and community, social and personal services at 11.1 per cent and 7.8 per cent, respectively, were comparable to 10.9 per cent and 7.7 per cent in 2005-06.

12.The acceleration in real activity propelled a sizeable expansion in monetary and banking aggregates in 2006-07 for the fourth year in succession. Non-food credit extended by the scheduled commercial banks (SCBs) increased by 28.0 per cent (Rs.4,10,285 crore) on top of 31.8 per cent (Rs.3,54,193 crore) in the previous year, exhibiting some moderation from the sustained growth that characterised the period 2003-06. The system-level incremental non-food credit-deposit ratio edged down to 84.6 per cent during 2006-07 from 109.3 per cent in the previous year, albeit with significant variations among banks. Food credit of SCBs increased by Rs.5,830 crore as compared with an increase of Rs.675 crore in the previous year.

13.Provisional information on the sectoral pattern of bank credit available up to December 2006 indicates some evening out of the skew towards the retail and services sector that dominated the deployment of gross bank credit since 2003-04. While on a year-on-year basis, personal loans continued to record the highest growth among major sectors, credit off-take was the highest in respect of the industrial sector in 2006-07. Personal loans recorded a growth of 34.9 per cent by December 2006 followed by services (32.4 per cent), agriculture (31.2 per cent) and industry (27.8 per cent). Housing loans increased by 30.3 per cent while real estate loans rose by 66.7 per cent by December 2006. Within the industrial sector, there was a sizeable credit pick-up in respect of infrastructure (21.7 per cent), basic metals and metal products (35.5 per cent), textiles (35.8 per cent), petroleum (67.0 per cent), chemicals (17.5 per cent), food processing (25.6 per cent) and engineering (19.6 per cent). Credit to industry constituted 35.3 per cent of the total expansion in non-food bank credit in 2006-07, followed by personal loans (28.7 per cent), services (23.7 per cent) and agriculture (12.2 per cent). The share of infrastructure and chemicals in total credit to industry declined marginally from 20.9 per cent and 8.9 per cent, to 19.9 per cent and 8.2 per cent, respectively. On the contrary, the share of credit to basic metals and metal products, textiles and petroleum sectors increased from 11.9 per cent, 10.4 per cent and 3.8 per cent, respectively, to 12.6 per cent, 11.1 per cent and 5.0 per cent. Priority sector advances grew by 25.0 per cent with a moderation in their share in outstanding gross bank credit to 34.8 per cent in December 2006 from 36.5 per cent a year ago.

14.Commercial banks’ investments in bonds/debentures/shares of public sector undertakings and the private corporate sector and commercial paper (CP) registered an increase of Rs.4,002 crore during 2006-07 in contrast to a decline of Rs.13,237 crore in the previous year. As a result, total flow of funds from SCBs to the commercial sector, including non-SLR investments, increased by 26.8 per cent (Rs.4,14,287 crore) in 2006-07 as against 28.3 per cent (Rs.3,40,956 crore) in 2005-06.

15.Aggregate deposits of SCBs increased by 23.0 per cent (Rs.4,85,210 crore) during 2006-07 as against 18.1 per cent (Rs.3,23,913 crore) in the previous year. Demand deposit growth slowed to 16.0 per cent from 27.5 per cent in 2005-06 but time deposit growth of 24.5 per cent was notably high vis-à-vis 16.4 per cent in the previous year. Several features distinguish deposit growth during 2006-07. First, there was a clear shift from postal savings to time deposits of banks due to favourable interest rate differentials. Second, the tax incentive available on small savings and equity-linked investments was extended to long-term bank deposits. Third, banks aggressively mobilised deposits in order to rebalance their portfolios consistent with emerging needs. Fourth, supported by continued high profitability, cash-rich private and public companies parked their surplus funds with banks. Fifth, non-resident deposits registered a higher growth during 2006-07 than in the previous year.

16.Commercial banks’ appetite for Government paper revived during 2006-07 and their investment in Government and other approved securities increased by Rs.74,706 crore in contrast to a decline of Rs.22,809 crore in 2005-06. Commercial banks’ holdings of Government and other approved securities declined from 31.4 per cent of the banking system’s net demand and time liabilities (NDTL) in March 2006 to 28.0 per cent in March 2007. While SCBs’ holdings of Government and other approved securities in excess of the statutory minimum requirement of 25 per cent amounted to Rs.85,728 crore, several banks are operating their statutory liquidity ratio (SLR) portfolios close to the statutory minimum level.

17.Money supply (M3), on a year-on-year basis, increased by 20.8 per cent (Rs.5,67,372 crore) in 2006-07 as compared with 17.0 per cent (Rs.3,96,881 crore) in 2005-06. Bank credit to the commercial sector increased by 25.4 per cent (Rs.4,30,287 crore) as compared with the increase of 27.2 per cent (Rs.3,61,746 crore) a year ago. Within credit to the Government sector, commercial banks’ credit to Government increased by Rs.70,318 crore as against a decline of Rs.19,514 crore in the previous year whereas net RBI credit to Government declined by Rs.3,775 crore as against an increase of Rs.35,799 crore in the preceding year. The banking sector’s net foreign exchange assets increased by 28.1 per cent (Rs.2,04,125 crore), primarily reflecting the increase in net foreign exchange assets of the Reserve Bank by 28.7 per cent (Rs.1,93,170 crore).

18.During the year, the financial markets shifted from conditions of easy liquidity to occasional spells of tightness necessitating injection of liquidity through the LAF. The total overhang of liquidity under the LAF, the Market Stabilisation Scheme (MSS) and surplus cash balances of the Central Government taken together increased from an average of Rs.74,334 crore in March 2006 to Rs.92,849 crore in September 2006. During October-December 2006, there was a progressive decline in LAF reverse repo levels. With the LAF slipping into net repos in December 2006 there was a steady moderation in the overhang of liquidity to Rs.78,555 crore by January 2007. In the following weeks, except for a brief episode of tightness during February 15-20 when enhanced cash reserve requirements become effective, liquidity conditions eased up to March 15 warranting moderation of excess liquidity through an augmented programme of MSS, a ceiling on LAF daily absorptions and calibration of CRR changes in addition to increases in the LAF repo rate. With liquidity shortages becoming accentuated in the second half of March 2007 in the wake of advance tax payments, net LAF injections rose to a peak of Rs.43,075 crore on March 21, 2007. The build-up of cash balances of the Government to a peak of Rs.77,726 crore on March 22, 2007 and shortage of collateral as a consequence of steady draw-down of excess SLR holdings exacerbated the tightening of liquidity. As a consequence of the enhanced absorption under the MSS and the build-up of the Centre’s cash balances, the overall liquidity overhang increased to an average of Rs.97,449 crore in March 2007.

19.On a net basis, average daily LAF reverse repo absorption declined from Rs.51,490 crore in the first quarter of 2006-07 to Rs.36,857 crore in the second quarter and more sharply to Rs.6,795 crore in the third quarter. Average daily LAF injections during the fourth quarter amounted to Rs.7,582 crore. The outstanding balances under MSS increased from Rs.29,000 crore at end-March 2006 to Rs.64,863 crore by end-March 2007. Cash balances of the Centre with the Reserve Bank increased from an average of Rs.49,995 crore in March 2006 to Rs.55,893 crore in March 2007. During April 2007 (up to April 20), a net amount of Rs.10,658 crore was absorbed by issuing fresh securities/Treasury Bills under MSS.

20.Reserve money increased by 23.7 per cent (Rs.1,35,892 crore) during 2006-07, higher than the increase of 17.2 per cent (Rs.83,922 crore) in the previous year. While currency in circulation rose by 17.1 per cent (Rs.73,491 crore) as compared with the increase of 16.8 per cent (Rs.62,015 crore) in the preceding year, bankers’ deposits with the Reserve Bank increased substantially by 45.6 per cent (Rs.61,784 crore) – augmented by the increase of 100 basis points in cash reserve ratio (CRR) during the year – as compared with the increase of 18.9 per cent (Rs.21,515 crore) in 2005-06. Among the sources of reserve money, the Reserve Bank’s foreign currency assets (adjusted for revaluation) increased by Rs.1,64,601 crore as compared with the increase of Rs.68,834 crore in the previous year. The Reserve Bank’s net credit to the Central Government (adjusted for the Government’s deposit balances including the MSS proceeds) declined by Rs.1,042 crore in 2006-07 as against an increase of Rs.28,417 crore in 2005-06. This decline was mainly due to an increase of Rs.33,912 crore in balances under the MSS, partly offset by increase in net LAF repos (Rs.36,435 crore). The Reserve Bank’s credit to banks and the commercial sector increased by Rs.1,990 crore as compared with an increase of Rs.534 crore in the previous year. The ratio of net foreign exchange assets (NFEA) to currency increased from 156.3 per cent in March 2006 to 171.8 per cent in March 2007.

21.Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, increased from 4.1 per cent at end-March 2006 to an intra-year peak of 6.7 per cent in end-January 2007 and remained firm in the range of 6.1-6.6 per cent in the succeeding weeks before moderating to 5.7 per cent on March 31, 2007. As on April 7, 2007 inflation stood at 6.1 per cent as against 3.8 per cent a year ago. On an average basis, annual inflation increased from 4.4 per cent in 2005-06 to 5.4 per cent in 2006-07.

22.Prices of primary articles (weight: 22.0 per cent in the WPI) rose by 10.7 per cent as against 4.8 per cent a year ago, largely on account of rising prices of food articles such as wheat, pulses, fruits and milk, and posed upward pressures on headline inflation through 2006-07. Wheat prices remained firm reflecting low stocks, both domestically as well as internationally, and high international prices. The stock of foodgrains with public agencies at 18.1 million tonnes as on February 1, 2007 was 7.4 per cent lower than a year ago. Since July 2006, wheat stocks have been lower than stipulated minimum norms for public agencies under the prevailing buffer stock policy. While prices of pulses went up sizeably reflecting stagnant domestic production as well as higher demand, edible oil prices were driven up by international prices and the decline in oilseeds production. Even excluding food articles, inflation at 5.3 per cent on March 31, 2007 would remain in the upper reaches of the tolerance threshold. Prices of manufactured products (weight: 63.8 per cent in the WPI) increased steadily to 5.8 per cent from 1.9 per cent a year ago. Inflation in terms of prices of manufactured products ruled consistently above 5.0 per cent from early November 2006 and generally above 6.0 per cent since end-January 2007. Within the category of manufactured products, a substantial rise in prices was observed in cement (11.6 per cent) and capital goods, in particular, electrical machinery (12.8 per cent) and metals (11.0 per cent). Within the WPI basket, wheat, milk, pulses, oilseeds, edible oils, oil cakes, grain mill products, basic metals and alloys, cement and electrical machinery with a combined weight of 29 per cent in the WPI contributed to over 63 per cent to headline inflation as compared with a share of 11 per cent a year ago. In the majority of these items, domestic prices are largely mirroring global trends. In addition, export demand is emerging as a significant determinant of inflation.

23.Prices of the ‘fuel, power, light and lubricants’ group (weight: 14.2 per cent) increased by 1.0 per cent in 2006-07 as against 8.3 per cent a year ago. The average price of the Indian basket of international crude varieties (comprising Brent and Dubai Fateh) increased from US $ 55.4 per barrel in 2005-06 to US $ 62.4 per barrel in 2006-07. In terms of monthly averages, the price of the Indian basket increased from US $ 66.8 per barrel in April 2006 to US $ 71.1 per barrel in July 2006, but declined to US $ 57.3 per barrel in October 2006 and further to US $ 53.0 per barrel in January 2007 before increasing to US $ 60.4 per barrel in March 2007. As on April 20, 2007 it stood at US $ 64.0 per barrel. In view of the intra-year decline in the average price of the ‘Indian basket’ of international crude, domestic retail prices of petrol and diesel were reduced in two stages - at end-November 2006 and again in mid-February 2007 - by around 6.0 per cent. Excluding mineral oils, WPI inflation works out to 6.6 per cent on March 31, 2007 as against 2.9 per cent a year ago.

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