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click here for Main Page of Third Quarter Review



Assessment of Macroeconomic and Monetary Developments- Third Quarter Review 2005-06


Domestic Developments

The outstanding balances under MSS, which were at Rs.65,481 crore at end-March 2005, increased to Rs.80,585 crore by September 2, 2005 when MSS securities worth Rs.20,000 crore were redeemed. Subsequently, outstanding balances under MSS reached another high of Rs.71,600 crore in early-November after which it declined in successive weeks to Rs.40,028 crore by January 20, 2006 due to unwinding of securities under MSS. The net absorption of liquidity under LAF was Rs.19,330 crore at end-March 2005 and reached its peak of Rs.51,390 crore by September 5, 2005. Subsequently, due to tightness in the market, the Reserve Bank injected liquidity through repo operations on several occasions. As on January 20, 2006 the net injection of liquidity was of the order of Rs.13,770 crore. During 2005-06 (up to January 18, 2006), the cash balances of the Central Government increased by Rs.11,864 crore. Accordingly, the total liquidity overhang fell to an average level of Rs.94,585 crore in December, 2005 and declined further to Rs.61,317 crore by January 20, 2006. Redemptions of the order of Rs.10,028 crore are due under the MSS during the remaining part of the current financial year and, if there are no fresh issues, the outstanding balances under the MSS would amount to about Rs.30,000 crore at the end of March, 2006.

As per the assurance given in the Mid-term Review, the Reserve Bank, in close coordination with the State Bank of India (SBI) and other market participants, put in place appropriate arrangements to ensure that the redemption of IMD of Rs.33,000 crore or US $ 7.1 billion occurs without undue stress on the money, foreign exchange and government securities markets. The entire foreign exchange outgo was met by the Reserve Bank out of the foreign exchange reserves in two tranches, i.e., US $ 5.1 billion on December 28 and US $ 2.0 billion on December 29, 2005. The SBI, on its part, undertook adequate steps to mobilise rupee resources to buy foreign exchange from the Reserve Bank. In addition, the Reserve Bank’s liquidity support through the LAF (including the second LAF) was also available to overcome short-term residual mismatches in rupee funds. The smooth redemption of IMD reflects the increasing resilience, strength and maturity of financial markets complemented by flexible operations of the Reserve Bank.

Turning to the fiscal situation, the revenue deficit of the Central Government at Rs.87,181 crore during April-November, 2005 accounted for 91.5 per cent of the budget estimates (BE) for 2005-06 as compared with 97.1 per cent (Rs.73,948 crore) in the corresponding period of the previous year. The slower pace of growth in the revenue deficit during the current year was enabled by the increase in tax revenue to 47.6 per cent of BE from 45.6 per cent a year ago and containment of growth in interest payments and subsidies. The gross fiscal deficit (GFD) was higher at Rs.1,12,949 crore or 74.7 per cent of the BE as against 51.5 per cent (Rs.70,717 crore) a year ago; however, adjusted for debt swap transactions, the GFD during April-November 2004 was 74.8 per cent of BE. The growth in the GFD during the current financial year has been mainly due to rise in Plan revenue expenditure and non-plan grants to States and Union Territories.

As on January 20, 2006 the Central Government had completed net market borrowings of Rs.90,051 crore (81.7 per cent of the budgeted amount of Rs 1,10,291 crore) and gross market borrowings of Rs.1,49,682 crore (83.8 per cent of the budgeted amount of Rs.1,78,467 crore) under the borrowing programme for 2005-06. Issuances of treasury bills and dated securities were mostly in accordance with the semi-annual indicative calendars. All issuances, except one, were reissuances reflecting efforts towards consolidation of public debt and imparting liquidity to the government securities market. The weighted average yield on fresh borrowings through dated securities rose to 7.29 per cent (up to January 20, 2006) from 6.11 per cent in the corresponding period last year. The weighted average maturity of dated securities of the Central Government issued during the current financial year so far increased to 15.61 years from 13.84 years in the corresponding period last year. During 2005-06, as against the net allocation of Rs.18,271 crore (gross Rs.24,546 crore) for their market borrowing programme, the State Governments have raised Rs.9,910 crore (net) and Rs.16,184 crore (gross) up to January 20, 2006.

During the current financial year, inflation measured by the wholesale price index (WPI) on a year-on-year basis, softened from a peak of 6.0 per cent on April 23 to a trough of 3.3 per cent on August 27, 2005. Between September 3 and December 31, 2005, inflation moved in the range of 3.6-4.9 per cent before touching 4.2 per cent on January 7, 2006.

Prices of primary articles (weight: 22.0 per cent) rose by 5.1 per cent as against 1.5 per cent a year ago, mainly on account of the increase of 13.9 per cent in the prices of fruits and vegetables as against an increase of 0.4 per cent a year ago. Prices of non-food articles and minerals increased by 0.8 per cent as compared with the increase of 1.5 per cent last year. Prices of manufactured products (weight: 63.8 per cent) rose by 2.5 per cent, lower than 5.8 per cent a year earlier. In the category of manufactured products, declines in the prices of edible oil, oil cakes and basic heavy organic chemicals softened the effects of sharp increases in the prices of tea and coffee processing, wine industries and wood and wood products.

Prices of the fuel, power, light and lubricants (FPLL) group (weight: 14.2 per cent) rose by 8.1 per cent as against 10.1 per cent a year ago. Within the group, the prices of mineral oils (weight: 6.99 per cent) increased by 12.7 per cent as against 14.8 per cent last year. Although the international crude prices have receded from record highs at end-August, incipient pressures persisted with the average international crude price basket relevant to India ruling at about US $ 62 per barrel on January 20, 2006. Mineral oils contributed to nearly 36 per cent of inflation as on January 7, 2006. Excluding mineral oils, inflation would have been at 2.7 per cent. Excluding the FPLL group, it would have been 2.5 per cent. On an average basis, inflation was 4.7 per cent as on January 7, 2006 which was lower than 6.5 per cent a year ago.

Inflation, measured by the consumer price index (CPI) for industrial workers on a year-on-year basis, was 5.3 per cent in November 2005 as against 4.2 per cent a year ago. On an average basis, CPI inflation was at 4.1 per cent as compared with 3.8 per cent.

Financial markets have remained generally stable although interest rates firmed up in almost all segments. The call money rate increased from an average of 4.77 per cent in April, 2005 to 6.58 per cent in January, 2006 (up to January 20). Through October, call rates remained orderly and closely aligned with the LAF reverse repo rate. Call rates started hardening in November and remained above the repo rate during November 10-18. Liquidity injections from the Reserve Bank calmed the call money market and call rates ebbed to settle at around 5.4 per cent by the end of the month. Call rates began rising again from December 10 and generally remained above the repo rate. The daily average turnover in the call money market increased from Rs.17,213 crore in April to Rs.18,776 crore in January (up to January 20, 2006).

Other market segments at the short end of the spectrum showed similar movements during the current financial year. The market repo (outside the LAF) rate increased from 4.63 per cent to 6.10 per cent with an increase in daily volume from Rs.3,958 crore (one leg) to Rs.6,440 crore (up to January 20, 2006). The average daily volume of collateralised borrowing and lending obligation (CBLO) increased significantly from Rs.5,185 crore to Rs.13,090 crore along with an increase in the CBLO rate from 4.58 per cent to 6.03 per cent. The weighted average discount rate on commercial paper (CP) of 61 to 90-day maturity increased from 5.80 per cent in April 2005 to 7.04 per cent by mid-January 2006 and the outstanding amount rose from Rs.14,809 crore to Rs.17,235 crore. The typical interest rate on 3-month certificates of deposit (CDs) increased from 5.87 per cent in April to 6.75 per cent by end-December 2005, accompanied by a significant rise in outstanding amounts from Rs.14,975 crore to Rs.32,806 crore.

In the government securities market, the 91-day and the 364-day Treasury Bill rates increased from 5.12 per cent and 5.60 per cent in April 2005 to 6.19 per cent and 6.30 per cent, respectively, in January 2006. The 182-day Treasury Bill rate moved up from 5.21 per cent to 6.22 per cent during this period. The yield on government securities with 1-year residual maturity in the secondary market increased from 5.77 per cent in April 2005 to 6.34 per cent in January 2006. The yield on government securities with 10-year and 20-year residual maturities, however, declined from 7.35 per cent and 7.77 per cent to 7.13 per cent and 7.37 per cent, respectively. Consequently, the yield spread between 10-year and 1-year government securities came down from 158 basis points in April 2005 to 79 basis points in January 2006. The yield spread between 20-year and 1-year government securities also declined to 103 basis points from 200 basis points.

The interest rates on deposits of over one year maturity of public sector banks (PSBs) moved up from 5.25-6.50 per cent in April 2005 to 5.50-7.00 per cent in January 2006. During the same period, the benchmark prime lending rates (BPLRs) of public sector banks, private sector banks and foreign banks remained unchanged in the range of 10.25-11.25 per cent, 11.00-13.50 per cent and 10.00-14.50 per cent, respectively. However, the median lending rates for term loans (at which maximum business is contracted) in respect of some major PSBs moved up to 8.00-12.25 per cent in December 2005 as compared with 8.00-11.90 per cent in September 2005.

The equity market remained buoyant with corporates raising resources from the domestic primary segment as well as international capital markets. The secondary market witnessed strong rallies with intermittent corrections. The BSE Sensex (1978-79=100) touched an all-time high of 9648 on January 4, 2006 driven by investments by foreign institutional investors (FIIs) and supported by robust corporate earnings, favourable investment climate and a positive macroeconomic and business outlook, before moving down to 9521 on January 20, 2006.

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