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Main Page of First Quarter Review of Annual Monetary Policy 2006-07 click here

Assessment of Macroeconomic and Monetary Developments

Domestic Developments

2. Real GDP growth during January-March 2006 is placed at 9.3 per cent as against 8.6 per cent in the corresponding quarter a year ago. Accordingly, the Central Statistical Organisation (CSO) in its end-May 2006 release, revised the estimates of real GDP growth for 2005-06 to 8.4 per cent - up from the advance estimates of 8.1 per cent released in February 2006. Real GDP originating in agriculture, industry and services sectors rose in the revised estimates by 3.9 per cent, 7.6 per cent and 10.3 per cent, respectively, during 2005-06 as against 0.7 per cent, 7.4 per cent and 10.2 per cent in 2004-05.

3. While the onset of the south-west monsoon occurred nearly a week in advance, its progress stalled in the subsequent fortnight which resulted in delay in sowing in some parts of the country. The revival of monsoon activity from the last week of June and its spread across various parts of the country should, however, mitigate the impact of these early adversities on the kharif output. Of the normal area of 101.1 million hectares under kharif crops, 27.2 million hectares were covered by sowing by July 10, up from 24.3 million hectares in the corresponding period of the preceding year. Significant increases in sown area have been recorded under rice (13.7 per cent), pulses (32.4 per cent), cotton (29.6 per cent), coarse cereals (7.7 per cent) and sugarcane (4.1 per cent). There has been a moderate rise so far in the area sown under oilseeds. Soil moisture conditions have improved in regions covered by these crops. During the season so far (June 1 to July 19), rainfall has been excess/normal in 24 of the 36 meteorological subdivisions and 86 per cent of the long-period average (LPA). The India Meteorological Department (IMD) has updated its initial forecast and has placed the rainfall for the south-west monsoon season at 92 per cent of the LPA for the country as a whole.

4. Led by manufacturing which returned to double-digit growth in April-May, 2006 (10.9 per cent) after a gap of five months and supported by mining (3.2 per cent) and electricity (5.3 per cent), the index of industrial production (IIP) rose by 9.8 per cent, the highest increase since July 2005 and up from 9.5 per cent in April-May, 2005. Within manufacturing, growth was driven by basic metals, machinery and transport equipment, with some slowdown in textiles. In terms of the use-based classification, the key feature in April-May 2006 was the growth of 21.1 per cent in capital goods (13.9 per cent a year ago), reflecting the strength of investment activity. The production of basic goods rose by 9.0 per cent (7.5 per cent) and intermediate goods by 7.6 per cent (3.4 per cent) drawing from the underlying buoyancy in industrial activity. On the other hand, there was some deceleration in the growth of consumer goods to 9.0 per cent (15.9 per cent), mainly on account of consumer non-durables. The six infrastructure industries, comprising nearly 27 per cent of the IIP, posted a growth of 5.9 per cent during April-May, 2006 as against 7.1 per cent a year ago. Improvement in performance was recorded in petroleum products, whereas the growth of coal production, cement, finished steel and electricity decelerated and crude petroleum production registered a decline.

5. The performance of the private corporate sector has been moderating through 2005-06 from a high growth phase in the preceding three years. A deceleration in sales growth, higher input costs, increase in borrowings, especially from banks, and the consequent increase in interest payments imposed pressures on margins, leading to a distinct slowdown in profit growth from 51.2 per cent in 2004-05 to 24.1 per cent in 2005-06. Early results for the first quarter of 2006-07, however, indicate that both sales growth and profits after tax improved vis-à-vis the trends in 2005-06.

6. The Reserve Bank’s Industrial Outlook Survey indicates sustained business confidence in April-June, 2006 in relation to the previous quarter and also its level a year ago. Companies reported improvement in the overall financial situation as availability of finance kept pace with the increasing working capital and other requirements. Performance indicators for order books, output, employment, capacity utilisation, exports and imports are expected to be above their levels in the preceding quarter. Over four-fifths of the respondents reported raw material and finished goods inventories to be around the average level and a majority indicated increase in raw material prices. Expectations regarding the overall business situation and other major indicators for July-September, 2006 are significantly higher than for April-June, 2006. Business expectation surveys conducted by most other agencies also indicate an optimistic outlook in terms of overall economic conditions and investment climate, though there are indications of some tempering of such optimism in one survey. Seasonally adjusted purchasing managers’ indices signal an ongoing improvement in operating conditions in June, driven by output and new orders growth, including for exports.

7. Lead indicators of services sector activity suggest that the robust growth recorded in 2005-06 has been sustained in the initial months of 2006-07. Railway revenue earnings from freight traffic increased year-on-year by 11.0 per cent in April 2006, while total cell phone connections and net addition in switching capacity in the telecom sector jumped by 167.0 per cent and 572.1 per cent, respectively. The import and export cargo handled by the civil aviation sector posted growth rates of 19.9 per cent and 10.1 per cent, respectively. Foreign tourist arrivals in April-May 2006 rose by 20.0 per cent over the corresponding period last year. The passengers handled at international and domestic terminals also registered growth of 16.2 per cent and 54.0 per cent, respectively, in April 2006.

8. Banking sector activity is closely reflecting the impulses from the real economy. In the interpretation of movements in banking aggregates, however, a caveat is in order. The Annual Policy Statement of April 2006 had indicated that March 31, 2006 being the last reporting Friday of 2005-06 lent an upward bias to data for that year (since 2005-06 covered 27 fortnights of reported data instead of the usual 26 fortnights). Per contra, the same phenomenon has imposed a downward bias on data for 2006-07. Illustratively, variations in banking aggregates up to July 7, 2006 are measured from March 31, 2006 i.e., seven reporting fortnights. Conventionally, they would have been compared with corresponding variations in 2005-06 which are measured from March 18, 2005 – the last reporting Friday for that year – i.e., covering eight reporting fortnights. On the other hand, if similar comparisons are made, i.e., variations in the corresponding period of 2005-06 are measured from April 1, 2005 so as to cover seven reporting fortnights, the co-movement between banking and real sector activity becomes clearer. All comparison of such aggregates is made on this basis in this Statement.

9. On this basis, non-food credit of scheduled commercial banks (SCBs) increased by Rs.37,749 crore (2.6 per cent) up to July 7, 2006 as compared with an increase of Rs.19,948 crore (1.8 per cent) in the corresponding period a year ago. This increase is contra-seasonal and is the highest first quarter expansion in the past five years. In view of the March 31, 2006 phenomenon, year-on-year changes in monetary, credit and other banking aggregates are more appropriate for analytical purposes than financial year variations. On a year-on-year basis, the increase in non-food bank credit was 32.9 per cent (Rs.3,71,993 crore) on top of an increase of 31.0 per cent (Rs.2,60,164 crore), net of conversion of a non-bank into a bank, a year ago. Provisional information available for April and May, 2006 indicates that within the services sector, which currently absorbs about 50 per cent of non-food bank credit, retail lending rose by 74 per cent on a year-on-year basis with growth in housing loans being 115.5 per cent. Loans to commercial real estate rose by 101.3 per cent. The year-on-year growth in credit to industry was of the order of 26.0 per cent by May 2006. Substantial increases were observed in credit flow to industries like infrastructure (34.7 per cent), metals (37.6 per cent), vehicles (37.9 per cent), gems and jewellery (43.5 per cent) and construction (52.6 per cent). The growth in bank credit to agriculture was of the order of 35 per cent in May 2006 on a year-on-year basis.

10. Commercial banks’ investments in shares, bonds/ debentures and commercial paper (CP) increased by Rs.1,075 crore (1.3 per cent) during 2006-07 so far, as against a decline of Rs.2,683 crore (-2.9 per cent) in the corresponding period of 2005-06. By contrast, on a year-on-year basis, there was a decline in such investments by banks of the order of Rs.9,508 crore (-10.5 per cent) in contrast to an increase of Rs.4,066 crore (4.7 per cent) a year ago. Banks appear to be undertaking portfolio shifts away from investments in order to accommodate the sustained demand for credit. Accordingly, the year-on-year growth in total flow of resources from SCBs to the commercial sector was 29.6 per cent (Rs.3,62,485 crore) over and above 27.7 per cent (Rs.2,57,062 crore), net of conversion, a year ago.

11. Aggregate deposits of SCBs increased by Rs.68,499 crore (3.2 per cent) up to July 7, 2006 as against an increase of Rs.19,435 crore (1.1 per cent) in the corresponding period of the previous year. The accretion to bank deposits during 2006-07 so far is the highest for any comparable period since 1993-94 (excluding the impact of conversion of non-banks into banks). The year-on-year increase in aggregate deposits at 20.7 per cent (Rs.3,72,977 crore) was significantly higher than 14.9 per cent (Rs.2,34,020 crore), net of conversion, a year ago. With the year-on-year growth in credit still outpacing deposit growth, the incremental non-food credit-deposit ratio continued to remain high at 99.7 per cent as compared with 111.2 per cent, net of conversion, a year ago.

12. Investments in Government and other approved securities by SCBs increased by Rs.49,697 crore during the current year so far (up to July 7, 2006) as against a decline of Rs.1,133 crore in the corresponding period of 2005-06. These investments mainly reflect large magnitudes of reverse repos with the Reserve Bank and the consequent acquisition of Government securities. Exclusive of liquidity adjustment facility (LAF) operations, however, banks’ investments in Government and other approved securities declined by Rs.1,328 crore during 2006-07 up to July 7, as compared with an increase of Rs.12,397 crore a year ago. The subdued appetite of banks for investments in general and a preference for funding advances by shedding incremental gilt holdings was reflected in commercial banks’ holdings of Government and other approved securities declining from 36.4 per cent of the banking system’s net demand and time liabilities (NDTL) on July 8, 2005 to 31.5 per cent as on July 7, 2006. Such investments remain at Rs.1,57,548 crore above the statutory requirement. Excluding LAF holdings, however, investments of banks in approved securities in excess of the prescribed statutory liquidity ratio (SLR) amounted to Rs.99,273 crore or 4.1 per cent of the system’s NDTL. This is indicative of the limits to which SLR disinvestment can potentially fund credit demand.

13. On a year-on-year basis, money supply (M3) growth at 18.8 per cent by July 7, 2006 was higher than 13.8 per cent, net of conversion, a year ago and above the projected trajectory of 15.0 per cent indicated in the Annual Policy Statement for 2006-07. On a financial year basis, M3 increased by Rs.91,114 crore (3.3 per cent) during 2006-07 up to July 7, 2006 as compared with the increase of Rs.40,730 crore (1.7 per cent) in the corresponding period of the previous year.

14. On a year-on-year basis, the expansion in reserve money as on July 14 was of the order of 16.0 per cent, lower than 18.0 per cent a year ago. On a financial year basis (July 14 over March 31, 2006), reserve money increased by Rs.15,165 crore (2.6 per cent) up to July 14, 2006 as compared with the increase of Rs.17,806 crore (3.6 per cent) in the corresponding period of the previous year. As regards the components of reserve money, currency in circulation increased by Rs.23,646 crore (5.5 per cent) as compared with Rs.19,536 crore (5.3 per cent). Among the sources of reserve money, foreign currency assets of the Reserve Bank increased by Rs.75,663 crore as against a decline of Rs.20,630 crore in the corresponding period last year. Net Reserve Bank credit to the Central Government declined by Rs.1,736 crore as against an increase of Rs.25,530 crore.

15. The movements in reserve money during 2006-07 so far reflect the significant turnaround in liquidity conditions that has occurred between the last quarter of 2005-06 and the current financial year so far. The overhang of liquidity in the system, as reflected in the LAF, the market stabilisation scheme (MSS) and the Central Government’s cash balances with the Reserve Bank which, put together, averaged Rs.65,174 crore during January-March, 2006 increased to Rs.92,664 crore in April 2006 and settled at Rs.85,287 crore and Rs.86,730 crore in May and June 2006, respectively. On a review of the liquidity conditions, the Reserve Bank resumed auctions under the MSS with effect from May 3, 2006 in accordance with the annual ceiling for 2006-07 fixed at Rs.70,000 crore. It may be mentioned that the Reserve Bank had refrained from fresh auctions under the MSS since the second half of November 2005. The Reserve Bank absorbed an average daily amount of Rs.46,088 crore during April, Rs.59,505 crore in May, Rs.48,611 crore in June and Rs.50,162 crore in July (up to July 20) under the LAF. The liquidity overhang in the system was placed at Rs.91,231 crore as on July 20, 2006.

16. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, rose from 4.1 per cent at end-March 2006 to 4.7 per cent as on July 8, 2006. Prices of primary articles, manufactured products and ‘fuel, power, light and lubricants’ registered increases of 4.7 per cent, 3.6 per cent and 7.3 per cent, respectively, as against 2.3 per cent, 3.0 per cent and 10.5 per cent a year ago. Inflationary pressures are mainly reflecting the pass-through of the hike in administered prices of petrol and diesel effected on June 6, 2006 and increases in prices of food items, including the seasonal spike in prices of fruits and vegetables.

17. The increase of 4.2 per cent in prices of food articles accounted for nearly 14 per cent of the year-on-year headline inflation. The main drivers of inflation in the food articles segment were milk, pulses and wheat. A number of measures have been recently undertaken with a view to heading off these supply side pressures on inflation. Import duty on wheat was reduced from 50 per cent to 5 per cent to moderate the landed import costs. In June, private entities were allowed to import wheat, pulses and sugar under easier terms to contain inflation. Furthermore, a general ban has been applied on the export of refined sugar and pulses until the end of March 2007. During 2005-06, total stock of foodgrains with the Food Corporation of India (FCI) and other Government agencies declined by 1.4 million tonnes. As on May 1, 2006 total foodgrains stock at around 22.8 million tonnes was above the buffer stock norm of 16.2 million tonnes. Procurement of wheat during 2006-07 at 9.2 million tonnes up to July 11, 2006 was lower by 37.6 per cent than in the corresponding period last year.

18. The average international price of the Indian crude basket increased from US $ 60.1 per barrel in January-March, 2006 to US $ 67.3 per barrel in April-June, 2006 and further to US $ 71.4 per barrel in July 2006 (up to July 21). Excluding mineral oils, however, the WPI inflation works out to 3.0 per cent on July 8, 2006. Fuel prices, which account for about 35 per cent of the increase in WPI, constitute a major risk to headline inflation. Domestic prices of petrol and diesel (average of four metros) were increased by nearly 9.0 per cent and 6.5 per cent, respectively, in early June; however, international crude oil prices continue to be volatile and rising.

19. On an annual average basis, WPI inflation was 4.3 per cent as against 6.3 per cent a year ago. During 2006-07 so far, there has been a reversal of the phenomenon of consumer prices lagging wholesale prices, indicative of the sharp increase in food prices which constitute a relatively larger share in the consumer price basket. On a year-on-year basis, inflation based on the consumer price index (CPI) for agricultural labourers and rural labourers increased to 7.2 per cent each in June 2006 from 2.7 per cent each a year ago. The year-on-year CPI inflation for industrial workers and urban non-manual employees was placed at 6.3 per cent and 5.8 per cent in May 2006 as against 3.7 per cent and 4.2 per cent, respectively, a year ago.

20. Revenue receipts of the Union Government improved from 3.4 per cent as a proportion to the budget estimates (BE) in April-May, 2005 to 4.8 per cent of the BE in April-May, 2006 reflecting both higher tax and non-tax revenue receipts. Total expenditure at 16.3 per cent of the BE was higher than 11.6 per cent of the BE in April-May, 2005. There was a substantial increase in Plan expenditures on account of front-loading of transfers to the public account under the Central Road Fund (CRF) and the National Rural Employment Guarantee Fund (NREGF). There was also a sharp rise in non-Plan revenue expenditure under grants to States, economic services and subsidies and, in particular, interest payments. Accordingly, as a proportion to the BE, the gross fiscal deficit (GFD) and revenue deficit increased to 48.5 per cent and 81.0 per cent, respectively, during April-May, 2006 as compared with 31.5 per cent and 46.3 per cent in the corresponding period last year.

21. Gross market borrowings of the Central Government at Rs.69,533 crore (Rs.60,282 crore a year ago) during 2006-07 so far (up to July 17, 2006) constituted 38.2 per cent of the BE while net market borrowings at Rs.34,572 crore (Rs.39,234 crore a year ago) constituted 30.4 per cent of the BE. The weighted average yield and weighted average maturity of Central Government securities issued during 2006-07 so far were 7.86 per cent and 14.95 years, as compared with 7.34 per cent and 16.90 years, respectively, for those issued during 2005-06.

22. Reflecting the easy conditions at the short end of the market spectrum, interest rates in the call, market repo and collateralised borrowing and lending obligations (CBLO) segments of the money market eased to an average of 5.81 per cent, 5.64 per cent and 5.56 per cent, respectively, in July (up to July 21, 2006) from 6.58 per cent, 6.17 per cent and 6.19 per cent in March 2006.

23. The primary yields on 91-day Treasury Bills increased to 6.44 per cent on July 21, 2006 from 6.11 per cent at end-March, 2006. Yields on 364-day Treasury Bills recorded a sharper rise from 6.42 per cent at end-March, 2006 to 7.02 per cent in July 2006. Activity in the CP market picked up with an increase in the outstanding amount by 53.2 per cent to Rs.19,490 crore by end-June, 2006 from Rs.12,718 crore at end-March, 2006. The weighted average discount rate on CP declined from 8.59 per cent to 7.10 per cent over this period. In the market for certificates of deposit (CDs), the weighted average discount rate declined from 8.62 per cent at the end of March 2006 to 7.19 per cent by end-June, accompanied by an increase of 29.4 per cent in the outstanding amount (i.e., from Rs.43,568 crore to Rs.56,390 crore).

24. Gilt prices declined in the secondary market for government securities. The yield on government securities with one-year residual maturity moved up from 6.52 per cent at end-March, 2006 to 6.95 per cent as on July 21, 2006. The yield on Government securities with 10-year residual maturity also firmed up from 7.52 per cent at end-March 2006 to 8.27 per cent as on July 21, 2006. The yield on Government securities with 20-year residual maturity rose from 7.72 per cent to 8.69 per cent during the same period. Consequently, the yield spread between 10-year and one-year Government securities widened from 100 basis points to 132 basis points as on July 21, 2006. The yield spread between 20-year and one-year Government securities widened from 120 basis points to 174 basis points during the same period. Secondary market yields have generally hardened since June 2006 with the 10-year yield increasing sharply from 7.67 per cent on June 8 to 8.24 per cent on July 21, 2006. The underlying factors in this regard could be unsettled inflation expectations in the wake of soaring international crude prices feeding into interest rate uncertainty; sustained credit growth and competing demand for funds between public and private sectors; some spillover from global markets; and apprehensions of additional pressures on market resources from perceptions of possible higher borrowings by the Centre in the second half of the year coupled with announcement of issuances of bonds to oil companies.

25. Banks increased their deposit rates by about 25-100 basis points across various maturities between March 2006 and July 2006. A majority of PSBs adjusted their deposit rates up to three year maturity upwards by 25 to 50 basis points, while keeping the range of 6.00-7.25 per cent unchanged for deposits of over three years over the same period. The adjustments in deposit rates made by some private sector and foreign banks were somewhat higher, up to 100 basis points, particularly for deposit rates of over one year maturity. The benchmark prime lending rates (BPLRs) of PSBs and private sector banks moved to a range of 10.75-11.50 per cent and 11.00-14.50 per cent from 10.25-11.25 per cent and 11.00-14.00 per cent, respectively, in the same period. The range of BPLRs for foreign banks remained unchanged at 10.00-14.50 per cent during the period.

26. In the foreign exchange market, some indications of pressure from mid-May, 2006 due to the sharp decline in stock indices and currencies worldwide were observed. Market sentiment corrected by June and orderly conditions have prevailed thereafter. In contrast to the movements in the spot segment, the forward rates appreciated after April 2006. The average six-month forward premia eased from around 1.3 per cent to about 1.0 per cent during May-July, 2006. Market activity as measured by the overall daily turnover in various foreign exchange market segments increased from about US $ 27 billion in April 3, 2006 to around US $ 36 billion by May 15, 2006 before moderating to about US $ 26 billion by June 30, 2006.

27. The equity markets witnessed significant swings during the first quarter of 2006-07. The BSE Sensex (1978-79=100) increased from 11,280 at end-March 2006 to reach the all-time high of 12,612 on May 10, 2006 and a decline set in during the second half of May. The Sensex reached a trough of 8,929 on June 14, 2006 but firmed up thereafter to reach 10,086 on July 21, 2006.

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