Second Quarter Review of Monetary Policy 2009-2010
-Announced on the 27th October 2009
Part A. Monetary Policy
I. Macroeconomic and Monetary Developments
37. Growth in monetary aggregates during 2009-10 (up to October 9, 2009) has evolved broadly in line with the projections. The year-on-year growth in reserve money (RM) turned negative reflecting the 400 basis points reduction in the cash reserve ratio (CRR) of banks during October–January 2008-09, which reduced the banks’ balances with the Reserve Bank. Adjusted for the first round impact of changes in the CRR, reserve money growth was positive, but lower than in the previous year
38. The money supply (M3) growth on a year-on-year basis at 18.9 per cent as on October 9, 2009 remained above the indicative projection of 18.0 per cent set out in the First Quarter Review of July 2009. The main source of M3 expansion was bank credit to the government reflecting large market borrowings of the Government. This is in contrast to what happened in 2008-09, when bank credit to the commercial sector and net foreign exchange assets of the banking sector drove the expansion of M3.
39. Monetary management during 2009-10 has been informed by the continued need to provide liquidity to mitigate the adverse impact of the global financial crisis and to complete the large market borrowing programme of the Government in a non-disruptive manner. The phenomenon of substitution of foreign assets by domestic assets, which began in the second half of 2008-09, continued during the first two months of the current year. This trend, however, reversed after May 2009, when capital inflows revived on a net basis. Liquidity conditions have remained comfortable since mid-November 2008. During 2009-10 (up to October 23, 2009), the average daily amount absorbed by the Reserve Bank under the LAF window was of the order of Rs.1,20,000 crore, indicating a large surplus with the banking system, equivalent to 2.7 per cent of the net demand and time liabilities (NDTL).
40. Non-food credit by scheduled commercial banks (SCBs) decelerated significantly, with the growth rate (y-o-y) falling to 11.2 per cent this year (as on October 9, 2009) from 29.4 per cent a year ago. On a financial year basis (up to October 9, 2009) too, the growth in scheduled commercial banks’ non-food credit at 4.3 per cent is significantly lower than the growth of 10.5 per cent in the corresponding period of last year.
41. Several factors have contributed to the slowdown in non-food bank credit. One, overall credit demand from the manufacturing sector slowed down reflecting a decline in commodity prices and drawdown of inventories. Two, corporates were able to access non-bank domestic sources of funds and external financing – which had almost dried up during the crisis – at lower costs. Three, unlike in the previous year, oil marketing companies reduced their borrowings from the banking sector as oil prices moderated. Four, a significant amount of bank finance has gone to the corporate sector through banks’ investment in units of mutual funds. Five, banks have also reined in credit to the retail sector due to the perceived increased risk on account of the general slowdown. This credit retrenchment was more pronounced in the case of foreign banks and private banks. This is evident from bank group-wise analysis, which shows that credit from private banks slowed down sharply, while that from foreign banks actually contracted. Thus, despite ample liquidity in the system, non-food bank credit expansion slowed down.
42. Banks used the ample liquidity available with them to make large investments in government securities and also fairly sizeable investments (of the order of Rs.92,000 crore during the current financial year so far) in units of mutual funds. Consequently, commercial banks’ investments in SLR securities (including securities acquired under the LAF) increased to 30.4 per cent of their NDTL as on October 9, 2009, up from 25.7 per cent a year ago. Net of LAF collateral securities, banks’ SLR investments were at 27.6 per cent of NDTL as on October 9, 2009.
43. As per data at a disaggregated level drawn from 49 banks accounting for 95 per cent of total bank credit, the year-on-year growth in bank credit to industry as of August 2009 was lower than that in the previous year. While the credit flow to agriculture, real estate and NBFCs remained high, it was lower for housing .
Total Flow of Financial Resources to the Commercial Sector
44. During the peak of the crisis (Third Quarter Review of January, 2009), it was noted that the flow of resources to the commercial sector from both bank and non-bank sources had contracted. While bank credit continues to decelerate as indicated earlier, there has been a turnaround in financing from non-bank sources. The resource flow from non-bank sources increased in Q2 of 2009-10 with increase in foreign direct investment, pick-up in primary issues, increased support from insurance companies, and large investment by mutual funds in non-gilt debt instruments. While the resource flow from the non-bank sources was marginally higher in 2009-10 (up to October 9), the total flow of financial resources to the commercial sector declined in comparison with the corresponding period of 2008-09 due to slowdown in bank credit.
45. In response to the crisis, the Reserve Bank has effected a substantial reduction in policy rates beginning October 2008: the repo rate by 425 basis points and the reverse repo rate by 275 basis points. The CRR was also reduced by 400 basis points of NDTL of banks.
46. Taking cues from the reduction in the Reserve Bank’s policy rates and easy liquidity conditions, all public sector banks and most private sector banks have reduced their deposit and lending rates. The reduction in the term deposit rates between October 2008 and October 1, 2009 has been in the range of 175-350 basis points by public sector banks, 100-375 basis points by private sector banks and 125-300 basis points by five major foreign banks. The reduction in the range of BPLRs was 125-275 basis points by public sector banks, followed by 100-125 basis points by private banks and 125 basis points by five major foreign banks.
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