home page



 

Newsletter

Daily Rates

Daily News

Book Store

Home

Conferences

Technology

Finance

click here


  credit policy   overview | coop banks | basics | lending |adv banking | products | IT & banking  
                                                         
daily news | banking software| bank directory| internet banking| IT directory| bankers forum


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

Developments in the Global Economy


37. The International Monetary Fund (IMF) has projected in its World Economic Outlook of September 2006 that global real GDP growth on a purchasing power parity basis is expected to accelerate to 5.1 per cent in 2006 from 4.9 per cent in 2005 but will slow down to 4.9 per cent again in 2007. World real GDP growth, on the basis of market exchange rates, is estimated to accelerate to 3.8 per cent in 2006 from 3.4 per cent in 2005 before easing back to 3.5 per cent in 2007.

38. In the US, real GDP growth was 2.0 per cent in the third quarter (July-September) as compared with 5.6 per cent and 2.6 per cent in the first and second quarters, respectively. The slowdown was mainly on account of lower residential fixed investment and higher imports. In the third quarter of 2006, the US current account deficit stood at 6.8 per cent of GDP. Recent indicators such as stronger employment in December and higher producer price indices reflect some support for growth in the fourth quarter. The year 2006 recorded the largest rate of decline in new home sales since 1990 and the inventory of completed-but-unsold homes rose to a record level. Euro area GDP growth decelerated to 0.5 per cent in the third quarter of 2006 from the second quarter growth of 1 per cent, though the year-on-year growth rate remained on the projected trajectory of 2.7 per cent. The European Central Bank (ECB) has estimated Euro area GDP growth to be between 2.5 per cent and 2.9 per cent in 2006 and between 1.7 per cent and 2.7 per cent in 2007. Activity has been strong in 2006, consumer and business confidence have risen, business investment has picked up and unemployment has fallen below 8 per cent for the first time since 2001. Buoyant household consumption has imparted further strength to the recovery. In Germany, marked buoyancy in economic activity has emanated from business confidence and exports. The weaker pace of expansion (0.8 per cent) in the recovering Japanese economy in the third quarter was due to downward revisions in consumer spending and capital investment. The outlook for the fourth quarter is, however, more positive on anticipated business plans to boost spending. Japan’s corporate sector activity has firmed in recent months as indicated by industrial production and machinery orders, and the household sector is recovering from the softness witnessed in mid-2006.

39. In the developing world, growth has picked up in Asia and other emerging markets, including Latin America and Russia, on account of favourable international financial conditions, strong commodity prices and abundant global liquidity. Growth held up well in most of Asia in the third quarter of 2006 despite a slowdown in US demand and, notwithstanding some uncertainties, growth forecasts for 2007 have been revised upward. Inflation risks remain moderate in the region, helped by the recent fall in global crude prices.

40. Rapid growth was experienced in China which expanded by 10.7 per cent in 2006, marking the fastest growth since 1995 and the fourth consecutive year of growth of at least 10 per cent. Inflation for 2006 was at 2.8 per cent. There are concerns that such high levels of growth might be unsustainable and that some parts of the economy are becoming overheated. Hence, the Government and the People’s Bank of China have taken a series of measures in a bid to slow down growth to more sustainable levels and reduce potential inflationary pressures in sensitive sectors. These measures are expected to help in containing the growth in money supply and credit in the Chinese economy and lessen the possibilities of overheating in 2007.

41. China’s foreign exchange reserves have crossed US $ one trillion in 2006 and China plans to ease the rules for capital outflows in 2007 while restricting inflows, together with actively exploring alternative channels to invest the reserves. A substantial amount of the liquidity emanating from China’s trade surplus has flowed into its stock markets and the total assets held in domestic equity funds accounted for about 10 per cent of China’s total equity market capitalisation. To rein in potential stock market overheating, measures have been taken to slow the large inflow of investments into the domestic share markets. China continues to maintain controls on portfolio equity flows in both directions. In January, 2007 the securities regulators have delayed approval for launch of new money market funds.

42. The Korean economy is expected to grow by 4.4 per cent in 2007, slower than 5.0 per cent in 2006. In Korea, consumer price inflation has decelerated over 2006. There are, however, concerns about a relatively rapid growth in house prices along with a rise in household indebtedness. In response, the Bank of Korea (BoK) has raised its policy rate, increased reserve requirements and has cut the ceiling on aggregate loans to commercial banks by 20 per cent for lending to small and medium enterprises in December. The BoK announced an increase in its foreign currency lending to banks so that they could increase their investment in overseas securities.

43. In Thailand, headline inflation had been gradually easing during 2006 in response to policy rate increases in January, March, April and June. Following an increase in headline inflation in November (3.5 per cent), however, the Bank of Thailand introduced controls on short-term capital inflows on December 18, 2006. This was preceded by a series of steps to stem strong capital inflows into the economy over the past few months, including a minimum three-month holding period for foreign investors for their investment in government or central bank paper; banning onshore banks from conducting sell-buy swap operations with non-residents who were using this method to increase their long baht positions; and seeking co-operation from the Thai business entities not to issue or sell short-term securities to non-residents.

44. Malaysia recorded a growth rate of 5.8 per cent in the third quarter of 2006 and is expected to grow by 5.3 per cent in 2007. Malaysia’s growth is largely export-oriented. Exports recorded a decline in October, 2006 in tandem with the slowdown in export growth in other Asian economies. Inflation has not been a serious concern in Malaysia during the last two years and has come down by 0.4 percentage point over 2006.

45. In 2006, there has been a surge in the international prices of cereals, in particular, wheat and maize. Poor harvests in key producing countries due to reasons such as drought conditions in Australia, the expectation of a decline in carry-over stocks in exporting countries, and fast growing demand for bio-fuel production have been the main constraints on grain markets. The decline in production of wheat in 2006 has turned out to be the largest since 1996 with concomitant sharp increases in prices. world trade in wheat in 2006-07 is, however, likely to remain at the high levels recorded in the previous year, mainly due to larger imports by Brazil and India. The steep rise in ocean freight rates has also contributed to the increase in the food import bills of developing countries. Supply constraints have also dominated the rice economy. After three years of deficit, global sugar production is expected to outpace demand in 2006, although the sugar market remains particularly susceptible to large demand swings and price volatility. Futures prices of foodgrains have climbed to record levels due to substantial reductions in crop production estimates. Wheat futures had risen to a 10-year high on October 17, 2006. Corn prices have surged to a 10-year high on January 16, 2007 in the US after the government predicted the smallest global supply in 29 years. These record prices are spilling over into wheat, soyabean and other agricultural commodities being traded on the futures market, except for sugar. Wheat futures are driven by concerns that US growers will switch from wheat to corn because of the improved outlook coupled with demand from the US ethanol industry, even as wheat stocks remain around 10-year lows.

46. Metal prices have risen by 53.6 per cent in 2006, over and above the increase of 36.2 per cent in 2005. Low stock levels and continuing demand has kept most metal prices high and elevated levels are likely to persist in the near term. Gold prices, which had sharply risen to its highest level in 26 years in May 2006, have eased recently due to the strengthening of the US dollar.

47. Spot crude oil prices softened from the July-August peak of US $ 78 per barrel to around US $ 53 per barrel in January due to unusually warm weather and change in funds flow to the oil sector, despite production cuts by the Organization of Petroleum Exporting Countries (OPEC) since December. In January 2007, the International Energy Agency has projected that demand growth in 2007 might slow down owing to uncertainty about the course of the US economy, fuel switching and lower demand in the former Soviet Union countries. In the futures market, the West Texas Intermediate (WTI) crude oil is currently being priced at US$ 57.59 per barrel six months hence.

48. In the US, consumer prices declined from 3.8 per cent in August to 2.0 per cent in November, 2006 but accelerated to 2.5 per cent in December. In the Euro area, inflation declined from 2.3 per cent during August to 1.9 per cent in December. Inflation decelerated in Japan, i.e., to 0.3 per cent in December from 0.9 per cent in August. In the UK, inflation has been exceeding the target of 2.0 per cent since May and stood at 3.0 per cent in December, the highest in a decade. The retail RPI inflation rose to 4.4 per cent in the UK in December, 2006 - the highest since 1991.

49. The slowdown in headline inflation in September-October in the US was not matched by similar declines in core inflation, indicating that underlying inflationary pressures persist. Core inflation in December was 2.6 per cent as against 2.7 per cent in October. In the UK, core inflation has been increasing in tandem with the headline rate and stood at 1.8 per cent in December, up from 1.6 per cent in November. In the Euro area, both headline and core inflation have stabilised with the latter at 1.5 per cent over the third quarter. Core inflation in Japan has declined by 0.3 per cent in December as compared with the decline of 0.2 per cent in November. globally, headline inflation has been moderating mainly on account of the decline in international crude prices, while core inflation has generally remained firm and is likely to shape inflation expectations which can get exacerbated if international crude prices start rising again and current pressures are allowed to continue.

50. The Dow Jones Industrial Average rose to an all-time intraday high on January 24, 2007. Markets have also been boosted by a number of company-specific events, including merger and acquisition announcements which reached record levels in 2006. Balance sheets of corporations and financial institutions have strengthened significantly, with many accumulating substantial liquid assets, and bankruptcy rates remained near record low levels worldwide. The US yield curve inverted with 10-year bond yields at 4.88 per cent between end-October and January 26, 2007 albeit with intermittent variations. The 10-year bond yields in the Euro area have increased from 4.0 per cent at end-October to 4.09 per cent. The Japanese 10-year bond yield has declined from 1.71 per cent at end-October to 1.68 per cent. On a trade-weighted basis, the US dollar which had depreciated during October-December, has appreciated marginally in January 2007. The US dollar rose to a seven-week high against major currencies on January 9, 2007 following concerns expressed by Fed officials about inflation. In credit markets, spreads on credit default swaps (CDSs), which had widened in May-June, has tightened.

51. The US current account deficit is projected by the OECD to reach 6.5 per cent of GDP in 2007 with substantial surpluses elsewhere, particularly in Asia. There has been a sharp expansion in long-term CDSs, reflecting increasing liquidity at the longer end of the maturity spectrum. Growth in lending to emerging Asian economies expanded, mainly to China and Korea. The US dollar remains the largest single currency of debt issuance for emerging market economies. The proportion of US dollars held in banks outside the US is 30–50 percentage points higher than the corresponding ratios for the euro or the Japanese yen, reflecting the continuing importance of the US dollar as an international currency. By and large, monetary policy authorities are inclined to continue to regard inflation as a major global risk and are vigilant about threats to inflation expectations. They are also watchful about the emergence of excessive volatility and disorderly conditions in currency markets. They have generally displayed a preparedness to act pre-emptively against the possibilityof these risks materialising.

52. Some central banks have paused in their policy cycles, particularly the US. The pause of the Federal Reserve during August-December came after seventeen increases by 25 basis points each between June 2004 and June 2006. Other central banks that have kept their policy rates steady include the Bank of Canada at 4.25 per cent since May, 2006); the Bank of Japan (uncollateralised overnight rate target at 0.25 per cent since July, 2006 after maintaining a zero interest rate policy since September 2001); Bank Negara Malaysia (Overnight Policy Rate at 3.5 per cent since April 2006); and the Banco de Mexico (benchmark overnight lending rate at 7.0 per cent since April, 2006).

53. Some other central banks have cut back their policy rates in recent months. These include Bank Indonesia (BI) (BI rate reduced from 12.50 per cent in May, 2006 to 9.50 per cent in January, 2007); the Banco Central do Brasil (Selic rate target cut between September 2005 and January 2007 to 13.0 per cent); the Banco Central de Chile (benchmark lending rate reduced to 5.00 per cent in January 2007 from 5.25 per cent in July 2006) and the Bank of Thailand (1-day repurchase rate reduced from 4.94 per cent to 4.75 per cent in January, 2007).

54. The central banks that have tightened their policy rates include the ECB which has raised its policy rates six times since December, 2005 by 25 basis points each to 3.50 per cent (main refinancing rate); the Bank of England (repo rate raised in August and November, 2006 and January, 2007 by 25 basis points to 5.25 per cent), the Reserve Bank of Australia (Cash Rate raised by 25 basis points each in August and November 2006 to 6.25 per cent); the People’s Bank of China (lending rate raised twice to 6.12 per cent by August 18, 2006); and the Bank of Korea (target overnight call rate raised by 25 basis points to 4.50 per cent on August 10). In order to contain financial market volatility arising from large liquidity flows, several central banks have tended to tighten monetary policy, even at relatively low current inflation rates, as in Thailand, Turkey, Saudi Arabia and Iceland. The Saudi Arabian Monetary Agency (SAMA) increased its policy repo and reverse repo rates by 45 basis points during 2006 to contain the inflationary impact of petro-dollars, though inflation in Saudi Arabia remains one of the lowest in the region given extensive price controls and subsidies. In Iceland, despite a deceleration in inflation since November, the central bank increased its policy rate to 14.25 per cent in December 2006, which is the twelfth increase in last two years to contain the price inflation in the housing market, investment boom and a depreciation in the currency.

55. A few central banks have sought to reinforce the increases in key policy rates with increases in the reserve requirements. In China, the required reserve ratio was raised by 50 basis points each effective from July 5, August 15, November 15, 2006 and January 15, 2007. The Bank of Korea raised reserve requirements from 5 per cent to 7 per cent for local currency deposits and short-term foreign currency deposits after 17 years in November and December 2006, respectively. Meanwhile, in China and Korea, central bank bonds have continued to absorb liquidity from the banking system.


Google
 
Web banknetindia.com




Advertise | Book Store | About us | Contact us | Terms of use | Disclaimer

© Banknet India | All rights reserved worldwide.
Best viewed with IE 4.00 & above at a screen resolution of 800 x 600 or higher