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Annual Policy
Statement for the Year 2006-07
by
Dr. Y. Venugopal Reddy, Governor,
Reserve
Bank of India
This Statement consists of two parts: Part I.
Annual Statement on Monetary Policy for the Year 2006-07;
and Part II. Annual Statement on Developmental and
Regulatory Policies for the Year 2006-07. An analytical
review of macroeconomic and monetary developments was
issued a day in advance as a supplement to Part I of this
Statement, providing the necessary information and
technical analysis with the help of charts and tables.
2.
The Annual Policy Statement for 2005-06 introduced
a change in format of the presentation, separately
focusing upon monetary policy and developmental and
regulatory policies in Part I and Part II, respectively.
This was intended to ensure clarity of roles and
responsibilities within the Reserve Bank and to enable
more transparency in policy communication. It has also
enabled more frequent reviews of monetary policy at
quarterly intervals. In recent years, financial stability
has assumed priority in the conduct of monetary policy.
The institutional environment has been changing rapidly
including, in particular, the implementation of the Fiscal
Responsibility and Budget Management Act and the increased
financial integration taking place domestically and with
global markets. In this context, it has become important
to recognise and exploit the strong complementarity
between macroeconomic and financial stability.
Accordingly, while separate coverage of monetary and
developmental and regulatory policies enhances clarity and
transparency in communication, it is important to take a
holistic approach.
3.
The Annual Statement on Monetary Policy will be
reviewed on a quarterly basis during 2006-07 as in the
previous year, whereas the Annual Statement on
Developmental and Regulatory Policies will be reviewed
along with the Mid-term Review of monetary policy.
Accordingly, the tentative dates for the First Quarter
Review, the Mid-term Review and the Third Quarter Review
are July 25, 2006, October 17, 2006 and January 23, 2007,
respectively.
Part
I. Annual Statement on Monetary Policy
for
the Year 2006-07
4.
The Annual Statement on Monetary Policy for the
Year 2006-07 consists of three Sections: I. Review of
Macroeconomic and Monetary Developments during 2005-06;
II. Stance of Monetary Policy for 2006-07; and III.
Monetary Measures.
I.
Review of Macroeconomic and Monetary
Developments
during 2005-06
Domestic
Developments
5.
Real GDP growth projections for 2005-06 for the
purpose of monetary policy formulation were revised
upwards in two stages from around
7.0 per cent in the Annual Statement for 2005-06 to a
range of 7.5 to
8.0 per cent in the Third Quarter Review of January 24,
2006 drawing from indications of a firming up of the
recovery in agriculture and sustained momentum of
expansion in industry and services. This upward revision
turned out to be in alignment with the advance estimate of
the Central Statistical Organisation (CSO) released in
February 2006 placing real GDP growth during 2005-06 at
8.1 per cent,
up from 7.5 per cent in the previous year.
6.
Real GDP originating from agriculture and allied
activities is estimated to have registered a growth of 2.3
per cent, reviving from a low of
0.7 per cent in the previous year. According to the
advance estimates of the Ministry of Agriculture,
foodgrain production is placed at 209.3 million tonnes in
2005-06. The outlook for sugarcane is bright while
production of oilseeds is expected to be moderately above
the level of the preceding year. Production improved in
respect of horticulture, livestock, fisheries and
plantation crops, imbuing resilience to the real GDP
originating from agricultural and allied activities.
7.
The growth of real GDP originating in industry is
estimated by the CSO to have stepped up to 8.0 per cent in
2005-06 from 7.4 per cent in the previous year. The
improvement in industrial activity in 2005-06 was mainly
due to acceleration of manufacturing growth from 8.1 per
cent in the preceding year to 9.4 per cent. Sustained
expansion in domestic as well as export demand, increased
capacity utilisation, augmentation of capacities and
positive business and consumer confidence underpinned the
strength of the manufacturing sector.
8.
The index of industrial production (IIP) recorded
an increase of
8.0 per cent during April-February 2005-06 on top of 8.2
per cent a year ago, led by manufacturing which recorded a
growth of 9.0 per cent, comparable to 8.9 per cent growth
in the corresponding period of the previous year. The
production of capital and consumer goods industries
increased by 16.5 per cent and 11.7 per cent,
respectively. The basic goods segment registered a growth
of 6.4 per cent as against 5.3 per cent a year ago. The
overall growth in six infrastructure industries was lower
at 4.5 per cent during April-February, 2005-06 as compared
with 5.8 per cent a year ago due to decline in crude
petroleum and deceleration in refinery products and
finished steel, somewhat offset by the pick-up in cement
and coal. Electricity generation rose by 5.3 per cent as
against 5.4 per cent in the preceding year.
9.
A review of the financing pattern of the corporate
sector over the
first half of the current decade indicates that corporates
took advantage of the declining interest rate cycle by
readjusting their debt portfolio in favour of low cost
resources, by increased recycling of internal resources
and access to external sources. It is also evident that
corporates focused on minimising financing costs and
boosting investment income to supplement normal business
income. These developments, in conjunction with stronger
sales growth, lower tax rates, downsizing and
restructuring led to high growth in after-tax profits from
mid-2003 until the second quarter of 2005-06, which helped
in improving business confidence. During 2005-06, private
corporate sales growth moderated from 18.5 per cent and
16.4 per cent during the first and second quarters,
respectively, to 13.2 per cent in the third quarter. The
growth in net profits slowed from 54.2 per cent and 27.5
per cent in the first and second quarters, respectively,
to 27.0 per cent in the third quarter. Corporate
investment intentions as also the proposals for capital
expenditure indicate prospects of substantial growth and
consolidation during 2006-07. The outlook for the
corporate sector in terms of financing needs would be
important for assessing the credit flow from the banking
system to the commercial sector.
10.
In response to the Reserve Bank’s Industrial
Outlook Survey, nearly half of the respondents indicated
an improvement in the overall business situation whereas
another 40 per cent respondents felt that the situation
may be similar to the previous quarter. The survey results
indicate seasonal decline in output and order books during
April-June 2006 though not as steep as in the preceding
years. As regards the overall financial situation,
capacity utilisation, employment and working capital
finance requirements and availability, most respondents
were positive although a majority expects some increase in
the cost of raw materials.
11.
Real GDP originating in the services sector is
estimated to have increased by 10.1 per cent during
2005-06 as against 10.2 per cent a year ago with most
sub-sectors sharing this buoyancy. The growth of
construction was sustained at 12.5 per cent in 2004-05 and
12.1 per cent in 2005-06, supported by increasing cement
and steel production. The growth of trade, hotels and
restaurants, transport, storage and communication rose
from 10.6 per cent in 2004-05 to 11.1 per cent. Financing,
insurance, real estate and business services posted a
growth of 9.5 per cent during 2005-06 as against 9.2 per
cent a year ago. Community, social and personal services
registered a growth of 7.9 per cent in 2005-06 as against
9.2 per cent a year ago.
12.
Financing requirements associated with the pick-up
in real economic activity were reflected in a robust
expansion of bank credit for the second year in
succession. Several features distinguish bank credit
growth in
2005-06. First, the fact that March 31, 2006 was the
balance sheet date for banks coinciding with the last
reporting Friday has lent an upward bias to banking data
for 2005-06 which had 27 reporting fortnights instead of
the usual 26 fortnights. Scheduled commercial banks’ (SCB)
credit rose by
36.0 per cent (Rs.3,96,045 crore) during 2005-06, over and
above
27.0 per cent (Rs.2,26,761 crore), net of conversion of a
financial institution into a bank, in the previous year.
Food credit increased by Rs.667 crore as against an
increase of Rs.5,159 crore in the previous year. Non-food
credit remained the key driver of banking activity,
growing by 37.3 per cent (Rs.3,95,379 crore) on top of
27.5 per cent (Rs.2,21,602 crore), net of conversion, a
year ago. Even after excluding the end-March build-up, the
year-on-year increase in non-food bank credit during
2005-06 (over April 1, 2005) was 30.8 per cent
(Rs.3,42,493 crore).
13.
Second, distinct shifts in the pattern of
deployment of non-food bank credit have become
increasingly evident as highlighted by successive monetary
policy reviews in 2005-06. During April–January, 2005-06
credit to services sectors emerged as the dominant
category, increasing by
36.2 per cent as against 25.1 per cent a year ago and
accounting for
63.1 per cent of the incremental non-food credit. Within
this category, retail lending has risen rapidly. Retail
credit expanded at rates ranging between 22-41 per cent
since 2001-02 and accounted for 26.7 per cent of the
incremental non-food credit in 2005-06. It is pertinent to
note that the share of advances to ‘individuals’
increased from about 10 per cent of total bank credit in
March 2002 to nearly 25 per cent in January 2006. Loans to
commercial real estate rose by 84.4 per cent in 2005-06,
constituting 4.4 per cent of incremental non-food credit.
Housing loans increased by 29.1 per cent and accounted for
14.6 per cent of incremental non-food credit. While the
flow of credit to industry as a whole showed a modest
increase of 15.6 per cent in 2005-06 from 11.3 per cent a
year ago, bank credit to the infrastructure industries,
especially power, rose by 28.8 per cent on top of 32.9 per
cent a year ago. Substantial increases were observed in
credit flow to industries like food processing, iron and
steel, cotton textiles, vehicles, chemicals, gems and
jewellery and construction. Agricultural credit increased
by 22.4 per cent as compared with 18.9 per cent in the
corresponding period of the previous year.
14.
Third, credit growth outpaced deposit growth by a
substantial margin. The aggregate deposits of SCBs
increased by 22.8 per cent (Rs.3,87,471 crore) during
2005-06 as against an increase of 12.8 per cent
(Rs.1,92,269 crore), net of conversion, in the previous
year. Excluding the end-March effect referred to earlier,
the year-on-year increase in aggregate deposits during
2005-06 (March 31, 2006 over April 1, 2005) was 16.9 per
cent (Rs.3,02,534 crore). The year-on-year incremental
non-food credit-deposit ratio continued to remain high at
113.2 per cent during 2005-06 as compared with 117.4 per
cent a year ago. Significantly, the incremental non-food
credit deposit ratio jumped from 90.4 per cent in the
first half of 2005-06 to 132.3 per cent in the second half
of the year.
15.
Fourth, banks’ efforts to raise deposits to fund the credit demand has
led to a visible shortening of the maturity profile of
deposits in the banking system and an escalation at the
margin in the cost of raising deposits. Demand deposits
registered a year-on-year growth of 21.4 per cent in
2005-06, up from 16.1 per cent a year ago. While time
deposits increased by 16.1 per cent (as against 14.9 per
cent a year ago), this was mainly on account of short-term
wholesale deposits up to one year maturity at rates which
were bid up to a range of 8.0-8.5 per cent. In consonance,
discount rates on certificates of deposit (CDs) also rose
beyond 8.0 per cent from February, 2006. Banks’ deposit
mobilisation efforts seem to have turned in favour of
non-core bulk deposits of corporates instead of core
retail deposits. Bulk deposits raised at relatively higher
rates cannot sustain a higher credit demand on an enduring
basis and have a potential for adverse consequences for
balance sheet management and profitability. It is,
therefore, necessary to reiterate the need for banks to
review their policies in this regard and make sustained
efforts towards mobilising stable retail deposits by
providing wider access to better quality of banking
services. This would sustain prudent business expansion
without facing undue asset-liability mismatches.
16.
Fifth, the drive to expand non-food credit induced
shifts in banks’ portfolios. The decline in statutory
liquidity ratio (SLR) investments accommodated the higher
credit demand to a large extent. For the first time since
the nationalisation of banks in 1969, investment by SCBs
in Government and other approved securities declined by
Rs.11,576 crore in contrast to an increase of Rs.49,373
crore, net of conversion, in 2004-05. Thus, major support
to the market borrowing programme of Central and State
Governments came from non-banks.
17.
Sixth, banks’ investments in
bonds/debentures/shares of public sector undertakings and
the private corporate sector and commercial paper (CP)
declined by 13.0 per cent (Rs.12,238 crore) as compared
with an increase of 5.3 per cent (Rs.4,775 crore) in the
previous year. The year-on-year increase in total flow of
funds from SCBs to the commercial sector, including non-SLR
investments, was 27.4 per cent (Rs.3,30,866 crore) as
against 30.2 per cent (Rs. 2,79,326 crore) a year ago.
18.
As regards money supply (M3),
it is necessary to factor in the
end-March effect. M3
increased by 20.4 per cent (Rs.4,58,456 crore) in 2005-06
as compared with 12.1 per cent (Rs.2,42,260 crore), net of
conversion, in the previous year. Even after excluding the
end-March effect, the year-on-year M3 growth was 16.2 per cent (Rs.3,77,238 crore) in 2005-06 (March
31, 2006 over April 1, 2005) reflecting the features
discussed above. The year-on-year increase in bank credit
to the commercial sector, which excludes the end-March
effect, was 26.7 per cent (Rs.3,55,251 crore), which was
higher than the increase of 24.3 per cent (Rs.2,54,035
crore), net of conversion, in the previous year. On the
other hand, net bank credit to Government increased by 3.8
per cent (Rs.28,819 crore) as against 0.9 per cent
(Rs.6,776 crore), net of conversion, a year ago. Banks’
credit to Government (excluding the Reserve Bank credit to
Government) declined by Rs.11,460 crore. The banking
sector’s net foreign exchange assets increased by 10.2
per cent (Rs.65,962 crore) year-on-year, primarily
reflecting the increase in net foreign exchange assets of
the Reserve Bank by
10.1 per cent (Rs.61,545 crore).
19.
The total overhang of liquidity as reflected in
outstandings under the Liquidity Adjustment Facility (LAF),
the Market Stabilisation Scheme (MSS) and surplus cash
balances of the Central Government taken together
increased marginally from an average of Rs.1,14,192 crore
in March 2005 to Rs.1,15,258 crore in October 2005.
Thereafter, there was a steady decline in the liquidity
overhang to Rs.74,334 crore in March 2006. The IMD
redemption at end-December, 2005 accounted for about
Rs.32,000 crore of this decline of Rs.40,924 crore. During
the year, the financial markets shifted from surplus mode
to deficit in terms of LAF. On a net basis, the average
daily LAF reverse repo absorption was Rs.22,481 crore and
Rs.25,409 crore in the first and the second quarters,
respectively, but declined to Rs.7,825 crore in the third
quarter, and finally shifted into average daily repo
injection of Rs.11,686 crore during the last quarter.
20.
Pressures on market liquidity warranted appropriate
monetary operations to obviate wide fluctuations in market
rates and to ensure reasonable stability in financial
markets consistent with the monetary policy stance. In
October, liquidity conditions firmed up with the onset of
festival demand for currency, superimposed upon sustained
credit demand. Accordingly, average reverse repo levels
under the LAF declined in relation to the preceding month.
With resumption of the market borrowing programme of the
Central Government under the indicative calendar for the
second half of the year, liquidity conditions tightened
further in November. There was a release of net liquidity
of the order of Rs.5,500 crore in November through MSS
redemptions as the Reserve Bank refrained from fresh
auctions under the scheme in the second half of the month.
Market conditions improved subsequently and the Reserve
Bank returned to absorption mode with a steady build-up of
reverse repos under the LAF, including under the second
LAF. Thereafter, liquidity tightened again in the run-up
to
quarterly advance tax outflows in the middle of December,
the redemption of IMD at the end of December and on
account of accretions to cash balances of the Central
Government. Declining reverse repo levels were accompanied
by repos from December 16, and generally there were net
injections of liquidity. There was a further unwinding of
MSS of the order of Rs.19,522 crore during December. On a
review of liquidity conditions including the IMD
redemption at the end of December 2005, the Reserve Bank
announced suspension of the issue of treasury bills and
dated securities under the MSS, while retaining the
flexibility of conducting auctions under the scheme from
time to time after giving sufficient notice to the market.
21.
The outstanding balances under MSS increased from
Rs.65,481 crore at end-March 2005 to a peak of Rs.80,585
crore in early September and thereafter declined by
Rs.51,585 crore to Rs.29,000 crore by end-March 2006
reflecting the unwinding of MSS balances. During
January-March 2006, Rs.17,578 crore was released through
unwinding of MSS securities.
22.
Consistent with the monetary policy stance of
ensuring appropriate liquidity, daily net injections of
liquidity under the LAF averaged Rs.11,686 crore during
January-March, 2006. In addition to the unwinding of funds
held under the MSS, the Reserve Bank’s open market
operations, private placement of Government securities and
foreign exchange operations also augmented market
liquidity. On the other hand, the cash balances of the
Centre with the Reserve Bank increased from an average of
Rs.19,693 crore in March 2005 to Rs.40,981 crore during
January-March 2006, which added to the tightness in
liquidity. Pressures began to ease in the last week of
February 2006 with the call rate returning to the level of
the repo rate and settling within the LAF corridor from
mid-March 2006. Daily average injections fell to Rs.6,319
crore under the LAF in March 2006. On March 31, 2006 there
was, in fact, net absorption of liquidity under the LAF of
Rs.7,250 crore. The liquidity conditions eased
considerably in April 2006 and the Reserve Bank absorbed
an average daily amount of Rs.31,532 crore during the
first 13 days of April. As on April 13, 2006 the LAF
reverse repo amount was Rs.57,050 crore. Thus, there has
been a significant shift in the liquidity conditions
between the second half of March 2006 and the first half
of April 2006.
23.
Reserve money increased by 17.2 per cent (Rs.83,900
crore) during 2005-06, higher than the increase of 12.1
per cent (Rs.52,623 crore) in the previous year. As
regards the components of reserve money, currency in
circulation rose by 16.8 per cent (Rs.61,879 crore) as
compared with the increase of 12.7 per cent (Rs.41,633
crore). Among the sources of reserve money, the Reserve
Bank’s foreign currency assets (adjusted for
revaluation) increased by Rs.68,834 crore as compared with
an increase of Rs.1,15,044 crore. Net Reserve Bank’s
credit to the Central Government (adjusted for the
Government’s deposit balances including the MSS
proceeds) increased by Rs.35,830 crore against a decline
of Rs.60,177 crore. The increase in net Reserve Bank’s
credit to the Central Government during 2005-06 mainly
comprised acquisition of securities against liquidity
injections through LAF of Rs.12,684 crore, MSS unwinding
of Rs.35,149 crore and private placement of government
securities with the Reserve Bank of Rs.10,000 crore,
partly offset by the increase of Rs.13,195 crore in the
Central Government cash balances (other than MSS) with the
Reserve Bank. The Reserve Bank’s credit to banks and the
commercial sector increased by Rs.534 crore as compared
with a decline of Rs.833 crore in the previous year. The
ratio of net foreign exchange assets (NFEA) to currency
declined from 166.2 per cent in March 2005 to 156.3 per
cent by March 31, 2006. As on April 7, 2006 the
year-on-year growth in reserve money was 16.9 per cent.
24.
Inflation, measured by variations in the wholesale
price index (WPI) on a year-on-year basis, was 4.0 per
cent at end-March 2006 and
3.5 per cent as on April 1, 2006 after receding from a
peak of 6.0 per cent on April 23, 2005. Prices of primary
articles (weight: 22.0 per cent) rose by
5.2 per cent as against 1.1 per cent a year ago, largely
on account of prices of food articles. Prices of
manufactured products (weight: 63.8 per cent), however,
remained benign through the year, rising by 1.0 per cent
as compared with 5.5 per cent in the previous year. Prices
of the ‘fuel, power, light and lubricants’ group
(weight: 14.2 per cent) increased by 8.3 per cent as
against 11.1 per cent a year ago.
25.
The incomplete pass-through to the prices of
domestic petroleum products, particularly kerosene,
liquefied petroleum gas (LPG), and to a smaller extent in
petrol and diesel, appropriate timing of administered
price increases into the retreating phase of inflation
during the first half of 2005-06 and some burden sharing
by oil companies as well as through customs/excise duty
reductions mitigated the immediate cost push impact of
international crude prices. The average price of the
Indian basket of international crude varieties (comprising
Brent and Dubai Fateh) ruled at around US $ 60.1 per
barrel in January-March, 2006 higher by 5.7 per cent than
in the preceding quarter and by 30.2 per cent than a year
ago. By April 13, 2006 the Indian crude basket price
increased to US $ 65.5 per barrel. In the event, mineral
oils accounted for 13.2 per cent of inflation in 2005-06.
Excluding mineral oils, the WPI inflation works out to 2.3
per cent on April 1, 2006. In terms of the year-on-year
change in the consumer price index (CPI) for industrial
workers, inflation was 5.0 per cent in February 2006 as
compared with 4.2 per cent a year ago. On an annual
average basis, the CPI inflation was 4.3 per cent during
2005-06 as compared with 3.8 per cent a year ago.
26.
Financial markets remained generally stable during
2005-06 although interest rates firmed up in all segments
and the uncollateralised overnight call market experienced
persistent tightness during the last quarter of the year.
A noteworthy and desirable development during the year was
the substantial migration of money market activity from
the uncollateralised call money segment to the
collateralised market repo and collateralised borrowing
and lending obligations (CBLO) markets. The daily average
volume (one leg) in the call money market increased from
Rs.8,607 crore in April 2005 to Rs.9,145 crore in March
2006. The corresponding volumes in the market repo
(outside the LAF) were Rs.3,958 crore and Rs.7,783 crore,
respectively, whereas in the CBLO markets, the volumes
were Rs.5,185 crore and Rs.17,299 crore, respectively.
Thus, the share of the uncollateralised call market in the
total overnight market transactions declined from 48.5 per
cent in April 2005 to 26.7 per cent in March 2006.
Increasingly, the CBLO market has emerged as the preferred
overnight segment in 2005-06. The shift of activity from
uncollateralised to collateralised segments of the market
has largely resulted from measures relating to limiting
the call market transactions to banks and primary dealers
only. This policy-induced shift is in the interest of
financial stability and is yielding results.
27.
The overnight rates in the call money, market repo
and CBLO segments, which were around the lower end of the
LAF rate corridor till October 2005, started hardening in
November as the shift in liquidity conditions from surplus
to deficit rendered a few market participants short of
both liquidity and collateral securities. The overnight
rates, which were around the LAF reverse repo rate,
registered a steep rise responding to the underlying
liquidity conditions. While the overnight rates in the
call money segment went above the LAF corridor during the
third quarter of 2005-06, rates in the collateralised
markets moved towards the upper end of the LAF rate during
the same quarter. The interest rate in the call market
moved up from an average of 5.12 per cent in October 2005
to 6.93 per cent in February 2006, but moderated
thereafter to 6.58 per cent in March 2006. The overnight
interest rate in the CBLO and market repo segments also
rose from 5.01 per cent and 4.98 per cent, respectively,
in October 2005 to 6.43 per cent and 6.41 per cent in
February 2006, before moderating to 6.22 per cent and 6.17
per cent in March 2006. Reflecting the easy liquidity
conditions, the call, market repo and CBLO rates (average
for the first 13 days) declined to 5.69 per cent, 5.20 per
cent and 5.24 per cent, respectively, in April 2006.
28.
The weighted average discount rate on commercial
paper (CP) of
61 to 90-day maturity increased from 5.80 per cent in
April 2005 to
8.72 per cent by end-March 2006 and the total outstanding
amount declined from Rs.15,214 crore to Rs.12,693 crore.
The typical interest rate on
3-month CDs increased from 5.87 per cent in April 2005 to
8.56 per cent by mid-March 2006 accompanied by a
significant increase in outstanding amounts from Rs.14,975
crore to Rs.36,931 crore.
29.
In the Government securities market, the primary
market yields of
91-day and 364-day Treasury Bills increased from 5.12 per
cent and
5.60 per cent at end-April 2005 to 6.11 per cent and 6.42
per cent, respectively, at end-March 2006. The 182-day
Treasury Bill yield moved up from 5.29 per cent to 6.61
per cent during this period. The primary market yields of
91-day, 182-day and 364-day Treasury Bills were 5.49 per
cent, 6.14 per cent and 6.06 per cent, respectively, in
the auctions held in April 2006. The yield on Government
securities with 1-year residual maturity in the secondary
market increased from 5.77 per cent as at end-April 2005
to 6.52 per cent at end-March 2006 but subsequently
declined to 6.29 per cent as on April 13, 2006. The yield
on Government securities with 10-year residual maturity
increased from 7.35 per cent at end-April 2005 to 7.52 per
cent at end-March 2006 and further to 7.55 percent as on
April 13, 2006 while the yield on Government securities
with
20-year residual maturity marginally declined from
7.77 per cent to 7.72 per cent but increased subsequently
to 7.80 per cent during the same period. Consequently, the
yield spread between 10-year and 1-year Government
securities came down from 158 basis points in April 2005
to 100 basis points in March 2006 but increased to 126
basis points on April 13, 2006. The yield spread between
20-year and 1-year Government securities, however,
declined from 200 basis points to 120 basis points as at
end-March 2006 but subsequently increased to 151 basis
points as on April 13, 2006.
30.
The interest rates on deposits of over one year
maturity of public sector banks (PSBs) moved up from
5.25-6.50 per cent in April 2005 to 5.75-7.25 per cent in
March 2006. During the same period, the benchmark prime
lending rates (BPLRs) of public sector banks and foreign
banks remained unchanged in the range of 10.25-11.25 per
cent and 10.00-14.50 per cent, respectively. The BPLRs of
private sector banks moved to a range of 11.00-14.00 per
cent from 11.00-13.50 per cent in the same period. The
median lending rates for term loans (at which maximum
business is contracted) in respect of major PSBs stood at
8.50-12.50 per cent in March 2006 as against 8.00-12.50
per cent in December 2005.
31.
The equity market witnessed strong rallies with
intermittent corrections and the BSE Sensex (1978-79=100)
increased from an average of 6,379 in April 2005 to 10,857
in March 2006. The steep rise in stock prices during the
year was largely driven by domestic mutual funds and
foreign institutional investors (FIIs) who were responding
to optimistic market sentiments as well as ample
liquidity. As on April 13, 2006 the BSE Sensex was at
11,237.
32.
The revised estimates (RE) of the Central
Government’s finances for 2005-06 indicate some
improvement in the fiscal position. Reduction in
non-plan expenditure and in non-defence capital outlay
enabled a lowering of the key deficit indicators relative
to budget estimates (BE). The revenue deficit, at
Rs.91,821 crore or 2.6 per cent of GDP, was lower than 2.7
per cent of GDP in the budget estimates (BE) for 2005-06.
This was enabled by some increase in tax revenue and
containment of growth in several items of non-plan
expenditure like interest payments, grants to States and
subsidies. The revised gross fiscal deficit (GFD) for
2005-06 at Rs.1,46,175 crore constituted 4.1 per cent of
GDP as against the budgeted 4.3 per cent, contributed by a
reduction in the revenue deficit, a decline in capital
outlay and the availability of disinvestment proceeds.
33.
During 2005-06, the Central Government’s net
market borrowings at Rs.95,370 crore were 86.5 per cent of
the budgeted amount of Rs.1,10,291 crore and gross market
borrowings of Rs.1,58,000 crore were 88.5 per cent of the
budgeted amount of Rs.1,78,487 crore. Issuances were
broadly in accordance with the indicative semi-annual
calendar except for rejection/cancellations of Rs.10,000
crore in October 2005 and Rs.5,000 crore in February 2006.
As against this, the Government privately placed dated
securities for an amount of Rs.10,000 crore with the
Reserve Bank on March 6, 2006 which was outside the
issuance calendar. All issuances, except one, were
reissuances imparting liquidity to the securities. The
State Governments raised Rs.15,455 crore (net) and
Rs.21,729 crore (gross). During 2005-06, the combined
issuance (net) of Government securities of the Centre
(including MSS) and States was, however, only Rs.74,344
crore due to the unwinding of MSS securities to the tune
of Rs.36,481 crore as against Rs.1,45,510 crore in 2004-05
and Rs.1,35,192 crore in 2003-04. It is noteworthy that
the aggregate net issuance of Centre and States in 2005-06
was at its lowest level in the last seven years.
34.
The weighted average yield on primary issuance of
the Central Government’s dated securities rose by 123
basis points to 7.34 per cent in
2005-06 from 6.11 per cent in the previous year.
The weighted average maturity of the dated securities
issued during the year increased to 16.90 years from 14.13
years in the previous year.
35.
Commercial banks’ holdings of Government and
other approved securities remained in excess of the
statutory minimum requirement of 25.0 per cent of net
demand and time liabilities (NDTL). Such holdings,
however, declined from 38.2 per cent of the banking
system’s NDTL in March 2005 to 31.9 per cent in March
2006. While the excess SLR holdings amounted to
Rs.1,56,504 crore in March 2006, several banks seem to be
operating their SLR portfolios close to the statutory
minimum level.
Developments
in the External Sector
36.
Balance of payments (BoP) data released at
end-March 2006 indicate that merchandise exports recorded
a growth of 27.7 per cent in US dollar terms during the
first nine months of 2005-06 as compared with 25.4 per
cent a year ago. Manufacturing exports provided the
leading edge with transport equipment, machinery and
parts, iron and steel, gems and jewellery, chemicals and
petroleum products emerging as the key drivers of export
growth. Merchandise import growth was 36.9 per cent as
against 44.5 per cent during the corresponding period a
year ago. Oil import payments rose by 47.1 per cent,
mainly reflecting the elevated levels of international
crude oil prices since volume growth was barely 0.8 per
cent. Non-oil imports expanded by 33.0 per cent, led by
export-related items and capital goods which mirrored the
growth in domestic industrial activity. Consequently, the
trade deficit widened to US $ 41.5 billion during
April-December 2005 as compared with US $ 26.5 billion a
year ago.
37.
Information available for subsequent months from
the Directorate General of Commercial Intelligence and
Statistics (DGCI&S) indicates that, in US dollar
terms, merchandise exports increased by 24.7 per cent
during 2005-06 as compared with 26.4 per cent in the
previous year. Imports showed an increase of 31.5 per cent
as compared with 36.4 per cent in the previous year. While
the increase in oil imports was higher at 46.8 per cent as
compared with 45.2 per cent in the previous year, non-oil
imports showed an increase of 25.6 per cent as compared
with 33.3 per cent in the previous year. At a further
disaggregated level, imports of gold and silver increased
by 15.7 per cent during April-December 2005 on top of a
high increase of 46.9 per cent in the corresponding period
of the previous year. Non-oil imports excluding gold and
silver increased by 35.5 per cent as against 32.7 per cent
in April-December 2005. During 2005-06, the trade deficit
widened to US $ 39.6 billion which was 52.7 per cent
higher than the deficit of US $ 26.0 billion in the
corresponding period of the previous year. The trade to
GDP ratio, which was 14.1 per cent in 1991-92 increased to
30.2 per cent in 2005-06, indicating increasing openness.
38.
Regional co-operation in Asia has strengthened over
the years and this is reflected in increasing trade
volumes within the region. The share of exports to
developing Asia in India’s total exports increased from
14.4 per cent in 1990-91 to 29.8 per cent in 2005-06
(April-December). The corresponding share in India’s
imports also increased from 14.0 per cent to 20.8 per cent
during this period. In recent years, China has emerged as
a major trading partner, accounting for 6.0 per cent of
total exports and 7.4 per cent of total imports in 2005-06
(April-December) as compared with 1.9 per cent and 3.0 per
cent, respectively, in 2000-01. In recognition of the
growing importance of Asian countries in India’s foreign
trade, the series on nominal and real effective exchange
rate indices (1993-94=100) released by the Reserve Bank in
December 2005 has added Chinese Renminbi and Hong Kong
Dollar in the weighting diagram.
39.
Invisible receipts rose by 28.1 per cent in
April-December 2005 mainly led by earnings from
transportation, software exports and other professional
and business services as well as remittances from overseas
Indians. Private transfers, comprising primarily
remittances from Indians working overseas, remained
sizeable at US $ 17.4 billion as compared with US $ 14.3
billion in April-December 2004. Invisibles payments
increased by 22.1 per cent mainly on account of IMD
interest payments and payments for transportation services
on account of the increase in trade volume and the rise in
freight rates.
As a result, the current account deficit was placed at US
$ 13.5 billion in
April-December 2005 as against US $ 5.9 billion in
April-December 2004.
40.
Net capital inflows at US $ 14.7 billion during
April-December 2005 comprised portfolio investment (US $
8.2 billion), direct investment
(US $ 4.7 billion), NRI deposits (US $ 1.1 billion) and
short-term credit
(US $ 1.7 billion) while external commercial borrowings
registered net outflows (US $ 1.5 billion) due to IMD
redemption. There was a one-off principal repayment of IMD
(US$ 5.5 billion) in the capital account and interest
payments (US$ 1.6 billion) under the current account.
Excluding the IMD redemption, external commercial
borrowings would show an inflow of US $ 4.0 billion as
compared with US $ 2.9 billion a year ago and net capital
inflow would work out to US $ 20.2 billion. The net
accretion to foreign exchange reserves excluding valuation
changes amounted to US $ 1.8 billion during April-December
2005. Taking into account the valuation loss of US $ 6.1
billion due to depreciation of major currencies against
the US dollar, foreign exchange reserves recorded a
decline of US $ 4.3 billion during April-December 2005. In
subsequent months, however, India’s foreign exchange
reserves increased by US $ 10.1 billion from US $ 141.5
billion at end-March 2005 to US $ 151.6 billion by
end-March 2006. As on April 7, 2006 the foreign exchange
reserves stood at US $ 154.2 billion.
41.
India’s external debt declined by US $ 4.0
billion from end-March 2005 to US $ 119.2 billion at
end-December 2005. The reduction was essentially brought
about by redemption of IMD in December 2005. The ratio of
short-term debt to total debt increased marginally from
6.1 per cent at end-March 2005 to 7.5 per cent at
end-December 2005.
42.
The foreign exchange market remained orderly in
2005-06 with the exchange rate exhibiting two-way
movements. The rupee appreciated by
0.6 per cent against the US dollar from Rs.43.75 per US
dollar to
Rs.43.49 per US dollar during April-July, 2005 but
depreciated by 4.2 per cent against the US dollar from
Rs.43.99 per US dollar at end-September 2005 to Rs.45.94
per US dollar at end-November 2005. Subsequently, the
rupee recorded an appreciation on the back of strong
portfolio inflows and the US dollar’s weakness against
other major currencies in the international markets.
Between end-November 2005 and end-February 2006, the rupee
appreciated by 3.4 per cent against the US dollar. During
2005-06, the rupee depreciated by 1.9 per cent against the
US dollar but appreciated by 4.4 per cent against the
euro, by 5.5 per cent against the pound sterling and by
7.5 per cent against Japanese yen. During 2006-07 so far
(up to April 13, 2006), the rupee depreciated by 1.5 per
cent against the US dollar, 1.24 per cent against the
euro, 2.1 per cent against the pound sterling and 0.68 per
cent against the Japanese yen.
43.
The exchange rate policy in recent years has been
guided by the broad principles of careful monitoring and
management of exchange rates with flexibility, without a
fixed target or a pre-announced target or a band, coupled
with the ability to intervene if and when necessary. The
overall approach to the management of India’s foreign
exchange reserves takes into account the changing
composition of the balance of payments and endeavours to
reflect the ‘liquidity risks’ associated with
different types of flows and other requirements.
44.
India’s approach to financial integration has so
far been gradual and cautious. Although capital inflows
have been associated with high growth rates in some
developing countries, a number of them have also
experienced periodic slumps in economic growth and
financial crises with substantial macroeconomic and social
costs. The cross-country experience suggests that while
trade integration is generally beneficial, there exists a
threshold in an economy’s resilience in the context of
an open capital account. At a more practical policy level,
financial integration may be conducive to growth, without
its attendant risks and vulnerabilities, when combined
with good macroeconomic policies and good quality of
domestic governance. Thus, the ability of a developing
country to derive benefits from financial globalisation in
the presence of volatility in international capital flows
can be significantly improved by the quality of its
macroeconomic framework and institutions. While a gradual
approach to liberalisation of capital account in India has
paid dividends so far, continuation of the gradual process
may warrant that some hard and basic decisions are taken
in regard to macro-economic management, in particular
monetary, external and financial sector management.
45.
The Reserve Bank of India, in consultation with the
Government of India, has appointed on March 20, 2006 a
Committee to set out a Roadmap towards Fuller Capital
Account Convertibility (Chairman: Shri S.S. Tarapore). The
terms of reference of the Committee will be: to review the
experience of various measures of capital account
liberalisation in India; to examine implications of fuller
capital account convertibility on monetary and exchange
rate management, financial markets and financial system;
to study the implications of dollarisation in India of
domestic assets and liabilities and internationalisation
of the Indian rupee; to provide a comprehensive
medium-term operational framework with sequencing and
timing for fuller capital account convertibility, taking
into account the above implications and progress in
revenue and fiscal deficit of both Centre and States; to
survey the regulatory framework in countries which have
advanced towards fuller capital account convertibility;
suggest appropriate measures and prudential safeguards to
ensure monetary and financial stability; and to make such
other recommendations as the Committee may deem relevant
to the subject. The Committee will commence its work from
May 1, 2006 and is expected to submit its report by July
31, 2006.
Developments
in the Global Economy
46.
Global growth moderated in the fourth quarter (Q4)
of 2005, but is estimated to have risen to 4.8 per cent by
the International Monetary Fund (IMF) for the full year in
view of the broad-based expansion in economic activity.
The strength of world GDP growth, well above its long-run
average of 3.8 per cent, has been accompanied by a growing
resilience to large systemic shocks. While oil prices
doubled between 2003 and 2005, the impact on world growth
has been well absorbed. The world economy is expected to
continue to grow at about the same pace during 2006 and
2007. The US economy remains the main engine of global
growth, but the sustained dynamism in China, India and a
few other large developing economies as well as some
recent signs of upturn in Japan considerably brightens the
outlook for the global economy.
47.
According to the World Bank, growth in the OECD
countries is expected to have slipped from 3.1 per cent in
2004 to 2.7 per cent in 2005, but is expected to
strengthen to 2.9 per cent in 2006 as a result of the
recovery in Japan and Europe. In the United States,
high oil prices, rising short-term interest rates,
cooling housing markets and the hurricanes in September
contributed to slowing of real GDP growth to 3.5 per cent
in 2005 from 4.0 per cent in 2004. Nonetheless, low
long-term interest rates boosted domestic demand.
Consequently, the US current account deficit widened to
6.4 per cent of GDP in 2005 from 5.7 per cent in 2004. The
current account deficit continued to be financed by
foreign purchases of US financial assets. GDP growth in
the US is expected to record a robust pace of 3.4 per cent
in 2006.
48.
In the euro area, a recovery is underway with real
GDP growth rising to 1.4 per cent in 2005 and projected at
1.7-2.5 per cent in 2006 and
1.5-2.5 per cent in 2007. There are signs that the
recovery in Japan is becoming more firmly entrenched with
real GDP growth rising in Japan by 2.7 per cent in 2005 on
top of 2.6 per cent in 2004. Growth remained robust in the
developing countries in 2005, led by China (9.9 per cent),
Hong Kong (7.3 per cent) and India (7.6 per cent). In
Russia and Latin America, too, growth has been buoyant.
49.
Consumer price inflation in the advanced economies
recorded a decline in the first quarter of 2006. In the
US, consumer prices increased to
4.1 per cent in January on account of oil prices but
dipped to 3.6 per cent in February. In the euro area too,
inflation edged down to 2.2 per cent in March from 2.3 per
cent in the previous month. Although deflation continued
in Japan with overall consumer prices falling by 0.1 per
cent in February, the drop was smaller than in the fourth
quarter of 2005. In major industrial countries, inflation
appears to be low and the second-round effects of oil
price increases in the form of wage increases have been
moderate so far. Though price stability has been
maintained in these countries in the face of the oil
shock, risks loom large in the form of lagged second order
effects of oil price increases, geopolitical tensions, the
probability of disorderly and rapid adjustment of current
account imbalances and the risks emanating from the
housing market, particularly when the cycle turns down.
Non-energy commodity prices have been increasing through
2005 and the first quarter of 2006 |
General Section
