Second Quarter Review of Monetary Policy 2009-2010
-Announced on the 27th October 2009
Part A. Monetary Policy
I. Macroeconomic and Monetary Developments
24. The headline inflation, as measured by year-on-year variations in the wholesale price index (WPI), which remained negative during June-August 2009 due to the base effect, returned to positive territory in September 2009. WPI inflation was 1.21 per cent on October 10, 2009 as compared with 11.30 per cent a year ago, and 0.84 per cent at end-March 2009. During the current financial year (up to October 10, 2009), WPI has increased by 5.95 per cent reflecting higher food price inflation aggravated by deficient monsoon.
25. The upside risk of deficient monsoon rainfall projected in the First Quarter Review of July 2009 has since materialised and prices of primary food items and manufactured food products have risen due to short supply. During the current financial year (up to October 10, 2009), the increases in prices of wheat (3.5 per cent) and rice (5.9 per cent) were relatively low as supply side pressures were mitigated by the comfortable levels of foodgrain stocks with public agencies which stood at 44.3 million tonnes as on October 1, 2009 as against the minimum stock norm of 16.2 million tonnes. However, large increases were recorded in prices of vegetables (59.3 per cent), tea (30.7 per cent), sugar, khandsari and gur (28.7 per cent), egg, meat and fish (25.3 per cent), pulses (19.2 per cent), jowar (14.9 per cent), condiments and spices (14.2 per cent), milk (7.0 per cent) and fruits (5.2 per cent).
26. The current inflationary pressures, as WPI moves from negative to positive territory, are quite different from the inflationary pressures witnessed in April-October 2008. Although both inflation episodes are driven by supply side pressures, the inflation in 2008 was triggered largely by a sharp increase in the prices of basic metals and mineral oils. In contrast, during the current episode, price pressures are emanating from domestic sources reflecting increase in prices of food articles and food products
27. At a disaggregated level, WPI inflation rates of food articles, essential commodities and manufactured food products are currently in double digits and are ruling much above their trend levels
28. The recent contrarian movements in the WPI and CPI inflation rates have raised questions about the correlation between them. In the short-term, inflation rates based on WPI and CPIs could be different due to differences in coverage and weights. However, these differences even out over time as wholesale price changes are followed by changes in the retail prices. For example, in the five year period 2003-08, the average inflation based on consumer price index for industrial workers (CPI-IW) of 4.83 per cent was not very different from the average WPI inflation of 4.99 per cent.
29. The first occasion in the recent past when CPI inflation diverged significantly from WPI inflation was in mid-2004. The divergence between the two inflation rates persisted thereafter but remained within a relatively narrow range. However, the divergence has widened in the recent period with WPI inflation turning negative even as CPI inflation crossed double digits (Chart 2). Several factors account for this phenomenon. One, food prices, which have higher weightage (in the range of 46-69 per cent) in the CPI measures than in WPI (26 per cent), have risen sharply in the recent period. Two, miscellaneous group (representing services) in various CPIs (weights in the range of 12-24 per cent) have also exhibited significant price pressures; these services are not included in WPI. Three, prices of metals, which do not form part of the CPI group, have declined sharply, thereby accentuating the divergence between CPI and WPI inflation rates. Four, while a strong base effect pushed WPI inflation into negative territory during June-August 2009, there was no base effect in play for CPI inflation.
30. Inflation based on the CPI for industrial workers (IW) and urban non-manual employees (UNME) has also witnessed a one-time step-up reflecting significant upward revision in imputed prices of rent-free houses emanating from the Sixth Pay Commission Award. Notwithstanding the current wide divergence between the two sets of price indices, CPI inflation tracks the essential commodities component of WPI inflation quite closely indicating that current CPI inflation is essentially driven by food prices
Asset Price Inflation
31. Asset prices have risen sharply in the recent period. Stock prices have increased by more than 70 per cent during the current financial year to date. After showing some correction in the latter part of 2008 and early part of 2009, real estate prices have risen significantly in major cities. Commodity prices in India have also hardened in recent months. Reflecting the firm trend in the global market, gold prices in India surged, especially after August 2009, and reached a level of Rs.16,035 per 10 grams on October 23, 2009, up from Rs. 15,105 at end-March 2009.
32. In the first five months of 2009-10 (April-August), the revenue deficit of the Central Government was 54.9 per cent of the budget estimate, while the fiscal deficit was 45.5 percent
33. As per budget estimates, the combined net borrowing requirements of the Central and State Governments for 2009-10 will be 34 per cent higher than the already elevated level of actual borrowings during 2008-09
34. A major challenge for the Reserve Bank, as indicated in the First Quarter Review of July 2009, has been the management of the large government market borrowing programme in a non-disruptive manner. For this purpose, the Reserve Bank initiated several measures, some of which were unconventional. First, the Reserve Bank front-loaded the borrowing programme for 2009-10 as credit offtake by the private sector is usually low in the first half. Second, MSS securities of the order of Rs.28,000 crore were de-sequestered. Third, the Reserve Bank resorted to active liquidity management by way of unwinding of MSS securities and purchase of securities through pre-announced calendar of open market operations (OMO). The unwinding of MSS securities through redemption was of the order of Rs.42,000 crore during the first half of the year. Besides, as against the OMO announcement of an indicative amount of Rs.80,000 crore through the auction route for the first half of 2009-10, the actual purchases were Rs.57,487 crore, the shortfall from projection being on account of easy liquidity conditions. Feedback from the market participants indicates that the OMO provided considerable comfort.
35. The Central Government has already completed net market borrowing of Rs. 3,19,911 crore (as much as 80.4 per cent of the budget estimate) through dated securities during 2009-10 (up to October 26, 2009) (Table 9). In addition, the State Governments also mobilised Rs.58,683 crore (net) through the market borrowing programme. Because of the front-loading of the market borrowing programme, net issuances under the Central Government borrowing programme in the remaining period of 2009-10 will be Rs.62,464 crore (Table 9). Given the current level of liquidity, it should be possible to complete this borrowing programme smoothly.
36. Despite the large government borrowing programme, the weighted average yield of dated securities issued under the Central Government borrowing programme in 2009-10 (up to October 26, 2009) at 7.14 per cent was lower than the yield of 8.81 per cent averaged for the corresponding period of the previous year. However, the yield on the 10-year government securities rose from 7.01 per cent at end-March to 7.47 per cent in early-September 2009 with increased volatility. Subsequently, it stabilised around 7.35 per cent by mid-October 2009. The Reserve Bank also varied the maturity profile of debt issuances tailored to market appetite. The weighted average maturity of securities issued during 2009-10 (up to October 26, 2009) was 11.0 years as compared with the average maturity of 15.5 years in the corresponding period of the previous year. Market participants indicate that had there not been active liquidity and maturity profile management by the Reserve Bank, the yield perhaps would have been significantly higher.
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