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Daily News RBI Credit Policies (1999-2005)
Assessment of Macroeconomic and Monetary Developments during the First Half of 2005-06
Domestic Developments
3. The onset of the South-West monsoon was delayed this year by a week, but it picked up by end-June. As per the India Meteorological Department (IMD), excess or normal rainfall was observed in 32 of the 36 meteorological subdivisions and, for the country as a whole, rainfall during June-September this year was 99 per cent of its long period average. By current assessment of area coverage under various crops, it is likely that the kharif output may register an increase over the previous year’s level. In addition, the improvement in water storage levels over the previous year augurs well for the outlook on rabi production.
4. Prospects for sustained growth in industrial output have improved in an environment of rising investment and export demand, strong corporate profitability and buoyant business confidence. The index of industrial production (IIP) increased by 8.8 per cent during April-August 2005 as compared with the increase of 8.0 per cent in the corresponding period of the previous year. There are signs of sustained growth in the production of basic goods, capital goods and consumer goods. Despite some deceleration, export growth at 20.5 per cent in US dollar terms during April-September, 2005 has remained robust, as against 30.8 per cent in the corresponding period of the previous year.
5. In consonance with the sustained growth of industry, there is a surge in non-food credit growth. Exports of manufactured goods and services remain buoyant and the international business environment and investor confidence in India continue to remain positive. Domestic production and imports of capital goods have risen strongly in tandem, indicative of ongoing capacity expansion. With continued business expansion and lower interest costs, corporate profitability is high and there is an expansion in internal resources available for investment. These factors have found reflection in upbeat sentiments and a brightened investment climate. The assessment of the corporate sector as reflected in the Reserve Bank’s Industrial Outlook Survey presents an optimistic picture and the expectations regarding the overall business situation for the October-December 2005 quarter have improved further. The performance indicators for output, exports, working capital finance requirements and capacity utilisation are expected to be well above their levels a year ago. Other business expectation surveys also exhibited similar improvements in outlook.
6. According to the Central Statistical Organisation (CSO), real GDP increased by 8.1 per cent during the first quarter of 2005-06 as against 7.6 per cent in the first quarter of the previous year. The elevated level of international crude prices imparts downside risks to overall GDP growth. At the same time, the robust industrial and service sector growth and buoyant exports are likely to have some positive impact on growth.
7. Scheduled commercial banks’ credit increased by 14.2 per cent (Rs.1,55,712 crore) up to September 30, 2005 which was higher than the increase of 11.7 per cent
(Rs.98,210 crore) in the corresponding period of last year. Food credit declined by Rs.1,571 crore – as against an increase of Rs.2,677 crore in the previous year – reflecting lower procurement of foodgrains during the current financial year. On the other hand, non-food credit posted an increase of 14.8 per cent (Rs.1,57,284 crore) as compared with an increase of 11.9 per cent (Rs.95,533 crore) in the corresponding period of the previous year. While the outstanding credit-deposit ratio increased to 65.8 per cent from 58.4 per cent a year ago, the incremental non-food credit-deposit ratio declined to 75.2 per cent as compared with 92.9 per cent.
8. On a year-on-year basis, non-food credit growth at 31.5 per cent, net of conversion, as on September 30, 2005 was higher as compared with 24.9 per cent a year ago. Non-food credit has witnessed a structural shift towards the non-agriculture non-industrial sectors in recent years. Credit off-take during the current financial year (up to August 2005) has, however, been broad-based. Credit to industry increased by 21 per cent whereas credit off-take by agriculture and non-agriculture non-industrial sectors increased by over 35 per cent each. The growth in credit to non-agriculture non-industrial sector is led by housing, real estate and personal loans. Within the industrial sector, significant increase in credit off-take has been recorded by petroleum, coal products, power, roads and ports, cotton textiles, drugs and pharmaceuticals, gems and jewellery, iron and steel, other metal and metal products, automobiles and engineering.
9. Scheduled commercial banks’ investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper (CP), etc., declined by 11.7 per cent (Rs.11,043 crore) during the current year so far (up to September 30, 2005) as compared with a decline of 3.9 per cent (Rs.3,463 crore) in the corresponding period last year. Scheduled commercial banks’ investments in instruments issued by financial institutions (FIs) and mutual funds also declined by Rs.3,835 crore as against a decline of Rs.2,864 crore in the previous year. With the significant expansion in non-food credit demand, the total flow of resources from scheduled commercial banks to the commercial sector increased by 12.7 per cent (Rs.1,46,241 crore) as compared with the increase of 10.3 per cent (Rs.92,070 crore) in the corresponding period of the previous year. The year-on-year growth in resource flow was also higher at 27.8 per cent, net of conversion, as against 21.4 per cent a year ago.
10. Money supply (M3) increased by 9.6 per cent (Rs.2,15,394 crore) in the current financial year up to September 30, 2005 as compared with 5.4 per cent (Rs.1,08,791 crore) in the corresponding period of the previous year. On an annual basis, growth in M3 at 16.6 per cent, net of conversion, was higher than 14.6 per cent in the previous year. Aggregate deposits of scheduled commercial banks rose by 12.3 per cent (Rs.2,09,015 crore) as compared with an increase of 6.8 per cent (Rs.1,02,885 crore) in the corresponding period of the previous year. On an annual basis, the growth in aggregate deposits at 18.6 per cent, net of conversion, was higher than that of 15.8 per cent a year ago.
11. Reserve money increased by 5.8 per cent (Rs.28,557 crore) in the current financial year up to October 14, 2005 as compared with the increase of 0.6 per cent (Rs.2,660 crore) in the corresponding period of the previous year. While currency in circulation increased by 6.1 per cent (Rs.22,516 crore) as compared with 4.3 per cent (Rs.14,039 crore), bankers’ deposits with RBI increased by 6.5 per cent (Rs.7,431 crore) as against a decline of 12.4 per cent (Rs.12,930 crore). As regards the sources of reserve money, net RBI credit to the Central Government increased by Rs.11,897 crore as against a decline of Rs.21,395 crore. Adjusted for transactions under the liquidity adjustment facility (LAF), net RBI credit to the Central Government showed a lower increase of Rs.1,822 crore. The Reserve Bank’s net foreign exchange assets (NFEA) increased by Rs.24,272 crore as against a higher increase of Rs.58,342 crore during the corresponding period of the previous year. NFEA adjusted for revaluation, however, increased by Rs.30,585 crore as compared with an increase of Rs.31,737 crore during the corresponding period of the previous year. The RBI’s credit to banks and the commercial sector continued to decline because of reduced reliance on the standing facilities on account of comfortable liquidity conditions. The year-on-year increase in reserve money was 17.9 per cent as on October 14, 2005 as compared with 18.0 per cent a year ago. The balances under the market stabilisation scheme (MSS) which were Rs.64,211 crore as on March 31, 2005 increased to Rs.68,276 crore by October 14, 2005. The ratio of NFEA to currency declined marginally from 166.2 per cent in March to 162.9 per cent (145.4 per cent, adjusted for MSS) by October 14, 2005.
12. Inflation, as measured by variations in the wholesale price index (WPI), on a point-to-point basis, receded from 6.0 per cent in April 2005 to 4.6 per cent by October 8, 2005 despite upward adjustments in the administered prices of petrol, diesel and electricity and increase in the prices of aviation turbine fuel, naphtha, furnace oil and iron and steel. On an average basis, annual inflation based on the WPI was 5.3 per cent as on October 8, 2005 as compared with 6.2 per cent a year ago.
13. At a disaggregated level, the prices of primary articles (weight: 22.0 per cent in the WPI basket) increased by 2.5 per cent as compared with an increase of 3.8 per cent in the previous year. The fall in prices of primary articles was mainly under non-food articles – raw cotton, oilseeds and sugarcane – and minerals, particularly iron ore. Prices of manufactured products (weight: 63.7 per cent) increased by 2.6 per cent as compared with 7.2 per cent a year ago. In the category of manufactured products, declines in the prices of edible oils, oil cakes, cotton textiles and manmade fibres softened the effects of sharp increases in the prices of basic metals, alloys and metal products (particularly, iron and steel), chemicals and chemical products and machinery and machine tools.
14. The annual increase in prices of the ‘fuel, power, light and lubricants’ group (weight: 14.2 per cent) at 12.0 per cent (as on October 8, 2005) was higher than 10.7 per cent a year ago. Excluding the fuel group, however, inflation on an annual basis at 2.1 per cent was significantly lower than headline inflation. During 2005-06 so far, oil prices in the international markets have continued to remain high and volatile with the latest spike occurring at the end of August on account of Hurricane Katrina in the US. The average price of a basket of major international crude varieties (Brent, WTI and Dubai Fateh) at around US $60 per barrel during July-October 2005 was 18.4 per cent higher than in April-June 2005 and 42.6 per cent higher than its level a year ago. Domestic prices of petrol and diesel were revised upwards in June and again in September 2005. With the latest hike in prices effective September 6, 2005 the average domestic price of petrol and diesel (in the four metropolitan cities) has increased by 13.6 per cent over the end-March 2005 level and 22.0 per cent over the level a year ago.
15. The full effects of the pass-through of the increase in international oil prices have so far been dulled and the underlying inflationary pressures have been contained. Crude prices continue to remain the most critical factor in the outlook on domestic inflation. In the remaining part of the year, inflation conditions will warrant continuous vigil in view of the heightened uncertainties surrounding international crude prices and the eventual pressures for fuller pass-through into domestic inflation.
16. Inflation, as measured by variations in the consumer price index (CPI) for industrial workers on a point-to-point basis, was 3.5 per cent in August 2005 as against 4.6 per cent a year ago. On an annual average basis, inflation as reflected in the CPI,
was 4.1 per cent in August 2005 as against 3.4 per cent a year ago.
17. The market borrowing programme of the Central Government has so far remained consistent with the projections set out in the Union Budget for 2005-06 which placed the net and gross market borrowings of the Central Government at Rs.1,10,291 crore and Rs.1,78,467 crore, respectively. By October 21, 2005 the Central Government had completed net market borrowings of Rs.59,831 crore (54.3 per cent of the budgeted amount) and gross market borrowings of Rs.1,08,506 crore (60.8 per cent of the budgeted amount). The Central Government’s borrowing programme broadly proceeded in alignment with the indicative issuance calendar for dated securities for the first half of 2005-06 which set gross borrowings through issuance of dated securities at Rs.83,000 crore. All issuances of dated securities were by way of fixed coupons in response to the favourable market appetite for such securities. During the second half, however, out of the two auctions scheduled in the indicative calendar of dated securities on October 6, 2005 all bids received in respect of one auction were rejected. On a review of the borrowing requirements, the auction of dated securities scheduled for October 18-25, 2005 for an amount of Rs.4,000 crore was cancelled in consultation with the Central Government. The weighted average yield on fresh borrowings through dated securities increased to 7.29 per cent (up to October 21), up from 5.76 per cent in the corresponding period last year. The weighted average maturity of dated securities of the Central Government increased to 15.1 years from 14.3 years over the same period. All issuances during the current financial year, except one, 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.16,112 crore (gross Rs.22,431 crore) for their market borrowing programme, the State Governments have raised Rs.6,274 crore (net) and Rs.14,265 crore (gross) up to October 21, 2005.
18. During 2005-06 so far (up to October 14, 2005), additional liquidity of Rs.4,065 crore was absorbed under the MSS. Notwithstanding the MSS operations, surplus liquidity conditions resulted in the reverse repo volumes tendered under the LAF increasing from an average of Rs.29,809 crore in March to Rs.34,832 crore in August before declining to Rs.21,128 crore in October 2005. Up to July, the absorption of liquidity through the MSS was more than offset by decreasing reverse repo levels. Thereafter, LAF reverse repo increased sharply as liquidity conditions eased with the resumption of inflows from abroad. Large MSS redemption in September resulted in accretions under LAF and absorption through acceptance of higher bids under fresh auctions. In addition to the MSS and the LAF, surplus balances in the Central Government account with the Reserve Bank rose from an average of Rs.5,142 crore in April-October 2004 to Rs.18,643 crore in April-October 2005 and also helped in sterilising excess liquidity from time to time. Accordingly, the total liquidity that remained sterilised (in the form of MSS, LAF and surplus balances of Central Government) increased from an average of about Rs.1,14,192 crore in March to Rs.1,23,844 crore in August before declining to Rs.1,20,076 crore in October 2005.
19. The revenue deficit and gross fiscal deficit (GFD) of the Central Government at Rs.74,372 crore and Rs.86,328 crore, respectively, during April-August, 2005 accounted for about 78.0 per cent and 57.1 per cent of the budget estimates for 2005-06 as compared with 82.6 per cent and 38.2 per cent, respectively, in the corresponding period of 2004-05. During April-August 2005, the revenue deficit of the Centre was higher by 18.2 per cent than its level in the corresponding period of the previous year while the GFD was higher by 64.4 per cent. Adjusted for transactions under the discontinued debt swap scheme, the GFD was higher by only 8.1 per cent than its level a year ago.
20. The market borrowing programme of the Centre and the States envisaged for 2005-06 is higher than in the previous year. Superimposed upon the underlying liquidity conditions and shifts in banks’ portfolio preferences in favour of credit as compared with investments, this has entailed some hardening of yields. Continued large borrowings from the market by the Centre and the States pose concerns for the efficient conduct of debt management as well as for monetary operations. In this context, the renewed commitment to fiscal consolidation through reduction in the revenue deficit and the gross fiscal deficit at all levels of Government and the diffusion of fiscal responsibility legislation at the sub-national level is heartening. States’ budgets for 2005-06 have generally not taken into account the recommendations of the Twelfth Finance Commission (TFC) relating to devolution, transfers and debt relief. With the phasing out of Central Plan Loans to the States as recommended by the TFC, the market borrowings of the States is not likely to be out of alignment with the net allocation for 2005-06 in the light of higher devolution of taxes and grants from the Centre to the States and larger receipts from the national small saving fund (NSSF).
21. Scheduled commercial banks’ investment in government and other approved securities at Rs.14,283 crore during the current year so far (up to September 30, 2005) was lower than that of Rs.28,526 crore in the corresponding period of the previous year, partly on account of the pick-up in credit demand. There has been substantial support for the market borrowing programme from non-bank entities. Commercial banks’ excess holding of SLR securities stood at Rs.2,24,701 crore.
22. Financial markets have remained stable and orderly although interest rates have firmed up in almost all segments. The average call money rate increased from 4.77 per cent in April to 5.06 per cent in October 2005 (up to October 21) although it has generally remained closely aligned with the LAF reverse repo rate. The 91-day and the 364-day Treasury Bill rates also increased from 5.12 per cent and 5.60 per cent in April to 5.53 per cent and 5.85 per cent, respectively, by October 2005. The 182-day Treasury Bill rate has moved up from 5.21 per cent to 5.78 per cent during this period. The yield on government securities with 1-year residual maturity in the secondary market increased from 5.66 per cent to 5.88 per cent. The yield on government securities with 10-year and 20-year residual maturities increased from 6.68 per cent and 7.08 per cent to 7.18 per cent and 7.52 per cent, respectively. With a relatively higher increase in the long-term yields, there was a steepening of the yield curve. The yield spread between 10-year and 1-year government securities moved up from 102 basis points to 130 basis points whereas the spread between 20-year and 1-year government securities increased from 142 basis points to 164 basis points.
23. The weighted average discount rate on commercial paper (CP) of 61 to 90-days maturity increased from 5.80 per cent in April to 5.89 per cent by mid-October 2005. The market repo rate increased from 4.63 per cent to 4.85 per cent with an increase in daily volume from Rs.3,958 crore (one leg) to Rs.5,661 crore by September 2005. The average daily volume of CBLO (collateralised borrowing and lending obligation) increased significantly from Rs.5,185 crore to Rs.8,572 crore along with an increase in the CBLO rate from 4.58 per cent to 4.80 per cent. The typical interest rate on 3-month certificates of deposit (CDs) increased from 5.87 per cent in April to 5.90 per cent by mid-September 2005. Public sector banks kept their rates for deposits of over one year maturity unchanged in the range of 5.25-6.50 per cent during April-September, 2005. The benchmark prime lending rates (BPLRs) of public sector banks, private sector banks and foreign banks remained unchanged in the range of 10.25-11.25 per cent, 11.00-13.50 per cent and 10.00-14.50 per cent, respectively.
24. The risk premium on private sector bonds, as measured by the yield spread between highly rated corporate paper and government securities, has increased. For example, the yield spread between AAA-rated corporate bonds of 5 years and government securities of similar maturity increased from about 34 basis points in April to about 47 basis points by October 21, 2005.
25. Equity market activity recorded a pick-up in terms of issuances in the domestic primary segment as well as in international stock exchanges. The BSE Sensex recovered from weak sentiment in April and rallied with intermittent corrections in the successive months. The Sensex rose to a new peak of 8800 on October 4, 2005 after which it registered some decline.
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