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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


2. Real gross domestic product (GDP) increased by 9.2 per cent in the second quarter (July-September) of 2006-07, according to the end-November, 2006 release of the Central Statistical Organisation (CSO), up from 8.9 per cent in the first quarter and 8.4 per cent a year ago. Accordingly, real GDP growth firmed up to 9.1 per cent in the first half of 2006-07 from 8.5 per cent in the first half of 2005-06. Real GDP originating in agriculture, industry and services sectors rose by 2.6 per cent, 10.1 per cent and 10.6 per cent, respectively, during the first half of 2006-07 as against 3.7 per cent, 7.9 per cent and 10.2 per cent a year ago.

3. Information that is available for the third quarter (October-December) of 2006-07 suggests that the momentum of economic activity has been sustained, but with some setbacks in the agricultural sector. First estimates of the Ministry of Agriculture place kharif foodgrains production at 105.2 million tonnes for the current financial year – lower than 109.7 million tonnes in 2005-06 and also well below the target of 115.3 million tonnes. Favourable soil moisture conditions and normal reservoir levels could, however, enable the recouping of kharif production losses in the rabi output. Rabi sowing acreage has increased by 3.4 per cent in the current season so far (i.e., up to January 5, 2007) from its level a year ago. Increases have been recorded in area sown under wheat (6.8 per cent), rice (8.1 per cent), coarse cereals (6.4 per cent) and pulses (4.4 per cent) whereas acreage under oilseeds declined by 8.7 per cent.

4.Industrial activity has picked up in an environment of favourable demand conditions, strong corporate profitability and overall business optimism. The index of industrial production (IIP) rose by 10.6 per cent during April-November 2006 as against 8.3 per cent a year ago. Manufacturing contributed nearly 91.2 per cent of this growth, expanding by 11.5 per cent (9.4 per cent a year ago). Manufacturing activity was led by basic metals and alloys, non-metallic mineral products, machinery and transport equipment, basic chemicals and products and cotton textiles. The strength of investment demand was reflected in an increase of 16.1 per cent (16.2 per cent) in capital goods production, supported by the growth in production of basic goods by 9.3 per cent (6.1 per cent), in intermediate goods by 10.9 per cent (2.5 per cent) and in consumer durable goods by 12.5 per cent (14.2 per cent). In the consumer non-durables segment, production rose by 8.7 per cent (12.9 per cent). Mining and electricity generation grew by 3.8 per cent (0.5 per cent) and 7.3 per cent (5.0 per cent), respectively. The six infrastructure industries, comprising 26.7 per cent of the IIP, posted a growth of 7.8 per cent during April-November, 2006 as against 5.2 per cent a year ago. Petroleum refinery products and cement production registered double-digit growth, production of crude petroleum recorded a turnaround and the growth of electricity production was higher than a year ago. On the other hand, the growth of coal and finished steel decelerated from the pace of expansion last year.

5. Buoyant domestic and export demand conditions continued to support private corporate sector performance. Sales of sampled non-financial private companies grew by 27.4 per cent in the first half of 2006-07, up from 17.2 per cent a year ago. Net profits increased by 41.6 per cent on top of a growth of 41.3 per cent in the first half of 2005-06. The gross profit margin (gross profits to sales) at 15.6 per cent and the net profit margin (profits after tax to sales) at 10.6 per cent were also at levels higher than those in the corresponding period of the previous year. Early results for the third quarter of 2006-07 indicate sustained growth in sales and in both gross and post-tax profits. At the same time, there was some reduction in the growth of interest burden, i.e., interest payments relative to gross profits in comparison with previous quarters.

6. The Reserve Bank’s Industrial Outlook Survey points to optimism on the growth outlook. The business expectations index for October-December, 2006 was higher than in the preceding quarter but marginally lower than in the corresponding quarter a year ago. The expectations index for January-March, 2007 is higher than in the preceding quarter as also in the corresponding quarter a year ago. A positive outlook for demand conditions continues with increased optimism reflected in order books, production, employment and profit margins. The assessment about growth of exports and imports indicates a marginally lower level of confidence. Expectations of increase in selling prices have moderated somewhat in relation to the preceding quarter.

7. Business confidence polled by other surveys also appears to have picked up in October-December, 2006 on the back of a healthy increase in sales, profits, new orders, selling prices, inventory levels and boosted by strong corporate results, record number of mergers and acquisitions by Indian companies and rising equity prices. Surveys of business expectations for January-March, 2007 indicate sustained optimism with regard to investment climate, financial position of firms, sales volumes, fuller capacity utilisation, new orders and profitability across the goods and services sectors. Selling prices are expected to increase along with some increase in employee levels. Seasonally adjusted purchasing managers’ indices for December 2006 signalled the continuing improvements in business conditions in the manufacturing sector, with expansion in production levels boosted by higher volumes of new orders. On the other hand, levels of unfinished business, average costs and output prices appear to have risen in relation to the preceding month while stronger demand and shortages of some raw materials have placed pressure on suppliers.

8. Lead indicators of services sector activity suggest that the robust growth recorded in 2005-06 was sustained in 2006-07 so far. Railway revenue earnings from freight traffic increased by 9.9 per cent in April-October 2006, while total cell phone connections and net addition in switching capacity in the telecommunication sector jumped by 121.9 per cent and 22.9 per cent, respectively. The import cargo handled by the civil aviation sector and cargo handled by major ports increased by 19.3 per cent and 6.6 per cent, respectively, whereas passengers handled at international and domestic terminals registered growth of 11.9 per cent and 38.8 per cent, respectively.

9. Driven by the pick-up in real activity, credit extended by scheduled commercial banks (SCBs) increased by Rs.2,50,402 crore (16.6 per cent) during the current financial year up to January 5, 2007 as compared with the increase of Rs.1,97,551 crore (17.1 per cent) in the corresponding period last year. The increase of Rs.2,392 crore in food credit was low and comparable to the increase of Rs.3,084 crore in the previous year. Non-food credit registered an increase of Rs.2,48,010 crore (16.9 per cent) as compared with an increase of Rs.1,94,468 crore (17.5 per cent) in the corresponding period of 2005-06.

10. On a year-on-year basis, non-food credit of SCBs expanded by Rs.4,07,735 crore (31.2 per cent) as on January 5, 2007 on top of an increase of Rs.3,11,013 crore (31.2 per cent) a year ago. Provisional information available from select SCBs for October 2006 indicates that credit to retail and services sectors increased by 33.4 per cent, constituting 49.2 per cent of total non-food bank credit with the share of retail credit alone at 25.9 per cent. Retail lending rose by 34.3 per cent. Within the retail sector, housing loans recorded a growth of 32.3 per cent. Loans to commercial real estate rose by 83.9 per cent with its share in total non-food bank credit at 2.5 per cent. On a year-on-year basis, credit to industry rose by 24.8 per cent by October 2006; however, industry’s share in total non-food bank credit fell from 40.2 per cent in October 2005 to 38.7 per cent in October 2006. Nevertheless, there was a pick-up in credit flow to industries like infrastructure (23.2 per cent), metals (34.6 per cent), textiles (34.2 per cent), chemicals (26.9 per cent), petroleum (42.0 per cent), food processing (23.6 per cent), construction (49.5 per cent), engineering (15.3 per cent), gems and jewellery (21.7 per cent) and vehicles (20.8 per cent). The share of infrastructure in total credit to industry declined marginally from 20.2 per cent in October 2005 to 20.0 per cent in October 2006. Bank credit to agriculture (which has a share of 12.1 per cent in total bank credit) recorded a growth of 30.8 per cent by October 2006. The share of priority sector advances declined from 36.5 per cent to 35.2 per cent.

11. Banks’ investments in shares, bonds/debentures and commercial paper increased by 0.6 per cent (Rs.484 crore) during the current financial year up to January 5, 2007 as against a decline of 14.8 per cent (Rs.13,794 crore) in the corresponding period last year. SCBs’ investments in mutual funds also increased by Rs.2,080 crore as against a decline of Rs.6,051 crore in the corresponding period of the previous year. The total flow of resources from SCBs to the commercial sector increased by 16.1 per cent (Rs.2,48,494 crore) during the current financial year so far as compared with the increase of 15.0 per cent (Rs.1,80,674 crore) in the corresponding period of the previous year. The year-on-year growth in total resource flow was 29.5 per cent, over and above the growth of 27.7 per cent a year ago.

12. Aggregate deposits of SCBs increased by Rs.2,72,194 crore (12.9 per cent) in the current financial year up to January 5, 2007 as compared with an increase of Rs.1,58,070 crore (8.9 per cent) in the corresponding period of the previous year. On a year-on-year basis, the growth in aggregate deposits at Rs.4,38,037 crore (22.5 per cent) was higher than that of Rs.2,85,182 crore (17.2 per cent) a year ago and was also the highest since 1993-94 on a comparable basis. There has also been an expansion in term deposits, indicative of time preference in response to rising interest rates. The incremental non-food credit-deposit ratio has declined to 91.1 per cent from 123.0 per cent a year ago.

13. Commercial banks’ investment in Government and other approved securities at Rs.48,331 crore during the current financial year up to January 5, 2007 was substantially higher than the decline of Rs.17,559 crore in the corresponding period of the previous year. Banks’ holdings of Government and other approved securities fell to 28.6 per cent of their net demand and time liabilities (NDTL) as on January 5, 2007 from 32.6 per cent a year ago. The stock of securities with banks in excess of the minimum statutory liquidity ratio (SLR) requirement amounted to Rs.96,407 crore on January 5, 2007. Adjusted for banks’ repo/reverse repo with the Reserve Bank under the liquidity adjustment facility (LAF), their investment in securities increased by Rs.50,396 crore during 2006-07 so far as against a decline of Rs.1,519 crore a year ago. Excess SLR investment, adjusted for LAF holdings, was higher at Rs.91,222 crore or 3.4 per cent of NDTL.

14. On a year-on-year basis, the growth in money supply (M3) at 20.4 per cent on January 5, 2007 was higher than 16.0 per cent a year ago and above the projected trajectory of 15.0 per cent indicated in the Annual Policy Statement for 2006-07. During the current financial year so far, M3 increased by Rs.3,24,624 crore (11.9 per cent) which was higher than the increase of Rs.2,04,175 crore (8.8 per cent) in the corresponding period of the previous year.

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