Annual Policy Statement for the Year 2010-11- 20th April 2010
Part A. Monetary Policy
I. The State of the Economy
11. Clearly, WPI inflation is no longer driven by supply side factors alone. The contribution of non-food items to overall WPI inflation, which was negative at (-) 0.4 per cent in November 2009 rose sharply to 53.3 per cent by March 2010. Consumer price index (CPI) based measures of inflation were in the range of 14.9-16.9 per cent in January/February 2010. Thus, inflationary pressures have accentuated since the Third Quarter Review in January 2010. What was initially a process driven by food prices has now become more generalised.
12. Growth in monetary and credit aggregates during 2009-10 remained broadly in line with the projections set out in the Third Quarter Review in January 2010. Non-food bank credit expanded steadily during the second half of the year. Consequently, the year-on-year non-food credit growth recovered from its intra-year low of 10.3 per cent in October 2009 to 16.9 per cent by March 2010. The increase in bank credit was also supplemented by higher flow of financial resources from other sources. Reserve Bank’s estimates show that the total flow of financial resources from banks, domestic non-bank and external sources to the commercial sector during 2009-10 at Rs.9,71,000 crore, was higher than the amount of Rs.8,34,000 crore in the previous year.
13. Scheduled commercial banks (SCBs) raised their deposit rates by 25-50 basis points between February and April 2010 so far, signalling a reversal in the trend of reduction in deposit rates. On the lending side, the benchmark prime lending rates (BPLRs) of SCBs have remained unchanged since July 2009 following reductions in the range of 25-100 basis points between March and June 2009. However, data from select banks suggest that the weighted average yield on advances, which is a proxy measure for effective lending rates, is projected to decline from 10.8 per cent in March 2009 to 10.1 per cent by March 2010. The Base Rate system of loan pricing, which will replace the BPLR system with effect from July 1, 2010, is expected to facilitate better pricing of loans, enhance transparency in lending rates and improve the assessment of monetary policy transmission.
14. Financial markets functioned normally through the year. Surplus liquidity that prevailed throughout the year declined towards the end of the year consistent with the monetary policy stance. The Reserve Bank absorbed about Rs.1,00,000 crore on a daily average basis under the liquidity adjustment facility (LAF) during the current financial year up to February 12, 2010, i.e., before the first stage of increase in the cash reserve ratio (CRR) came into effect. During February 27- March 31, 2010, the average daily absorption of surplus liquidity declined to around Rs. 38,200 crore reflecting the increase in the CRR, year-end advance tax outflows and higher credit demand from the private sector. However, as the overall liquidity remained in surplus, overnight interest rates generally stayed close to the lower bound of the LAF rate corridor.
15. The large market borrowing by the Government put upward pressure on the yields on government securities during 2009-10. However, this was contained by active liquidity management by the Reserve Bank. Lower credit demand by the private sector also cushioned the yield. Equity markets generally remained firm during the year with intermittent corrections in line with the global pattern. Resource mobilisation through public issues increased sharply. Housing prices rebounded during 2009-10. According to the Reserve Bank’s survey, they surpassed their pre-crisis peak levels in Mumbai.
16. During 2009-10, the Central Government raised Rs.3,98,411 crore (net) through the market borrowing programme while the state governments mobilised Rs.1,14,883 crore (net). This large borrowing was managed in a non-disruptive manner through a combination of active liquidity management measures such as front-loading of the borrowing calendar, unwinding of securities under the market stabilisation scheme (MSS) and open market operation (OMO) purchases.
17. The Union Budget for 2010-11 has begun the process of fiscal consolidation by budgeting lower fiscal deficit (5.5 per cent of GDP in 2010-11 as compared with 6.7 per cent in 2009-10) and revenue deficit (4.0 per cent of GDP in 2010-11 as compared with 5.3 per cent in 2009-10). As a result, the net market borrowing requirement of the Central Government in 2010-11 is budgeted lower at Rs.3,45,010 crore as compared with that in the previous year.
18. Historically, fiscal deficits have been financed by a combination of market borrowings and other sources. However, in 2009-10 and 2010-11, reliance on market borrowings for financing the fiscal deficit increased in relative terms. The large market borrowing in 2009-10 was facilitated by the unwinding of MSS securities and OMO purchases, as a result of which fresh issuance of securities constituted 63.0 per cent of the total budgeted market borrowings. However in 2010-11, almost the entire budgeted borrowings will be funded by fresh issuance of securities. Therefore, notwithstanding the lower budgeted net borrowings, fresh issuance of securities in 2010-11 will be Rs.3,42,300 crore, higher than the corresponding figure of Rs.2,51,000 crore last year. The large government borrowing in 2009-10 was also facilitated by sluggish private credit demand and comfortable liquidity conditions. However, going forward, private credit demand is expected to pick up further. Meanwhile, inflationary pressures have also made it imperative for the Reserve Bank to absorb surplus liquidity from the system. Thus, managing the borrowings of the Government during 2010-11 will be a bigger challenge than it was last year.
19. The current account deficit during April-December 2009 was US$ 30 billion as compared with US$ 28 billion for the corresponding period of 2008. Net capital inflows at US$ 42 billion were also substantially higher than US$ 7 billion in the corresponding period last year. Consequently, on a balance of payments basis (i.e., excluding valuation effects), foreign exchange reserves increased by US$ 11 billion as against a decline of US$ 20 billion during the corresponding period a year ago. Foreign exchange reserves stood at US$ 279 billion as on March 31, 2010. The six-currency trade-based real effective exchange rate (REER) (1993-94=100) appreciated by 15.5 per cent during 2009-10 up to February as against 10.4 per cent depreciation in the corresponding period of the previous year.
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