Second Quarter Review of Monetary Policy 2009-2010
-Announced on the 27th October 2009
Part A. Monetary Policy
I. Macroeconomic and Monetary Developments
Money and G-Sec Markets
47. As a result of the monetary easing and policy rate reductions beginning September 2008, interest rates have declined across the term structure in the domestic financial markets. The call money rates have remained near or below the lower bound of the LAF corridor since November 2008. Primary yields on Treasury Bills have also moderated.
48. The yield on government securities moved up with increased volatility during the early part of the year in the face of a large borrowing programme of the Central and State Governments. There was a sudden surge in bond yields in late August due to change in market sentiment with the yield on 10-year Government security moving up by 42 basis points during August 13 - September 3, 2009. However, the yield stabilised subsequently on assurances by the Reserve Bank that it would manage liquidity conditions and market borrowing programme of the Government in a non-disruptive manner (Chart 4).
49. Presently, banks are permitted to hold statutory liquidity ratio (SLR) securities up to 25 per cent of their demand and time liabilities (DTL) in the ‘held to maturity’ (HTM) category of investments. Recently, there has been some debate on the need to raise this limit on the ground that such a relaxation will mitigate the upward pressure on G-Sec yields, and consequently on the overall interest rate regime. The Reserve Bank considered the advisability of raising the HTM limit. It may be recalled that in 2004-05 banks were allowed to shift SLR securities to the HTM category as a one-time measure subject to the total SLR securities held in the HTM category capped at 25 per cent of their DTL. This limit was kept unchanged even as the SLR was reduced from 25 per cent to 24 per cent in November 2008. As the HTM ratio is already higher than the prescribed SLR, it is not considered desirable to further raise the HTM ratio.
50. The changes in the Reserve Bank’s policy rates were quickly transmitted to the money and debt markets. However, transmission to the credit market was slow due to several structural rigidities in the system, especially fixed interest rate deposit liabilities. As bank deposits, contracted in the past at high rates, have started to mature and banks have significantly reduced their term deposit rates, the transmission of lower policy rates to the credit market has improved. In this context, it should be recognised that the movement in the benchmark prime lending rates (BPLRs) does not fully and accurately reflect the changes in effective lending rates as nearly two-thirds of banks’ lending takes place at sub-BPLR rates. As such, the true movements in lending rates of banks are better captured in the weighted average lending rates of banks. Rough estimates show that the effective average lending rate for scheduled commercial banks declined from 12.3 per cent in March 2008 to 11.1 per cent by March 2009 – the latest period for which data are available (Chart 5). Further, data from select banks, as a proxy measure for effective lending rates, suggest that weighted average yield on advances declined from 10.6 per cent in March 2009 to 10.3 per cent in June 2009.
51. The analysis by the Working Group on BPLR (Chairman: Shri Deepak Mohanty), which submitted its Report on October 20, 2009, has demonstrated that though there was considerable divergence in weighted average lending rates in 2004 among the various bank-groups, these have tended to converge in the recent period. The Group has recommended the introduction of a Base Rate system.
Foreign Exchange Market
52. The foreign exchange market remained orderly during 2009-10 (up to October 23, 2009) with the rupee exhibiting a two-way movement against major currencies. During the current financial year, the rupee appreciated by 9.7 per cent against the US dollar and 2.6 per cent against the Japanese yen, whereas it depreciated by 5.7 per cent against the pound sterling and 3.2 per cent against the euro (Chart 6). In terms of the real exchange rate, the six-currency trade-based real effective exchange rate (REER) (1993-94=100) moved up from 96.3 at end-March 2009 to 104.2 by October 23, 2009.
53. During the current financial year (up to October 23, 2009), the secondary segment of the domestic capital market has remained buoyant. The stock market staged a smart recovery reflecting large net FII inflows due to the optimistic outlook for the Indian economy. FIIs made net purchases of US$ 13.8 billion in 2009-10 (up to October 21, 2009) in the Indian equity market as against net sales of US$ 8.6 billion in the corresponding period of 2008-09. The BSE Sensex rose from 9,709 at end-March 2009 to 16,811 on October 23, 2009, showing an increase of 73.1 per cent during 2009-10 to date.
54. India’s external account has remained comfortable during the current financial year. Merchandise trade contracted due to depressed external demand and slowdown of the domestic economy, with imports declining more than exports. The trade deficit narrowed down to US$ 26.0 billion in Q1 of 2009-10 from US$ 31.4 billion in Q1 of 2008-09. However, trade deficit in Q1 of 2009-10 was higher than US$ 14.6 billion in Q4 of 2008-09 partly due to a rise in crude oil prices (Table 18). The current account deficit at US$ 5.8 billion in Q1 of 2009-10 was also lower compared to the deficit of US$ 9.0 billion in Q1 of 2008-09; a current account surplus of US$ 4.7 billion was recorded in Q4 of 2008-09. The capital account showed a turnaround from a negative balance in the last two quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10.
55. In 2009-10 to date, foreign exchange reserves have increased by US$ 32.9 billion, including allocation of SDRs (US$ 5.2 billion) by the IMF, and were at US$ 284.8 billion as on October 16, 2009 .
56. The management of foreign exchange reserves is guided by the changing composition of the balance of payments and endeavours to reflect the ‘liquidity risks’ associated with different types of flows.
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