Third Quarter Review of Annual Statement on Monetary Policy for 2006-07, RBI Credit Policy

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Third Quarter Review of Annual Statement on Monetary Policy for 2006-07 click here

Third Quarter Review of Annual Statement on Monetary Policy for 2006-07

I. Assessment of Macroeconomic and Monetary Developments

Domestic Developments

15.The year-on-year increase in reserve money was 20.0 per cent as on January 19, 2007 as compared with 14.9 per cent a year ago. On a financial year basis, reserve money increased by Rs.68,724 crore (12.0 per cent) up to January 19, 2007 as compared with the increase of Rs.45,809 crore (9.4 per cent) in the corresponding period of the previous year. While currency in circulation increased by Rs.57,575 crore (13.4 per cent) as compared with Rs.48,574 crore (13.2 per cent), bankers’ deposits with the Reserve Bank registered a growth of Rs.12,319 crore (9.1 per cent) due to the increase in the cash reserve ratio (CRR) as compared with a decline of Rs.870 crore (0.8 per cent). Among the sources of reserve money, net Reserve Bank’s credit to the Central Government increased by Rs.6,963 crore as compared with the increase of Rs.50,622 crore in the corresponding period last year. Adjusted for transactions under the LAF, net Reserve Bank’s credit to the Central Government showed a decline of Rs.12,097 crore, mainly reflecting the changes in balances under the Market Stabilisation Scheme (MSS) and the Centre’s cash balances. The Reserve Bank’s net foreign exchange assets (NFEA) increased by Rs.1,14,337 crore as against an increase of Rs.2,043 crore during the corresponding period of the previous year. The Reserve Bank’s foreign currency assets, adjusted for revaluation, increased by Rs.80,166 crore as compared with an increase of Rs.11,185 crore (inclusive of sales towards IMD redemption) during the corresponding period of the previous year. The ratio of NFEA to currency increased from 156.3 per cent on March 31, 2006 to 161.3 per cent by January 19, 2007.

16. Average daily net absorption under the LAF which was Rs.36,857 crore in July-September, 2006 moderated to Rs.12,262 crore in October, 2006. The Reserve Bank injected liquidity through LAF repos during October 20-25, 2006; however, some reverse repo bids were also received during this period, indicating that the distribution of liquidity in the system was skewed. Liquidity conditions balanced in subsequent weeks with the LAF returning to absorption mode. Reverse repo under the LAF came down to Rs.9,937 crore in November and net absorptions continued until December 12, 2006. Injections under the LAF resumed from December 13, 2006 as liquidity tightened with outflows from the banking system on account of advance tax payments as well as the 25 basis points increase in the CRR which became effective from December 23, 2006. Average daily liquidity injection under the LAF amounted to Rs.16,768 crore during December 13-31, 2006 as against average daily liquidity absorption of Rs.22,125 crore during December 1-12, 2006. In January so far (up to January 25, 2007), with the second round of 25 basis points increase in the CRR coming into effect from January 6, 2007 there was net average daily injection of liquidity of Rs.11,034 crore. Additional liquidity amounting to Rs.13,040 crore was absorbed under the MSS during 2006-07 up to January 25, 2007. The balances under the MSS increased from Rs.29,000 crore on March 31, 2006 to Rs.42,040 crore by January 25, 2007. In several auctions of Treasury Bills and dated securities under the MSS, there was partial acceptance of the notified amounts. The Central Government’s cash balances with the Reserve Bank increased from an average daily level of Rs.9,569 crore in April-June 2006 to Rs.16,029 crore in July-September, 2006, Rs.36,769 crore in October-December and Rs.49,156 crore in January 2007 (up to January 25). The average liquidity overhang as reflected in outstandings under the LAF, MSS and surplus cash balances of the Central Government taken together, which was Rs.89,786 crore in April-June, 2006 and Rs.92,354 crore in July-September, 2006 declined to Rs.84,312 crore in October-December, 2006 and further declined to Rs.78,800 crore in January (up to January 25, 2007).

17. Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, increased from its end-March 2006 level of 4.1 per cent to 5.4 per cent at end-October, 2006 and increased to the intra-year peak of 6.1 per cent on January 6, 2007 before marginally declining to 6.0 per cent by January 13, 2007. On an average basis, annual inflation based on the WPI, which was at 4.6 per cent at end-October 2006, increased to 4.9 per cent by January 13, 2007 as compared with 4.7 per cent a year ago.

18. At a disaggregated level, prices of primary articles (weight: 22.0 per cent in the WPI basket) registered a year-on-year increase of 9.3 per cent as on January 13, 2007 as compared with an increase of 5.6 per cent a year ago. The rise in prices of primary articles was under food as well as non-food items. Prices of manufactured products (weight: 63.8 per cent) was steadily driven up by rising domestic demand and the return of pricing power to corporates. Manufacturing inflation increased to 5.6 per cent by January 13, 2007 from 1.9 per cent at the beginning of the current financial year and 2.2 per cent a year ago, led by prices of paper, non-metallic mineral products, food products, rubber and plastic products. There was deceleration/decline in the prices of wood and leather products, chemicals, basic metals and alloys, machinery and transport equipment. Within the category of manufactured products, prices of cement have risen by 17.9 per cent (12.9 per cent a year ago), contributing 4.5 per cent of the headline WPI inflation. Prices of capital goods have been rising, coincident with high growth in production and imports, and are indicative of rising investment demand. Among capital goods, prices of electrical machinery rose by 11.3 per cent (1.9 per cent a year ago) with a contribution of 5.8 per cent to overall inflation.

19. The average price of the ‘Indian basket’ of international crude which was US $ 67.3 per barrel in April-June, 2006 and US $ 67.9 per barrel during July-September, 2006 declined to a low of US $ 57.6 per barrel in October 2006 before firming up to US $ 58.4 per barrel and US $ 60.0 per barrel in November and December 2006, respectively. Thereafter, it reduced to US $ 51.0 per barrel by January 25, 2007. The annual increase in prices of the ‘fuel, power, light and lubricants’ group (weight: 14.2 per cent)at 3.7 per cent as on January 13, 2007 was lower than 7.9 per cent a year ago and reflected the impact of reduction in prices of petrol and diesel at end-November 2006. Excluding the fuel group, inflation was at 6.6 per cent (2.5 per cent a year ago), which was higher than the headline.

20. inflation based on the consumer price index (CPI) for urban non-manual employees, agricultural labourers and rural labourers showed a sharp year-on-year increase to 6.9 per cent, 8.9 per cent and 8.3 per cent in December 2006, respectively, from 5.7 per cent, 4.7 per cent and 4.9 per cent, a year ago. The year-on-year CPI inflation for industrial workers was also placed higher at 6.3 per cent in November 2006 than 5.3 per cent a year ago. On an annual average basis, CPI for industrial workers registered a year-on-year increase of 6.0 per cent in November 2006 as against 4.1 per cent a year ago. Elevated prices of food articles, which have a higher weightage in the CPI basket relative to the WPI, is a significant factor in the divergence between consumer prices and wholesale prices.

21. Revenue receipts of the Union Government as a proportion to the budget estimates (BE) improved to 54.8 per cent in April-November, 2006 from 49.5 per cent in April-November 2005. Revenue expenditure at 62.6 per cent of the BE was, however, higher than 58.4 per cent a year ago mainly on account of a substantial increase in non-Plan revenue expenditure. Accordingly, the revenue deficit increased to 99.7 per cent of BE during April-November, 2006 as compared with 91.5 per cent in the corresponding period last year. The gross fiscal deficit as a proportion to the BE, however, decreased to 72.8 per cent from 74.7 per cent a year ago due to cutbacks in non-defence capital outlay.

22. The gross borrowings of the Central Government at Rs.1,25,000 crore (Rs.1,15,000 crore a year ago) through dated securities during 2006-07 so far (up to January 22, 2007) constituted 83.1 per cent of the BE, while net market borrowings at Rs.91,432 crore (Rs.83,079 crore a year ago) constituted 80.4 per cent of the BE. The weighted average yield and weighted average maturity of the Central Government securities issued during 2006-07 so far were 7.86 per cent and 14.56 years, as compared with 7.34 per cent and 16.90 years, respectively, for those issued during 2005-06. All issuances during the current financial year, except three, were reissuances reflecting efforts towards consolidation of public debt and imparting liquidity to the Government securities market. As against the provisional net allocation of Rs.17,242 crore (gross: Rs.25,860 crore) for their market borrowing programme, the State Governments have raised a net amount of Rs.7,668 crore (gross: Rs.14,204 crore) up to January 25, 2007.

23. Stable and orderly conditions in financial markets were interrupted by short episodes of volatility in the first half of November and the second half of December with interest rates firming up in almost all segments. Tightness in liquidity due to advance tax outflows, which had pushed up call rates above the LAF repo rate in the second half of September, resurfaced during October in the run up to the announcement of the Mid-Term Review. In the second half of November, stability returned and call rates fell back to within the LAF corridor. Reduction in liquidity with the banking system on account of sustained credit demand, sizeable tax outflows and build-up of the Centre’s cash balances led to a sharp drop in the daily volumes of funds offered at the LAF auctions and a rise in overnight rates after December 13, 2006. Call rates touched a level of 16.9 per cent on December 29 – the highest since June, 2000. In subsequent weeks, while call rates have come off these levels, they remain above the LAF corridor. Interest rates in the call, market repo and collateralised borrowing and lending obligations (CBLO) segments of the money market averaged 8.28 per cent, 7.34 per cent and 7.10 per cent in January 2007 (up to January 25, 2007) respectively, up from 6.75 per cent, 6.44 per cent and 6.29 per cent in October 2006.

24. The primary yields on 91-day Treasury Bills increased to 7.39 per cent on January 24, 2007 from 5.41 per cent at end-April, 2006 and 6.65 per cent in end-October 2006. Yields on 364-day Treasury Bills increased to 7.27 per cent on January 17, 2007 from 5.90 per cent at end-April, 2006 and 6.99 per cent in end-October 2006. The outstanding amount of CP was Rs.23,663 crore by mid-January 2007 as compared with Rs.12,718 crore at end-March, 2006. The weighted average discount rate (WADR) on CP increased to 8.70 per cent from 8.59 per cent over this period. In the market for certificates of deposit (CDs), WADR declined from 8.62 per cent at the end of March, 2006 to 8.28 per cent by December 22, 2006 accompanied by 57.5 per cent increase in the outstanding amount (i.e., from Rs.43,568 crore to Rs.68,619 crore).

25. In the foreign exchange market, there was an increase in activity in both the spot and the forward segments during the third quarter of 2006-07. The average daily turnover in the inter-bank segment increased from US $ 16.08 billion during the quarter ended September, 2006 to US $ 19.75 billion during the quarter ended December, 2006. The average daily turnover in the merchant segment also increased from US $ 6.20 billion to US $ 7.78 billion during the period. The ratio of inter-bank to merchant turnover was 2.54 during the quarter ended December, 2006 as against 2.59 in the previous quarter. Six-month forward premia increased from 2.11 per cent in end-October, 2006 to 3.98 per cent by January 25, 2007.

26. The yield on Government securities with one-year residual maturity moved up from 6.22 per cent at end-April, 2006 to 7.30 per cent as on January 25, 2007. The yield on Government securities with 10-year residual maturity also firmed up from 7.40 per cent at end-April, 2006 to 7.89 per cent as on January 25, 2007. The yield on Government securities with 20-year residual maturity increased from 7.80 per cent to 8.16 per cent during the same period. The yield spread between 10-year and one-year Government securities narrowed down from 118 basis points to 59 basis points as on January 25, 2007. The yield spread between 20-year and one-year Government securities narrowed down from 158 basis points to 86 basis points.

27.Deposit rates offered by SCBs on various maturities have generally been revised upwards during the current financial year. Deposit rates, which had increased by 25-175 basis points in October over April 2006, particularly for the longer end, rose further by 25-50 basis points in December over October 2006, and by 25-125 basis points in January 2007 across various maturities. In addition, higher interest rates have been offered on special deposit schemes of specified maturities in terms of number of days, with attractive features such as put options for depositors and in schemes specifically meant for senior citizens. In January 2007, some private sector banks raised deposit rates on specific maturity brackets by over 200 basis points, reflecting aggressive pricing strategies in the wake of continuing high credit growth, but also indicative of growing mismatches in their asset-liability positions.

28. On the lending side, most SCBs increased their lending rates (BPLRs) by 75-150 basis points between April, 2006 - January, 2007. The BPLRs of public sector banks (PSBs) and private sector banks increased to a range of 11.50-12.25 per cent and 11.75-15.50 per cent from 10.25-11.25 per cent and 11.00-14.00 per cent, respectively, during the same period. The weighted average BPLR of PSBs increased from 10.71 per cent in March, 2006 to 11.18 per cent in June, 2006 and further to 11.58 per cent in December, 2006. The weighted average BPLRs of private sector banks also increased from 12.37 per cent in March, 2006 to 12.80 per cent in June, 2006 and 13.22 per cent in December, 2006. The weighted average BPLRs of foreign banks increased from 12.67 per cent to 12.72 per cent during the same period.

29. During the current year so far, equity market activity recorded a significant increase in terms of issuances in the domestic primary segment as well as in international stock exchanges. The BSE Sensex (1978-79=100) which had risen from 11,280 in end-March, 2006 to 12,612 on May 10, 2006 before receding to 8,929 on June 14, 2006 was supported in subsequent months by robust macroeconomic fundamentals and high private corporate profitability. The Sensex rallied with intermittent corrections to reach a high of 14,283 on January 25, 2007.

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