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Banking > Policies>
Mid-Term Review of Monetary and Credit Policy 1999-2000 > Part I

Mid-Term Review of Macro-economic and Monetary Developments in 1999-2000

Domestic developments :
According to the latest meteorological report, the rainfall in terms of quantum and spatial distribution was generally satisfactory. During the year, upto end September 1999, 28 out of 35 meteorological sub-divisions covering 81 per cent of the area and 67 per cent of the districts in the country received normal to excess rainfall. Seven meteorological sub-divisions received deficient rainfall, of which the deficiency was marginal in three sub-divisions. The overall assessment of the Meteorological Department is that the monsoon has been "normal" (90 per cent of the long-term average of 903 mm). The best estimate at present is that the Kharif crop would be of the order of 102 - 103 million tonnes, about the same as the last year's level. Assuming the expected improvements in the Rabi crop, it is likely that agricultural production for the year 1999-2000 will be higher than the previous year.

So far as the industrial sector is concerned, after a period of deceleration, there are now welcome signs of a recovery. The Index of Industrial Production (IIP) registered a growth of 6.0 per cent in the current financial year (April-August 1999) as compared with 4.2 per cent during the corresponding period of the previous year. The increase in the IIP was mainly due to revival of growth in demand for manufactured products and is reflected in the significant improvement in the manufacturing output growth by 6.7 per cent as against 4.2 per cent in the comparable period of the previous year. Signs of recovery were observed in steel, cement and certain other sectors. This is reflected also in the turnaround in the demand for non-food bank credit, and in the buoyancy seen in the stock and fixed income securities markets.

According to the preliminary estimate of the Central Statistical Organisation (CSO), the Gross Domestic Product (GDP) during the first quarter of the current year grew at 5.5 per cent as against 3.6 per cent in the previous year. Assuming that the recovery in industrial production witnessed in the first half of the year will gather further momentum during the rest of the year, and there is no unexpected setback on the agricultural front, growth in GDP in the current year is projected to be in the range of 6 to 6.5 per cent. This is consistent with the range of 6 to 7 per cent, indicated in the April Statement.

The rate of inflation on a point-to-point basis on October 9, 1999 was 2.51 per cent as against 8.07 per cent at the same time last year. On an average basis, the annual inflation rate is lower at 4.33 per cent as against 6.28 per cent at the same time last year. The drop in wholesale prices has also been reflected in the sharp fall in the Consumer Price Index (CPI). In August 1999, the CPI inflation rate was on a point-to-point basis as low as 3.15 per cent as against 15.04 per cent in August 1998. Allowing for some increase in prices due to seasonal factors later in the year and adjustment lags in administered prices, the inflation rate for the current year as a whole is likely to be lower than that of 4.8 per cent in the previous year. Food stocks at the end of August 1999 were 29.90 million tonnes, which is higher by 4.04 million tonnes over the same time last year. High level of food stocks combined with a low rate of inflation, should provide greater manoeuvrability in managing the economy in the event of any unexpected shocks.

The rate of growth in money supply (M3) during the current financial year upto October 8, 1999 has been 7.9 per cent compared with 10.1 per cent in the corresponding period of the previous year. Annual growth in M3 (October 8, 1999 over October 9, 1998) was 16.0 per cent as against 21.1 per cent in the comparable period of the preceding year (excluding the contribution of receipts under Resurgent India Bonds, the increase in M3 last year was 18.7 per cent). Aggregate deposits of scheduled commercial banks in the current year upto October 8, 1999 showed an increase of Rs.53,487 crore (7.5 per cent) as compared with Rs.66,978 crore (11.2 per cent). Excluding Resurgent India Bonds, the increase in the current year so far was 7.7 per cent against 8.2 per cent in the same period last year. On the basis of current trends, the projected growth in aggregate deposits of Rs.1,18,500 crore for the year as a whole looks realistic. In the light of the real sector trends and the expected inflation outlook, which are more or less consistent with the April Statement, the projected order of monetary expansion of 15.5 - 16.0 per cent indicated in the April Statement, appears reasonable.

Reserve money showed a lower expansion by Rs.6,322 crore (2.4 per cent) in the current financial year so far upto October 22, 1999 as against an increase of Rs.11,623 crore (5.1 per cent) in the comparable period of previous year. Currency in circulation increased by 7.7 per cent in the current financial year so far as against 9.4 per cent in the last year. On an annual basis, currency expansion was 14.6 per cent as against 13.6 per cent a year ago. The net foreign exchange assets of RBI showed an increase of Rs.5,618 crore as compared with an increase of Rs.9,472 crore in the previous year. Net RBI credit to Government showed a lower increase of Rs.6,044 crore than Rs.13,710 crore in the previous year, mainly due to a decline in credit to State Governments of Rs.3,843 crore as against a decline of Rs.307 crore in the previous year. On the components side, the large increase in currency in circulation was the characteristic feature of the reserve money expansion. Any possible expansion in currency till December/January 1999-2000 in the context of the millennium change is expected to reverse to normal before the year end.

Domestic and international developments have so far allowed the Reserve Bank to keep liquidity in the system at a comfortable level without too large an expansion of reserve money. As per current expectations, it appears that, with some appropriate adjustments, there should be no difficulty in meeting fully the liquidity needs of different sectors.

There has also been a significant pick up in the bank credit and other flows to the commercial sector from the banking system during the current year, especially from the fortnight ending July 2, 1999. Scheduled commercial banks' credit expanded by Rs.19,237 crore (5.2 per cent) upto October 8, 1999 as against an increase of Rs. 11,645 crore (3.6 per cent) in the previous year. Food credit increased by Rs.4,436 crore as against Rs.3,464 crore in the previous year. Non-food bank credit increased by Rs.14,802 crore (4.2 per cent) as against an increase of Rs.8,181 crore (2.6 per cent) in the previous year. Together with the provisional data on investments in commercial paper, investments in bonds / shares / debentures of PSUs and private corporate sector, the flow of resources from scheduled commercial banks to the commercial sector increased by Rs.21,116 crore (5.3 per cent) as against Rs.17,540 crore (5.1 per cent) in the previous year. Banks' investments in instruments issued by financial institutions and mutual funds this year increased by Rs.1,498 crore as against Rs.3,136 crore last year. Total resource flow to the commercial sector including capital issues, GDRs and borrowings from financial institutions increased by Rs.41,046 crore as compared with Rs.33,573 crore in the previous year.

The Union Budget for 1999-2000 placed the net market borrowings of the Central Government at Rs.57,461 crore and gross borrowings at Rs.84,014 crore. In the current financial year upto October 26, 1999, the Central Government mobilised net borrowings of Rs.57,977 crore, and gross market borrowings of Rs.72,630 crore. As spelt out on earlier occasions, RBI has been combining auction issues with acceptance by private placement of dated securities of the Government consistent with market conditions. The release of such securities through open market sales at opportune moments has helped to contain the volatility in securities prices and reduce the associated risks to major participants like banks and primary dealers. Accordingly, in the current financial year so far, while devolvement including private placements with RBI amounted to Rs.29,267 crore accounting for 40.3 per cent of the gross market borrowings, the reserve money impact of this was neutralised by sales through open market operations conducted by RBI. Upto October 26, 1999, net sales of government securities amounted to Rs.23,695 crore. Thus, RBI's subscriptions in primary issues under the Government borrowing programme, net of open market sales, this year remained at Rs.3,305 crore compared to Rs.8,909 crore in the corresponding period last year.

In the current financial year, there has also been a move to elongate the maturity structure of marketable debt of Government. The maturity period of issued securities ranged between 6 years and 20 years. Scheduled commercial banks' investment in government securities increased by Rs.36,648 crore in the current financial year so far (upto October 8, 1999) as against an increase of Rs.27,533 crore in the corresponding period of previous year. Banks are presently holding government securities in excess of SLR prescription by a considerable margin. As mentioned in the April statement, in the interest of maintaining stable interest rate environment, Government's borrowing programme needs to be kept within reasonable limits. This will also reinforce the process of recovery in industrial sector and enable banks to adequately meet the demand for non-food bank credit.

While RBI's policy of subscribing to government securities on private placement basis, combined with active open market operations, has proved to be highly effective in keeping interest rates relatively stable, an issue that needs to be considered is whether this is a desirable policy of debt management from the long term point of view. There is merit in the view that ideally government securities should be sold in the market directly through auctions, and the interest rate determined by the market. However, at the present stage of development, government securities market is not deep or broad enough to correctly reflect the prevailing liquidity conditions or the underlying interest rate outlook based on secondary market transactions. As the secondary market develops and turnover increases, it should be possible to exclusively rely on auctions to sell Government paper. This is the direction in which RBI would like to move. However, one of the important requirements for the secondary market in government securities to develop is for Government's net borrowing requirements to be sustainable. Unfortunately, at present, there is very little flexibility available in regard to either the timing or the size of Government borrowings in the primary market.

In the management of monetary policy during the second half of the year, a critical factor is the fiscal outlook for the rest of the year. While gross revenues during the first half have been buoyant, the net revenue of the Central Government is actually a little lower than in the previous year because of the large increases in transfers to States and Union Territories. The Central Government's gross fiscal deficit during the first five months constituted 60.2 per cent of the budget estimate as compared with 52.0 per cent in the previous year. The revenue deficit has also been high and contributed nearly 70.0 per cent to gross fiscal deficit as compared with

0 per cent last year. These developments do not augur well for the future unless determined action is taken to increase revenues, reduce deficits in the public sector, and reduce expenditure through appropriate policy actions. As recently announced by the Government, it is imperative that necessary actions to correct fiscal distortions are taken as early as possible. It may also be mentioned that fiscal slippages are no longer regarded as a matter of domestic concern alone. All over the world, international agencies and investors keep a close watch on emerging trends in Government finances, as they have a bearing on future macro-economic stability.

External Developments
The two-year period since September 1997 has presented major challenges for the management of the external sector. During this period, India had to cope with the global effects of a series of intense crises in East Asia, Russia and Brazil, in addition to continued uncertainties in industrial economies, particularly Japan. After the Pokhran test last year, India was also confronted with certain other unfavourable external developments, including sanctions imposed by several industrialised countries, the suspension of multilateral lending (except for some sectors), downgrading by international rating agencies, and reduction in investment by Foreign Institutional Investors (FIIs). While there has been improvement in some of these areas and there are signs of an upturn in the world economy in the last six months, the external outlook continues to be characterised by several uncertainties. The management of the external sector in the first half of the current year also had to cope with some uncertainties in investment outlook consequent upon dissolution of the Lok Sabha in April 1999 and the ensuing electoral process.

Viewed against the background of external and domestic uncertainties, developments in respect of both the exchange rate of the rupee as well as movement in foreign exchange reserves have been reasonably satisfactory. As on October 22, 1999, the foreign currency assets of the country were higher by US $ 3.70 billion compared with a year ago. Foreign exchange reserves, including gold and SDR were also higher by US $ 3.43 billion. At the present level of foreign exchange reserves (at US $ 33.07 billion), reserves substantially exceed the total stock of short-term debt and portfolio flows. As pointed out in the April Statement, as a matter of conscious policy, India will continue to keep its short-term as well as forward liabilities at a manageable level in relation to the size of its reserves.

The day-to-day movements in exchange rates are market determined. The primary objective of the Reserve Bank in regard to the management of the exchange rate is to maintain orderly conditions in the foreign exchange market, to meet temporary supply-demand gaps which may arise due to uncertainties or other reasons, and to curb destabilizing and self-fulfilling speculative activities. To this end, as in the past, the Reserve Bank will continue to monitor closely the developments in the financial markets at home and abroad, and take such monetary and administrative actions as may be considered necessary from time to time.

An important development in regard to balance of payments outlook is the substantial increase in the price of crude oil and petroleum products in the last six months. Crude oil prices have increased from US $ 16.71 per barrel at the beginning of April 1999 to US $ 22.95 per barrel at the end of September 1999. On the whole, the current expectation is that despite the effect of increase in oil prices, the current account deficit in 1999-2000 will still be below 2 per cent of GDP in view of the encouraging developments in respect of invisibles, particularly private remittances and software exports.

An important area of concern for the management of the balance of payments continues to be that of exports. Partly because of slowdown in the world economy and also the East Asian economic crisis, exports in 1998-99 declined by 3.9 per cent in US dollar terms. There is some evidence of pick up in exports during the first five months of the current year when exports grew by 4.6 per cent in US dollar terms. It is necessary that this momentum is kept up. In the previous year, several measures for improving the delivery of export credit in foreign currency to exporters at internationally competitive interest rates (with a maximum spread of 1.5 per cent over the LIBOR) were initiated. Some measures were also announced in the April 1999 Statement in order to ensure the timely availability of export credit and remove procedural hassles. These measures included provision of 'On Line credit' to exporters, extension of 'Line of Credit' for longer duration for exporters with good track record, peak/non-peak credit facilities to exporters, permission for interchangeability of pre-shipment and post-shipment credit and meeting the term loan requirements of exporters for expansion of capacity and modernisation of machinery and upgradation of technology. Improvements have also been made in the procedure for handling of export documents and fast track clearance of export credit at specialised branches of banks. In August 1998, the Reserve Bank issued new simplified guidelines for sanction of credit facilities for software services, project services and software products and packages.

In order to improve the delivery of export credit, the Reserve Bank has set up a Bankers Group at the operational level (comprising senior officials from commercial banks and the Reserve Bank). So far, the Group has held 22 meetings with Chief Executives of major banks and also held parallel interactive sessions with the exporters as also base-level officials of the commercial banks at 14 major export centres in the country in addition to discussions with industry associations. Based on the deliberations in these meetings, the Reserve Bank has issued further guidelines to banks relating to simplification of application forms in respect of medium and small exporters and deployment of trained and experienced staff in branches dealing with export finance. The experience seems to have proved useful in improving credit delivery to exporters.

In addition to foreign currency credit, exporters also have access to rupee credit at a concessional rate of 10 per cent per annum at present. The six month forward premium on sales of export proceeds has generally ranged between 5 and 6 per cent per annum in the last six months. Taking into account the premium available to exporters on forward sales, the cost of credit in rupee would work out to 4 - 5 per cent per annum, which compares favourably with the prevailing international rates of interest for corporate borrowers.

An important priority of the Government and the Reserve Bank of India is to create an environment which is favourable to investment and strengthening of financial links with the non-resident Indian community abroad. In line with this approach, earlier this year, procedures applicable to operations of bank accounts and financial transactions in India by non-resident individuals of Indian nationality/persons of Indian origin were drastically simplified and a Non-Resident (special) Rupee (NRSR) account was introduced in addition to other existing facilities for non-resident Indians. The objective of the measures taken so far is to eliminate the need for case by case permission and to provide as far as possible a 'domestic' treatment to NRI community (in addition to the special facilities available to them in respect of foreign exchange transactions). New measures taken in the recent past include:
(i) the extension of general permission under the Portfolio Investment Scheme, available to individual NRIs to Overseas Corporate Bodies.
(ii) the permission to buy/sell equity shares/debentures through brokers under the Portfolio Investment Scheme
(iii) the general permission to purchase shares of Indian companies from other NRIs, PIOs/OCBs. With immediate effect, it is proposed to provide the following further facilities to NRIs without the need for approval of the Reserve Bank :
i. Authorised Dealers may grant rupee loans and overdrafts in India to NRIs against the security of shares/securities/ debentures or immovable properties held by such persons in India for purposes other than investment.
ii. General permission to Indian companies for issuing non-convertible debentures by way of public issue to NRIs/OCBs on repatriation basis. The Indian companies, for such issues, need not obtain approval of the Reserve Bank.
iii. At present, NRIs/PIOs/OCBs are permitted portfolio investments in shares/debentures. These permissions by RBI are originally for a period of 5 years which can be renewed by designated banks. It has now been decided to delegate the powers to Authorised Dealers to permit portfolio investment by NRIs/PIOs/OCBs in shares/debentures.

Foreign Direct Investment (FDI) proposals are approved under the automatic route by RBI and under the approvals granted by Foreign Investment Promotion Board (FIPB) in the Central Government. In order to simplify FDI investment procedures, RBI has granted general permission to the Indian companies under the automatic route to receive funds and issue shares to their foreign collaborators without approval of RBI. The same benefit has been extended to foreign investments approved by the FIPB. Thus, in respect of all cases of foreign direct investments, which are in line with Government policy, case-by-case approval of RBI is no longer required.

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