First Quarter Review of the Monetary Policy for 2010-11
-Announced on the 27th July 2010
I. The State of the Economy
16. On the deposit side, banks increased their term deposit rates by 75-100 basis points between March 2010 and July 16, 2010. On the lending side, benchmark prime lending rates (BPLRs) of scheduled commercial banks remained unchanged from July 2009 till end-June 2010. The banking system switched over to the Base Rate system with effect from July 1, 2010. The Base Rates set by major banks are in the range of 7.25-8.0 per cent. While information on effective lending rates to major categories of borrowers is not yet available, it is expected that the Base Rate system will make credit pricing more efficient. Further, it will enhance transparency in lending rates and improve monetary policy transmission.
17. Money markets remained orderly during Q1 of 2010-11. A significant development was that the Liquidity Adjustment Facility (LAF) window of the Reserve Bank, after remaining in surplus mode for nearly 18 months, switched into deficit mode towards the end of May 2010 and has remained there since. This liquidity pressure was triggered by the increase in government cash balances on account of larger than expected 3G and BWA spectrum auction receipts combined with advance tax payments.
18. Consistent with the stance of active liquidity management and in order to prevent a disruption in credit flow, the Reserve Bank took several measures to ease the pressure. First, on May 26, 2010, the Reserve Bank announced additional liquidity support under the LAF to scheduled commercial banks to the extent of up to 0.5 per cent of their net demand and time liabilities (NDTL). A second LAF (SLAF) was also made available on a daily basis. Both these facilities, which were initially available till July 2, 2010, were later extended. While the additional liquidity support facility was extended up to July 16, 2010, the SLAF remains extended up to July 30, 2010. Second, in consultation with the Government, the notified amounts for the issuance of Treasury Bills during June 2010 were reduced by Rs.22,000 crore. Third, during June 16-21, 2010, the Government bought back securities worth Rs.9,614 crore, ahead of schedule.
19. There was net injection of liquidity by the Reserve Bank in June and July 2010 (up to July 23). As a result, overnight interest rates, which generally remained around the floor of the LAF corridor up to May, moved up to the ceiling of the corridor in June 2010 and have remained there in July 2010 so far. Similarly, yields on other money market instruments increased, reflecting autonomous tightening of monetary conditions by 150 basis points, equivalent to the prevailing width of the LAF corridor.
20. At the longer end of the market, the monthly average yield on the 10-year benchmark government security fell to 7.59 per cent in June 2010 from 8.01 per cent in April 2010 in the expectation that the Government will reduce market borrowing because of higher realisations from spectrum auctions. Subsequently, the yield moved up to 7.73 per cent by the third week of July 2010.
21. Equity markets exhibited volatile conditions during the current financial year, although they have firmed up in recent weeks. Resource mobilisation by the corporates through public issues in the primary segment of the capital market continued its uptrend. The foreign exchange market saw volatility increase relative to the previous quarter, with the rupee showing two-way movements in the range of Rs.44.33-Rs.47.57 per US dollar.
22. During the first quarter of 2010-11, both the nominal and real effective exchange rates (NEER and REER) have appreciated. While the appreciation in 36-currency NEER/REER at about 1.5 per cent (up to May) was similar, real appreciation on the basis of 6-currency REER was higher at 3.3 per cent as compared with 6-currency NEER appreciation of 1.4 per cent, reflecting higher inflation differentials between India and major advanced economies.
23. Of the budgeted net market borrowing of the Central Government for 2010-11 at Rs. 3,45,010 crore, about 38.5 per cent (Rs.1,32,900 crore) of the borrowing was completed by mid-July 2010. As against the budgeted amount of Rs 35,000 crore, the actual realisations under 3G and BWA auctions were about Rs. 1,06,000 crore, resulting in an increase in receipts by over one per cent of GDP. It is, however, important to ensure that this one-off increase does not slacken the much needed efforts towards fiscal consolidation.
24. During the first two months of 2010-11, both exports and imports continued to expand in contrast to the contraction they showed during the corresponding period of last year. The trade deficit widened during April-May 2010 to US$ 21.7 billion, up from
US$ 14.4 billion in the corresponding period of the previous year, reflecting the sustained increase in domestic activity.
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