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Mid-term Review of Monetary and Credit Policy for the year 2001-2002              Click here for FULL credit policy

Mid-term Review of Macroeconomic and Monetary Developments in 2001-02

Domestic Developments

2. The annual Statement on monetary and credit policy, released on April 19, 2001 projected a GDP growth of 6.0 to 6.5 per cent for the year 2001-02. This projection was based on the assumptions of a reasonable monsoon, good performance of exports and a revival of the industrial sector beginning second quarter of the year. As per the latest information available from the India Meteorological Department, the behaviour of the South-West monsoon this year has been better than last two years, with 30 out of 35 sub-divisions showing normal or excess rainfall. According to the current estimates of the Ministry of Agriculture, kharif output this year is expected to increase by 2.5 million tonnes to 105.6 million tonnes. Assuming a normal North-East monsoon, agricultural growth in 2001-02 is expected to be significantly higher than the previous year.

3. While agricultural performance is encouraging, the position regarding revival of industrial sector and export growth in the first half of the current year is not favourable. According to the latest estimates released by the Central Statistical Organisation, growth rate of industrial production during April-August 2001 was lower at 2.2 per cent as against 5.6 per cent in the corresponding period of the previous year. The deceleration in growth was observed across the sectors. Manufacturing sector recorded a much lower growth rate of 2.5 per cent as compared with 6.1 per cent in the previous year. While basic goods, intermediate goods and consumer durables have shown lower growth during April-August 2001 as compared with the corresponding period of the previous year, capital goods sector continues to show a negative growth rate (- 8.0 per cent as against 4.3 per cent) reflecting a sluggish investment demand. The performance of the infrastructure industries, a stimulant for industrial activity, also remained at a low key. The composite index of six infrastructure industries, viz., electricity, coal, steel, cement, crude petroleum and refinery products registered a substantially lower growth of 1.2 per cent during April-August 2001 as against 6.9 per cent in the corresponding period of the previous year. While cement, electricity and petroleum refinery products recorded lower growth rates than those in the corresponding period of the previous year, coal and crude petroleum showed negative growth rates. Export growth has also been negative. According to the latest information available, exports in US dollar terms during the period April-August 2001 declined by 2.3 per cent against a growth of 21.1 per cent in the corresponding period last year.

4. Taking into account the positive developments regarding the likely rate of growth in agriculture during the current year on the one hand, and the unfavourable behaviour of industrial and export sectors on the other, on balance, the projection of 6.0 to 6.5 per cent growth rate for the year 2001-02 now appears optimistic.

5. In view of the global uncertainty, and the impact of global slowdown on exports as well as domestic growth, a firm projection of revised growth rate for the year as a whole is difficult. According to the latest International Monetary Fund (IMF) projections, which may be revised downward again, the global growth rate during the current year is expected to be of the order of 2.6 per cent and almost all developing as well as industrialised countries are likely to show a substantially lower growth than projected a few months ago. Recent growth projections for the Indian economy made by the IMF, other international agencies as well as domestic research and monitoring agencies have also ranged widely from 4.5 to over 6.0 per cent. Balancing various factors, and assuming no further serious disruption in the world economic environment, at this stage, a projection in the range of 5.0 to 6.0 per cent growth rate in the current year may be reasonable for the purpose of credit and monetary management. India is likely to be one of the very few countries in the world which would show a growth rate of this order in the current year.

6. The relatively sombre outlook for industrial growth is reflected in the credit flow during the period April-October 5, 2001. The expansion of bank credit and other flows to the commercial sector from the banking system remained sluggish due to subdued industrial growth and depressed investment demand. Scheduled commercial banks’ credit increased by 6.1 per cent (Rs.31,104 crore) upto October 5, 2001 as against an increase of 9.7 per cent (Rs.42,211 crore) in the corresponding period of the previous year. Food credit increased by Rs.10,211 crore as against Rs.7,193 crore in the previous year reflecting higher procurement operations. The increase in non-food bank credit by 4.4 per cent (Rs.20,894 crore) was lower as against an increase of 8.5 per cent (Rs.35,018 crore) in the corresponding period of the previous year. In late September and early October 2001, however, some pick-up in non-food bank credit is discernible.

7. The increase in scheduled commercial banks’ investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper (CP), etc., was 4.3 per cent (Rs.3,333 crore) (upto September 21, 2001) as compared with an increase of 4.6 per cent (Rs.2,873 crore) in the corresponding period of the previous year. Together with such investments, the increase in total flow of resources from scheduled commercial banks to the commercial sector was only 4.4 per cent (Rs.24,227 crore) as against 8.0 per cent (Rs.37,891 crore) in the corresponding period of the previous year. The year-on-year growth in resource flow was 12.0 per cent as against 20.2 per cent a year ago.

8. Scheduled commercial banks’ investments in instruments issued by financial institutions and mutual funds this year declined by Rs.300 crore as against a decline of Rs.255 crore last year. Total resource flow to the commercial sector including capital issues, Global Depository Receipts (GDRs) and borrowings from financial institutions was Rs.64,734 crore during the financial year so far as compared with Rs.83,178 crore in the previous year. Most of the debt issues by both private corporates and public sector units are on private placement basis which has caused some regulatory concerns. (This issue is addressed in Part III of this Review.)

9. The feedback on credit flows received from banks reveals that at a disaggregated level during April-August 2001, there was an increase in scheduled commercial banks’ credit to agriculture, housing, consumer durables, personal loans, tourism, other textiles, pharmaceuticals, automobiles, construction and infrastructure. On the other hand, decline in credit was observed in petroleum, coal, cotton textiles, jute textiles, tobacco, vegetable oils, all engineering and wholesale trade.

10. In the current financial year upto October 5, 2001, money supply (M3) increased by 8.2 per cent (Rs.1,08,102 crore) as compared to 8.3 per cent (Rs.93,762 crore) in the corresponding period of the previous year. On an annual basis, growth in M3 at 16.6 per cent was higher than the growth of 15.3 per cent a year ago. Aggregate deposits of scheduled commercial banks increased by 9.1 per cent (Rs.87,895 crore) as compared with an increase of 8.9 per cent (Rs.72,687 crore) in the corresponding period of the previous year. On an annual basis, growth in aggregate deposits at 18.6 per cent was higher than that of 15.4 per cent a year ago. In view of the adverse developments in the other segments of the financial market, the relative attractiveness of bank deposits seems to have increased. If the surge in deposit growth continues, it may pose a challenge to the banking system in deploying resources, particularly in the context of sluggishness in credit and investment demand.

11. Reserve money increased by 1.8 per cent (Rs.5,516 crore) in the current financial year upto October 12, 2001 as compared to an increase of 1.6 per cent (Rs.4,427 crore) in the corresponding period of the previous year. On the sources side, while net RBI credit to the Central Government showed a modest increase of 4.5 per cent (Rs.6,552 crore) as compared to an increase of 14.9 per cent (Rs.20,859 crore) in the corresponding period of the previous year, RBI’s net foreign exchange assets increased significantly by 9.9 per cent (Rs.19,531 crore) in sharp contrast to a decline of 2.1 per cent ( - Rs.3,469 crore) during the corresponding period of the previous year. RBI’s subscriptions to primary issues of Central Government dated securities (Rs.21,679 crore) was more than offset by net open market sales (Rs.22,275 crore). There was also reduced reliance on standing facilities due to comfortable liquidity conditions. On the components side, while currency in circulation increased by 5.7 per cent (Rs.12,461 crore) as compared to 6.2 per cent (Rs.12,138 crore), bankers’ deposits with RBI declined by 8.3 per cent ( - Rs.6,766 crore) as against a decline of 9.8 per cent ( - Rs.7,871 crore) reflecting the impact of reduction in Cash Reserve Ratio (CRR). On balance, the reserve money expansion is expected to remain moderate during 2001-02.

12. Annual inflation, as measured by variations in Wholesale Price Index (WPI), on a point-to-point basis, on October 6, 2001 was 3.2 per cent as against 7.4 per cent a year ago. Annual inflation, as measured by Consumer Price Index (CPI) for industrial workers on a point-to-point basis, was 5.2 per cent in August 2001 as against 4.0 per cent a year ago.

13. The contribution to inflation emanating from ‘fuel, power, light and lubricants’ sub-group (weight 14.2) was moderate at 5.7 per cent this year (compared to 31.4 per cent last year). The annual inflation rate, excluding the impact of price increases of this energy related sub-group was at 2.6 per cent. While prices of primary articles (weight 22.0) recorded an increase of 4.6 per cent, manufactured products (weight 63.7) registered an increase of 1.8 per cent. Among primary articles, the increase in prices was concentrated in a few articles such as fruits and vegetables, oilseeds and pulses. In manufactured products, the increase in prices of edible oils and cement was relatively high. The inflation outlook for the year appears comfortable as agricultural growth prospects remain positive, and foodgrain stocks are very high.

14. The Union Budget for 2001-02 placed the net and gross market borrowings of the Central Government respectively at Rs.77,353 crore and Rs.1,18,852 crore. Upto October 20, 2001, the Central Government completed net market borrowings of Rs.66,647 crore and gross borrowings of Rs.96,251 crore. The government market borrowing programme during 2001-02 has been conducted by elongating the maturity pattern and at a lower cost. The weighted average maturity of borrowings was 13.9 years this year as against 10.6 years last year. The weighted average yield on government borrowings through dated securities was lower by nearly 100 basis points at 9.96 per cent this year as against 10.95 per cent last year. In its debt management, RBI continued to combine auction issues with acceptance by private placement of dated securities consistent with market conditions. The total private placement of dated securities with RBI during the current year so far was Rs.21,679 crore. In order to neutralise the monetary impact of private placements, RBI conducted outright open market operations (OMO) sales of government securities to the tune of Rs.27,359 crore (upto October 20, 2001).

15. Gross fiscal deficit of the Central Government at Rs.56,079 crore upto August 2001 was higher by about 54 per cent over the corresponding period of last year and constituted about one half of the budget estimate for the current year. Similarly, revenue deficit (Rs.43,640 crore) accounted for above 55 per cent of the budget estimate for the year as a whole. Gross fiscal deficit as a proportion of GDP so far has been higher at 2.3 per cent as against 1.7 per cent in the corresponding period of the previous year.

16. A steady increase in net foreign currency assets of the Reserve Bank combined with subdued real economic activity created a situation of excess liquidity during most part of the first half of the year. The Reserve Bank, therefore, had to actively manage liquidity not only through outright OMO sales of securities but also through its daily Liquidity Adjustment Facility (LAF). The average daily absorption through repo transactions under LAF amounted to about Rs.3,600 crore.

17. Scheduled commercial banks’ investments in government securities this year (upto October 5, 2001) has been significantly large at Rs.43,664 crore as compared with Rs.25,636 crore in the corresponding period of the previous year. Commercial banks already hold government securities much in excess of the prescribed Statutory Liquidity Ratio (SLR), to the extent of Rs.1,29,450 crore, constituting 36.3 per cent of NDTL.

18. The overall interest rate structure which had come down substantially in the last two years, continued to show a softening trend. The prime lending rates (PLRs) of public sector banks, which were ranging between 11.75 and 13.00 per cent in September 2000, softened to 10.0-13.0 per cent in March 2001 and further to 10.0-12.5 per cent by mid-October 2001. As banks are permitted to lend to exporters and their prime customers at sub-PLR rates, the cost of bank borrowings to such corporates has come down even further. Long-term domestic deposit rates of public sector banks declined from 10.5 per cent in March 2001 to 9.5 per cent by mid-October 2001; however, at the shorter end there was a marginal increase by 25 basis points.

19. As announced in the annual policy Statement of April 2001, during the first half of the fiscal year, the Reserve Bank continued to provide appropriate liquidity through its repo operations. Barring a few days, the overnight call money rate remained around 7.0 per cent during the entire period, and the overall easy liquidity conditions were reflected in the response to daily repos conducted by RBI. The interest rate environment also remained fairly soft with yields on 10-year Government paper declining by about 100 basis points (on top of a decline of about 170 basis points in the previous two years). The weighted average discount rate on CP of 61 to 90-day maturity declined from 11.74 per cent in end-September 2000 to 9.71 per cent in end-March 2001 and further to 8.58 per cent by end-September 2001. This constitutes a decline of as much as 3.16 percentage points in the discount rate on such paper over the past year.

External Developments

20. The world economy, which had slowed down considerably during the first eight months of the year 2001, experienced one of its worst shocks in the aftermath of the September 11 events in the US. All segments of the financial markets, particularly the equity markets, were badly affected. While global financial markets have stabilised in the past four weeks, the outlook for growth and recovery in the world economy remains highly uncertain. The outlook for growth in major industrialised countries as also the emerging economies has become adverse with estimated growth rates being scaled down. According to the latest World Economic Outlook brought out by the IMF, the downturn in the emerging markets of Asia is likely to continue for a longer period than that anticipated earlier. The advanced economies are expected to grow by only 1.3 per cent during 2001 as compared with 3.8 per cent last year. However, according to the IMF, India and China are expected to be less affected by this downturn. India is relatively insulated from this global slowdown because of its lower share of trade in GDP and service oriented and cost efficient information technology sector. Since these growth projections were made before September 11, it is likely that actual global growth will be even less than projected. The chances of world economy sliding into a recessionary phase are now believed to be much greater than that a few weeks ago.

21. India was also affected by the global economic slowdown and instability in financial markets. Equity markets, which had shown a fall of about 360 points between end-March and end-August 2001, declined further, and BSE Sensex, the Index of the Mumbai Stock Exchange, touched an eight year low on September 21, 2001. It has since gained 417 points to reach 3017 by October 19, 2001. There was net capital outflow of Foreign Institutional Investors (FIIs) by about US $ 179 million in September 2001. Foreign exchange markets also became volatile with the rupee showing a depreciation of 1.3 per cent vis-à-vis US dollar during the 10-day period of September 11-20, 2001. The consequent uncertainties affected the bond market, particularly the government securities market.

22. Adverse external developments after September 11, and their effect on India’s financial markets, necessitated a quick response to provide appropriate liquidity and overall comfort to the markets. In order to stabilise domestic financial markets, RBI announced the following measures during the period September 15-25, 2001:

On September 15, 2001, despite some emerging pressures in the forex market, RBI announced that it does not intend to presently shift its monetary policy stance in regard to keeping interest rates stable with adequate liquidity. RBI further assured the markets that it will be prepared to sell foreign exchange directly or indirectly, if it considers it necessary to do so, to meet any unusual supply-demand gap in view of the prevailing uncertainties.

In view of the extraordinary circumstances in the government securities market, RBI opened a purchase window for select government securities on an auction basis.

On September 20, 2001, in consultation with the Government of India, Indian companies were permitted to increase the FII investment limit upto the sectoral cap/statutory ceiling, as applicable.

With effect from September 22, 2001, banks were allowed to finance stock brokers for margin trading for an initial period of 60 days (i.e., up to November 22, 2001) in actively traded scrips which form part of the National Stock Exchange (NSE) Nifty and BSE Sensex within the overall existing ceiling of bank exposure to capital market.

On September 24, 2001, in consultation with the Government of India, a special financial package was announced, for large value exports of six select products, which were internationally competitive and had high value addition.

With effect from September 26, 2001, interest rates charged by scheduled commercial banks on pre-shipment and post-shipment rupee export credit were reduced by 1.0 percentage point for a period of six months (upto March 31, 2002).

23. The above measures had the desired effect of moderating possible panic reactions and reducing volatility in financial markets, particularly in money, forex and government securities markets. While financial markets are generally stable, liquidity is adequate, and interest rate environment is favourable, so far, there is no perceptible upturn in industrial output. This continues to be a matter of serious concern. It is to be hoped that as global markets gain back momentum after some time, it will have a favourable impact on the investment climate in India also.

24. The annual monetary policy Statements of last two years as well as mid-term Reviews have attempted to highlight the main lessons emerging from our experience in managing the external sector during periods of external and domestic uncertainties. The recent experience has once again highlighted the need for continuous vigilance and the importance of building adequate safety nets to withstand the effects of unexpected shocks and market uncertainties. In this context, India’s exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way, has stood the test of time. Despite several unexpected external and domestic developments, India’s external situation has remained satisfactory. RBI will continue to follow the same approach of watchfulness, caution and flexibility in regard to the forex market. It will continue to monitor closely, as in the past, the developments in the financial markets at home and abroad, and carefully coordinate its market operations with appropriate monetary, regulatory and other measures as considered necessary from time to time.

25. India’s foreign exchange reserves have increased sharply by over US $ 10 billion from US $ 34.9 billion as on October 20, 2000 to US $ 45.1 billion by October 19, 2001. India’s sustained efforts to build an adequate level of foreign exchange reserves in the last few years have also been fully vindicated by recent developments. As pointed out in previous policy Statements, the overall approach to the management of India’s foreign exchange reserves in recent years has reflected the changing composition of balance of payments, and has endeavoured to reflect the "liquidity risks" associated with different types of flows and other requirements. The policy for reserve management is thus judiciously built upon a host of identifiable factors and other contingencies. Such factors, inter alia, include: the size of the current account deficit; the size of short-term liabilities (including current repayment obligations on long-term loans); the possible variability in portfolio investment and other types of capital flows; the unanticipated pressures on the balance of payments arising out of external shocks (such as, the impact of the East Asian crisis in 1997-98 or increase in oil prices in 1999-2000 or recent events in the US); and movements in the repatriable foreign currency deposits of Non-resident Indians (NRIs). Taking these factors into account, India’s foreign exchange reserves are at present comfortable. However, there can be no cause for complacency. We must continue to ensure that, leaving aside short-term variations in reserve levels, the quantum of reserves in the long run is in line with the rate of growth in the economy, the share of external sector in the economy and the size of risk-adjusted capital flows. This will provide us with greater security against unfavourable or unanticipated developments of the type witnessed recently as well as during earlier years.

26. On account of global slowdown, exports have not done well during the current year. India’s exports during the first five months of the current financial year at about US $ 17.1 billion registered a decline of 2.3 per cent over the corresponding period of the previous year. Imports increased by 2.5 per cent as against an increase of 13.8 per cent last year. Trade deficit in the first five months of the current financial year at US $ 4.6 billion was higher than that of US $ 3.7 billion in the same period last year. Oil imports declined by 6.1 per cent in US dollar terms as compared with a large increase of 78.7 per cent in the corresponding period of the previous year on account of moderation of international oil prices. Non-oil imports increased by 6.7 per cent during April-August 2001 as against a decline of 3.2 per cent in the corresponding period of the previous year. While the surplus on the non-oil account declined from US $ 2.9 billion to US $ 1.1 billion, the deficit on oil account decreased from US $ 6.5 billion during April-August 2000 to US $ 5.7 billion during April-August 2001. For the rest of the year, there is some uncertainty about the likely course of international oil prices. If the average oil prices for the rest of the financial year are assumed to be at US $ 25.0 per barrel, the oil import bill for 2001-02 will be in the range of US $ 17.5-18.0 billion as against actual imports of US $ 15.6 billion in the previous year. However, on present reckoning, it is expected that the current account deficit for the year 2001-02 will still be well below 2.0 per cent of GDP and no significant pressures on balance of payments are expected on this account.

27. A strong effort to accelerate the growth of exports is essential for long-term viability of balance of payments as well as for generation of income and employment in the economy. As mentioned earlier, as part of the efforts to provide support to exporters during the prevailing period of global uncertainty, the Reserve Bank advised reduction in ceiling interest rates on rupee export credit by 1.0 percentage point across the board for a period of six months. It may be emphasised that so far as interest cost to the exporters is concerned, taking into account forward premia, the effective interest cost on six-month rupee export credit is only 3.0-4.0 per cent (assuming a forward premia of 5.0 per cent), which is internationally competitive. Similarly, exporters are free to avail of foreign currency loans in the currency of their choice at internationally competitive rates. Foreign currency loans from banks in India can be availed of by exporters at LIBOR plus a maximum of 1.0 percentage point.

28. In the past three years, several measures have also been introduced to ensure timely delivery of credit to exporters at reasonable cost and removal of procedural hassles. It was announced in the last annual policy Statement that a survey of exporters’ satisfaction would be conducted through an independent agency. Accordingly, the work of the survey has been entrusted to National Council of Applied Economic Research (NCAER), New Delhi. NCAER has launched the survey on August 31, 2001 and has started interacting with bank officials and exporters/export organisations at various centres in the country.

29. In the recent period, procedures for financial transactions such as remittances, investments and maintenance of bank accounts, etc., for non-residents have been considerably simplified. Foreign direct investment (FDI) is permitted under the automatic route for most activities except in certain circumstances and for a very small negative list. Indian companies are allowed to increase the FII investment limit upto the sectoral caps/statutory ceilings as applicable. A number of steps have been taken to improve liquidity in the American Depository Receipt/Global Depository Receipt (ADR/GDR) market and to give opportunity to Indian shareholders to divest their shareholding in the ADR/GDR market abroad. Indian companies wishing to make acquisitions of foreign companies or direct investment abroad in Joint Ventures/Wholly Owned Subsidiaries can now invest upto US $ 50 million on an annual basis through automatic route with additional block allocation of foreign exchange subject to certain conditions.

30. Over a period, considerable flexibility has been given to the corporates to hedge their forex exposure in the market. Instruments available to the corporates for hedging their exchange risks include forward cover, currency options, foreign currency-rupee swaps, hedging of the loan exposures, etc. Banks are also allowed to hedge their asset-liability portfolio, after obtaining necessary policy approval in this regard from their top management.

31. It is, however, observed that sometimes a noticeable portion of the corporate foreign currency commitments tend to remain unhedged by the coporates on the basis of their perceptions of the market and these could impact the overall financial status of the corporates under severe uncertainties. It is, therefore, desirable for banks which have large exposures to such corporates to put in place a system for monitoring such unhedged external exposures. Illustratively, banks could consider introducing a periodical review of the unhedged portion of foreign currency exposures of the corporates whose total exposure is relatively large (say, above US $ 25 million or so) through a suitable reporting system.

32. The Reserve Bank will continue with its efforts to simplify procedures, reduce documentation requirements and further liberalise opportunities for productive investment in India by NRIs and others and by Indian corporates/entities abroad. Further suggestions from experts, corporates and market participants in these areas are welcome, and can be sent by e-mail at helpnri@rbi.org.in

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