First Quarter Review of Annual Monetary Policy for 2008-09
I. Assessment of Macroeconomic and
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12. During 2007-08, there have been noteworthy shifts in aggregate demand. In real terms, private final consumption expenditure (PFCE) and gross fixed capital formation (GFCF) increased by 8.3 per cent and 13.8 per cent, respectively, as compared with 7.1 per cent and 15.1 per cent in the previous year. In nominal terms, PFCE declined to 55.3 per cent of GDP during 2007-08 from 55.8 per cent in the previous year whereas GFCF increased to 33.9 per cent from 32.5 per cent.
13. Up to July 4, 2008 non-food credit of scheduled commercial banks (SCBs) rose by 25.9 per cent (Rs.4,85,709 crore) on a year-on-year basis, higher than 24.6 per cent (Rs.3,69,109 crore) a year ago. During the current financial year so far, non-food credit of SCBs increased by Rs.40,344 crore (1.7 per cent) as against a decline of Rs.12,519 crore (–0.7 per cent) in the corresponding period of the previous year. Food credit recorded an increase of Rs.6,322 crore as against a decline of Rs.2,292 crore in the corresponding period last year.
14. Provisional information on the sectoral deployment of bank credit available up to May 2008 indicates that on a year-on-year basis, credit to the services sector recorded the highest growth (31.3 per cent), followed by industry (26.9 per cent), the agriculture sector (19.3 per cent) and personal loans (15.9 per cent). Growth in housing and real estate loans decelerated to 13.8 per cent (21.6 per cent a year ago) and 31.9 per cent (69.7 per cent), respectively. Within the industrial sector, there was a sizeable credit pick-up in respect of infrastructure (41.7 per cent as against 32.6 per cent a year ago), cement and cement products (54.5 per cent over 18.3 per cent), chemicals (24.8 per cent as against 14.2 per cent) and petroleum (62.8 per cent as against 51.6 per cent). There was moderation in credit growth to basic metals and metal products (24.0 per cent as against 29.3 per cent), textiles (20.9 per cent as against 32.9 per cent), engineering (23.4 per cent as against 25.1 per cent), construction (29.6 per cent as against 49.2 per cent) and vehicles (26.7 per cent as against 28.6 per cent). Credit to industry constituted 43.1 per cent of the total expansion in non-food bank credit up to May 2008, followed by services (29.5 per cent), personal loans (17.2 per cent) and agriculture (10.1 per cent). The share of infrastructure in total credit to industry increased from 21.2 per cent to 23.7 per cent. On the contrary, the share of credit to textiles, chemicals, engineering and metals declined to 10.9 per cent, 7.6 per cent, 6.1 per cent and 12.1 per cent, respectively, from 11.5 per cent, 7.7 per cent, 6.3 per cent and 12.4 per cent. Priority sector advances grew by 18.3 per cent with a moderation in their share in outstanding gross bank credit to 34.0 per cent in May 2008 from 35.7 per cent a year ago.
15. Commercial banks' investments in shares, bonds/debentures and commercial papers (CPs) increased by Rs.9,510 crore (12.1 per cent) on a year-on-year basis up to July 4, 2008 as against a decline of Rs.1,188 crore (1.5 per cent) a year ago. During the current financial year so far, such investments by banks fell by Rs.7,126 crore (7.5 per cent) as compared with a decline of Rs.4,676 crore (5.6 per cent) in the corresponding period of 2007-08. Commercial banks invested Rs.13,810 crore in instruments issued by mutual funds during the current financial year so far as against Rs.43,066 crore in the corresponding period of 2007-08. The year-on-year growth in total flow of resources from SCBs to the commercial sector was 25.4 per cent (Rs.4,95,220 crore), higher than 23.2 per cent (Rs.3,67,921 crore) a year ago.
16. The year-on-year increase in aggregate deposits of SCBs at 21.7 per cent (Rs.5,89,646 crore) up to July 4, 2008 was lower than 24.6 per cent (Rs.5,36,617 crore) a year ago. On a financial year basis, aggregate deposits increased by Rs.1,11,286 crore (3.5 per cent) during 2008-09 up to July 4, 2008 as against an increase of Rs.1,06,646 crore (4.1 per cent) in the corresponding period of the previous year. The incremental non-food credit-deposit ratio increased to 82.4 per cent on July 4, 2008 from 68.8 per cent a year ago.
17. Commercial banks' investment in statutory liquidity ratio (SLR) eligible securities increased by Rs.43,667 crore up to July 4, 2008 as against an increase of Rs.57,653 crore in the corresponding period of2007-08. Abstracting securities committed for liquidity adjustment facility (LAF) operations, however, banks' investments in Government and other approved securities would have declined by Rs.18,383 crore as compared with an increase of Rs.25,469 crore a year ago. Commercial banks' holdings of Government and other approved securities was 27.7 per cent of the banking system's net demand and time liabilities (NDTL) which was marginally lower than 27.8 per cent at end-March 2008 and 28.7 per cent a year ago. Such investments were Rs.99,238 crore above the prescribed SLR level of 25 per cent of NDTL. Adjusted for banks' holding of market stabilisation scheme (MSS) securities and the collateral securities repoed under the LAF, commercial banks' holding of SLR securities was less than 23.0 per cent of their NDTL.
18. Money supply (M3) increased by 20.5 per cent on a year-on-year basis on July 4, 2008, lower than 21.8 per cent a year ago. On a financial year basis, M3 increased by 3.5 per cent (Rs.1,39,475 crore) during 2008-09 up to July 4, 2008 as compared with the increase of 3.8 per cent (Rs.1,26,058 crore) in the corresponding period of the previous year.
19. Reserve money increased by 26.5 per cent on a year-on-year basis on July 18, 2008 as compared with 29.0 per cent a year ago. Currency in circulation increased by 21.6 per cent (Rs.1,11,077 crore), higher than 14.3 per cent (Rs.64,432 crore) a year ago. There was also a large increase in bankers' deposits with the Reserve Bank, i.e., of the order of Rs.95,986 crore on top ofRs.97,923 crore a year ago due to successive increases in the cash reserve ratio (CRR). During the current financial year up to July 18, reserve money increased by 2.5 per cent (Rs.23,281 crore) as compared with the increase of 6.1 per cent (Rs.43,080 crore) in the corresponding period of the previous year. Among the components, currency in circulation recorded a higher increase of 5.9 per cent (Rs.34,915 crore) as compared with 2.1 per cent (Rs.10,539 crore) in the corresponding period last year. Among the sources of reserve money, the Reserve Bank's net foreign exchange assets increased by Rs.75,552 crore, mainly due to revaluation on account of depreciation of the rupee against other currencies during the period, as against an increase of Rs.27,735 crore inthe corresponding period last year. Adjusted for revaluation effects, the Reserve Bank's net foreign currency assets declined by Rs.18,139 crore as against an increase of Rs.72,947 crore in the corresponding period of 2007-08. The Reserve Bank's net credit to the Central Government increased by Rs.55,581 crore as against an increase of Rs.18,875 crore in the corresponding period last year. Adjusted for issuances under the MSS, the Reserve Bank's net credit to the Central Government showed an increase of Rs. 58,628 crore as compared with an increase of Rs. 40,928 crore a year ago.
20. Under the Special Market Operation (SMO) scheme announced on May 30, 2008 the Reserve Bank has been conducting open market operations (OMOs) in the secondary market against oil bonds held by public sector oil marketing companies and providing them equivalent foreign exchange through the designated banks. An overall daily ceiling under the SMO was initially set at Rs.1,000 croreand subsequentlyrevised to Rs.1,500 crore on June 11, 2008 on a review of operations. Public sector oil marketing companies have been provided US $ 4.3 billion (Rs.19,325 crore) against oil bonds purchased under the scheme up to July 25, 2008. The SMO is an ad hoc measure and is being reviewed on a continuous basis with a view to terminating these operations as soon as feasible.
21. During the first quarter of 2008-09, there were some shifts in liquidity conditions. As end-March balance sheet adjustments unwound and advance tax payments flowed back into the banking system with a large drawdown of Central Government's cash balances, liquidity conditions eased between the first week of April 2008 and the first week of May 2008. Absorption under the LAF averaged Rs.26,556 crore during April 2-May 15, 2008 with the peak absorption of Rs.79,005 crore on April 8, 2008. During April 1-May 21, 2008 there was net absorption of Rs.7,868 crore under the MSS.Under normal 91-day Treasury-bill auctions, an enhanced amount of Rs.3,000 crore was notified during May 14-June 18, 2008 for meeting farm debt waiver commitments. Banks' dependence on export credit refinance (ECR) fell from a daily average of Rs.820 crore during the fortnight ended April 11, 2008 to Rs.208 crore in the fortnight endingMay 23, 2008. With increases in the CRR effective from April 26, May 10 and May 24, liquidity conditions tightened. There were net injections through the LAF between May 26-July 1, 2008 but for a brief lull during June 2-9, 2008. During June 2008, however, there was average net injection under the LAF of the order of Rs.8,622 crore. Advance tax outflows and the consequent building up of Central Government's cash balances tightened liquidity conditions further from mid-June 2008. The increase in the CRR announced on June 24, 2008 in two stages of 25 basis points each effective from July 5 and July 19, 2008 sucked out an amount of nearly Rs.20,000 crore from the system. LAF repo operations rose to a peak of Rs.52,315 crore on July 21, 2008.On a review of liquidity conditions, MSS auctions were resumed on July 9, 2008.Banks also availed of ECR in the range of Rs.144 crore - Rs.5,605 crore during June-July 2008.
22. On a net basis, average daily LAF absorption, which stood at Rs.2,116 crore in the last quarter of 2007-08, increased to Rs.9,881 crore in the first quarter of 2008-09 but changed to net injection of Rs.28,730 crore in July so far (up to July 25). The average daily balances under the MSS increased from Rs.1,71,090 crore in January-March 2008 to Rs.1,75,588 crore during April-June 2008 but fell to Rs.1,73,317 crore by July 25, 2008. Cash balances of the Central Government with the Reserve Bank fell from an average of Rs.66,844 crore in January-March2008 to Rs.30,587 crore in the first quarter of2008-09and declined further to Rs.9,109 crore on July 24, 2008. The total overhang of liquidity as reflected in the balances under the LAF, the MSS and the Central Government's cash balances taken together declined from an average ofRs.2,42,370 crore in April 2008 to Rs.2,12,201 crore in May 2008 and Rs.1,93,726 crore in June 2008 (with an intra-year peak of Rs.2,93,048 crore on April 8, 2008) before declining to Rs.1,45,200 crore on July 25, 2008.
23. Inflation has increased to a 13-year high and inflation expectations have been driven up partly by unrelenting pressures from international commodity prices, particularly crude oil, basic metals and selected food items. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, increased to 11.89 per cent as on July 12, 2008 from 7.75 per cent as at end-March 2008 and 4.76 per cent a year ago. Prices of primary articles and manufactured products rose by 10.15 per cent and 10.72 per cent, respectively, on a year-on-year basis as compared with the increase of 11.13 per cent and 4.80 per cent a year ago. Prices of the fuel group increased by 16.94 per cent as against a decline of 1.44 per cent a year ago. Excluding the fuel group, year-on-year inflation rose to 10.52 per cent from 6.59 per cent a year ago. Similarly, excluding fuel and food, inflation rose to 11.83 per cent from 5.65 per cent a year ago. The main drivers of inflation during 2008-09 so far have been mineral oils (with a weighted contribution of 28.1 per cent), basic metals and alloys (18.8 per cent), oilseeds, edible oils and oil cakes (13.9 per cent), chemicals and chemical products (9.5 per cent), milk (2.7 per cent), and minerals (4.1 per cent) with a total weight of 36.8 per cent in the WPI basket and a combined contribution of over 77.3 per cent to overall inflation. On an annual average basis, headline WPI inflation was 5.98 per cent up to July 12, 2008 as against 5.62 per cent a year ago.
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