2.64 The annual average inflation, measured on the basis of annual percentage variation in the average wholesale price index, a better indicator of underlying inflation pressures, trended downwards to touch 2.3 per cent on October 12, 2002 and rose thereafter, ruling at 3.0 per cent as on March 1, 2003. The annual average WPI inflation during the comparable period of 2001-02 stood at 3.9 per cent (Chart II.33).

2.65 During 2002-03 (up to March 1, 2003), on an average basis, the primary articles and fuel group inflation decelerated to 3.2 per cent and 4.9 per cent, respectively, from 3.7 per cent and 8.9 per cent during the corresponding period last year. On the other hand, manufactured products inflation increased moderately to 2.4 per cent from 1.8 per cent during the same period. An analysis of the weighted contributions of major groups of WPI (on an average basis) during 2002-03 so far indicates that, while the contribution of the manufactured products group increased to 44.6 per cent from 29.6 per cent during the corresponding period of the previous year, that of the fuel group declined to 31.6 per cent from 46.7 per cent over the same period. The weighted contributions of primary articles group was steady at around 23.8 per cent during the same period (Chart II.34).

2.66 At the retail level, consumer price inflation, as measured by the annual variation in the consumer price index for industrial workers (CPI-IW), on a point-to-point basis, decelerated to 3.4 per cent in January 2003 from 4.9 per cent in January 2002. On an average basis, however, consumer inflation stood higher at 4.2 per cent as compared with 3.9 per cent a year ago (Chart II.35).

2.67 Inflationary pressures generally remain subdued across the globe during the year. International commodity prices recovered in the second half of 2002 after bottoming out in late 2001 from a prolonged decline in the aftermath of the Asian crisis. Non-fuel commodity prices, however, remain bound by weak demand and inventory drawdown. Since early August 2002, spot oil prices have risen markedly owing to concerns about a further deterioration in the geopolitical situation in the Middle East. Thus, the major risk to the current benign outlook for inflation hinges upon the prospects for uncertainty relating to the future movements in international oil prices.

2.68 Orderly conditions prevailed in the financial markets during 2002-03 (Chart II.36). The presence of adequate liquidity conditions and moderation of inflation expectations enabled a softening of interest rates. The foreign exchange market continued to witness excess supply conditions. The capital market began to recover from November 2002 after being adversely affected by a number of external shocks, including border tensions. At the same time, the Reserve Bank carried forward structural reforms to develop the various financial market segments with a view to enhancing financial stability and improving allocative efficiency.

2.69 Reflecting ample liquidity conditions during 2002-03, there was a softening of interest rates across the various segments of the financial market, although the pace of reduction of interest rates was not necessarily uniform. At the short end of the market, the average overnight call rates declined from 6.58 per cent in April 2002 to 5.71 per cent by February 2003 and further to 5.21 per cent on March 17, 2003.

The primary implicit yields of both 91-day and 364-day Treasury Bills declined to 5.89 per cent as on March 19, 2003 from 5.97 per cent and 6.09 per cent, respectively, as on April 3, 2003. At the longer end of the spectrum, the secondary market yields on government securities in the maturity range of 10 to 20 years softened from 7.37-7.91 per cent in April 2002 to 6.34-7.05 per cent by February 2003. Deposit rates of public sector commercial banks with a maturity of more than one year softened from 7.25-8.75 per cent during March 2002 to 5.25-7.00 per cent by end-February 2003. However, the fall in prime lending rates of the public sector banks from 10.0-12.5 per cent during March 2002 to 9.00-12.25 per cent by end-February 2003 did not match the fall in yields in government securities.

2.70 The call/notice money market was orderly and stable during 2002-03 so far. The weighted average call money borrowing rates remained, by and large, within the informal corridor of the repo and reverse repo rate. After edging up during the first two months of the fiscal year, the weighted average call money borrowing rate softened thereafter, occasionally dipping below the repo rate (Chart II.37).

2.71 Various reform measures were undertaken in the call money market during the year. The phasing out process of non-banks from the call/notice money market began with mapping of a four-stage exit of non-banks from this market. During the first stage, which commenced with effect from May 5, 2001, non-banks were allowed to lend, on an average, up to 85 per cent of their average daily lending in the call/notice market during 2000-01 in a reporting fortnight. Such limits would come down to 75 per cent as part of stage II from a date to be notified later by the Reserve Bank when the Negotiated Dealing System/Clearing Corporation of India Limited (CCIL) becomes fully operational and widely accessed. Call lending by corporates was disallowed effective July 1, 2001. The Reserve Bank instituted a daily call money borrowing ceiling of 2 per cent of aggregate deposits (as at the end of March of the previous financial year) for urban co-operative banks, which was extended to State Co-operative Banks (SCBs) and District Central Co-operative Banks (DCCBs). In respect of scheduled commercial banks, effective from the fortnight beginning October 5, 2002, the fortnightly average ceiling for call/notice money lending for banks was stipulated at 50 per cent of their owned funds with the daily lending ceiling fixed at 100 per cent of their owned funds. The fortnightly average ceiling for call/ notice money borrowing for banks was placed at 150 per cent of their owned funds or 2 per cent of aggregate deposits, whichever is higher, as at end-March of the preceding financial year. The daily borrowing ceiling was specified at 250 per cent of their owned funds. Simultaneously, primary dealers were permitted to lend in the call/notice money market up to 25 per cent of their net owned funds. Effective from the fortnight beginning December 14, 2002, the fortnightly average ceiling for call/notice money lending for banks was further scaled down to 25 per cent of their owned funds and the daily lending ceiling to 50 per cent of their owned funds. The fortnightly average ceiling for call/notice money borrowing for banks is 100 per cent of their owned funds or 2 per cent of aggregate deposits, whichever is higher, as at end-March of the preceding financial year with the daily borrowing ceiling at 125 per cent of their owned funds.

2.72 The progression of money market reforms was smooth with the monthly weighted average call money borrowing rates steadily softening as the current financial year has progressed.

2.73 The fiscal year 2002-03 commenced with easy liquidity conditions as reflected in the substantial amount of repo bids received under the LAF auctions, pulling call rates below the repo rate during the first week of April 2001. The absorption of surplus liquidity through both LAF auctions as well as OMO outright sales and the launching of the government borrowing programme balanced the money market liquidity, reverting the call money rates above the repo rate. The pick up in the tempo of the Government borrowing combined with border tensions in May 2002 tightened liquidity conditions, firming up the weighted average call money borrowing rates to 7.7 per cent on May 22, 2002.

2.74 The Reserve Bank’s primary market operations, monetary easing and redemption inflows comforted the money markets in June 2002. The Reserve Bank undertook devolvements and private placements of government primary issuances and advanced the date of the CRR cut of 50 basis points to 5.0 per cent, by a fortnight to June 1, 2002. These measures as well as government bond redemptions softened call money rates steadily to a band of 6.0-6.2 per cent during end-May to June 23, 2002. The easy liquidity conditions also reflected the fact that the repo cut-off rate was brought down by 25 basis points to 5.75 per cent on June 27, 2002.

2.75 The banks appeared to have factored in the two-stage prudential restrictions on their call money market exposures during the third quarter of 2002-03 quite smoothly as the call money borrowing rates hovered mostly at or below the repo rate. Prudential limits on borrowings and lendings of scheduled commercial banks and on lendings of primary dealers in the call/notice money market became operative, effective October 5, 2002. Simultaneously, the collateralised lending facility available to banks and primary dealers was phased out.

2.76 The repo rate reduction on October 30, 2002 by 25 basis points to 5.5 per cent, expectedly brought down the call money rate. However, the call money rates exhibited some volatility with the weighted average borrowing rate inching up above 6.0 per cent on November 12, 2002 reflecting, inter alia, outflows on account of a gilt auction as well as a 13-day repo auction at a time when banks were making preparations towards graduating for maintaining a minimum of 80 per cent of eligible CRR balances on a daily basis. The markets, however, soon stabilised with the weighted average call money borrowing rate coming down to 5.27 per cent on November 30, 2002.

2.77 The second stage of prudential restrictions on call money lendings and borrowings of banks became effective fortnight beginning December 14, 2002. The usual advance tax outflows and State loan auctions in December 2002 firmed up call rates temporarily. There was some temporary tightness of liquidity in January 2003 as a result of open market sales. The call rates, however, soon turned easy on account of augmenting of money market liquidity through redemptions, coupon inflows and some selling of government securities with the waning of expectations of any reduction in policy interest rates and war tensions in the Middle East. There was some edging up of call rates towards the last week of February 2003 on account of some outflows of funds towards State loan auctions. Although the repo rate was reduced by 50 basis points to 5.0 per cent, a second round of State loan auctions pushed call rates to 6.2 per cent as on March 12, 2003. The call rate eased thereafter to 5.21 per cent as on March 17, 2003.

2.78 The Reserve Bank continued to take measures to deepen and widen the government securities markets. As a step towards enhancing transparency, an indicative calendar for the issuance of marketable dated Government securities for the first half of year 2002-03 was issued on March 27, 2002 to enable investors to plan their investments in a better manner. The calendar was generally adhered to with some minor deviations. In continuation of this, the Reserve Bank announced the calendar for the second half-year (October-March) on September 18, 2002 in consultation with the Government. In future, the calendar would be issued every half-year. A bond with put and call options (6.72 per cent Government Stock 2007/12) exercisable on or after 5 years from the date of issue was issued for the first time. The Reserve Bank issued a 30-year paper in July 2002, in line with the policy of elongating the maturity structure of dated securities.

2.79 Stable and soft money market interest rates, ample liquidity conditions and moderate inflation expectations provided the conditions for a continued rally in the prices of government securities through most of the year up to mid-January 2003. The surplus liquidity in the banking system drove down gilt yields during 2002-03 (up to mid-January 2003). The outlook on gilts turned bearish during the second half of January due to a host of negative factors like the rising oil prices, a worsening situation in the Middle East, a sharp rise in domestic WPI inflation rate and indications of a recovery in industrial production.

2.80 Yields fell in the usual flush of early April liquidity but started firming up by May 2002, with the tightening of liquidity conditions, a lower than expected CRR reduction in the Monetary and Credit Policy of April 2002 and as the market expectation of a Bank Rate cut did not materialise (Chart II.38). Besides, border tensions also affected market sentiment by end-May. This was reflected in a drop in the market turnover. The rise in yields abated as market sentiment improved after the Reserve Bank advanced the CRR reduction by a fortnight in June 2002. As monetary conditions continued to ease mainly due to a sharp rise in capital inflows, yields continuously declined till mid-January 2003. The investor interest in gilts was further strengthened by the monetary easing in the Mid-Term Review of the Monetary and Credit Policy in October 2002. As prices continued to rally, transaction volumes also steadily increased, reaching a peak in November 2002. The OMO sales as well as renewed tensions in the Middle East in January 2003, however, halted the rally and the yields have somewhat firmed up since mid-January 2003. Gilt prices rallied sharply after the Union Budget 2003-04 with a reduction in the repo rate by 50 basis points to 5.0 per cent on February 28, 2003. However, continuing uncertainties and the usual year-end profit booking led to the reversal of post-Budget gains in early March 2003.

2.81 The average decline of yields in the 2-5 year segment has been of the order of 23 basis points while the same for the 6-10 year and 11-20 year sector has fallen by 83 and 89 basis points, respectively. The 10-year yield rose by about 85 basis points to 8.13 per cent by the third week of May 2002 from 7.28 per cent at the beginning of the current financial year and subsequently eased to 6.34 per cent at the end of February 2003. While yields have declined across the maturity spectrum, there has also been a flattening of the yield curve during the year which could be reflecting a combination of factors including a demand for longer-term paper in the face of sustained easy liquidity and subdued inflation expectations. The spread between AAA-rated corporate bonds and government securities, which widened during 2001-02, narrowed by March 2003 (Chart II.39).

2.82 The Indian Rupee generally exhibited an appreciating trend with respect to the US dollar during 2002-03 due to excess supply conditions on account of steady foreign exchange inflows from exporters, foreign direct investment as well as remittances by NRIs coupled with modest corporate demand. The slow growth in imports continued despite some industrial recovery, exacerbating the appreciating pressure. The exchange rate of the Indian Rupee vis à-vis the US dollar moved within a range of Rs.47.63 Rs.49.06 per US dollar during 2002-03 (up to March 13, 2003) (Chart II.40). On the basis of monthly average exchange rates, the Indian Rupee appreciated by 2.5 per cent from Rs.48.92 per US dollar in April 2002 to Rs.47.73 per US dollar in February 2003.

2.83 The Rupee remained broadly stable during the first quarter of 2002-03, except for a brief period of uncertainty on account of concerns regarding higher global oil prices and border tensions in May 2002. There was appreciating pressure since June 2002 on account of the positive sentiment created by easing of border tensions and the continued weakness of US dollar against other major international currencies on account of doubts over the strength of the US recovery and a series of corporate accounting scandals in the US. The strengthening of the Rupee continued in the following months due to heavy US dollar inflows mainly in the form of foreign direct investments and exporter remittances. This prompted the Reserve Bank to mop up surplus US dollars in the market in order to prevent excessive appreciation of the Rupee.

2.84 Cross-currency movements reveal that due to depreciation of the US dollar against major currencies, the Rupee depreciated steadily against the Euro and the Pound Sterling during 2002-03 (up to February) (Chart II.41). In terms of monthly average exchange rates, while the Rupee depreciated by 8.3 per cent against the Pound Sterling, its depreciation against the Euro was sharper at 15.8 per cent during the 11-month period. The Euro became costlier than the US dollar in terms of Rupees for the first time on November 7, 2002, with the value of Euro rising to Rs.48.54 per Euro as against Rs.48.33 per US dollar on the same day. The Rupee depreciated against the Japanese Yen by 6.6 per cent during the same period.

2.85 The depreciation of the Rupee against major currencies is also reflected in the movements in the nominal effective exchange rate (NEER) and real effective exchange rate (REER) (Chart II.42). The REER of the Indian Rupee depreciates with the depreciation in the US dollar against the major currencies as well as depreciation of the Indian rupee against the US dollar. Further, the REER also depreciates with a fall in inflation in India as compared with other major economies included in the basket. Despite the recent appreciation of rupee against the US dollar, the NEER and REER depreciated reflecting a depreciation of the US dollar against the major currencies. Inflation remained subdued in India as well as abroad.

2.86 The Clearing Corporation of India (CCIL), which commenced its operations from February 15, 2002 in clearing and settlement of transactions in government securities, also started settlement of foreign exchange transactions through multilateral netting of member obligations for both the Indian Rupee and US dollar. This process significantly reduces individual funding requirements for every member as well as liquidity risk in the market. The average monthly total turnover in the foreign exchange market marginally increased to US $ 129.2 billion during 2002-03 (up to January 2003) from US $ 118.5 billion in 2001-02. The monthly turnover remained within the range of US $ 22.5-31.7 billion in the merchant segment and in a range of US $ 84.1-124.3 billion in the inter-bank market during 2002-03 (up to January 2003) (Chart II.43). Reflective of the stable foreign exchange market conditions, the ratio of inter-bank to merchant turnover fell steadily from 5.5 per cent in April 2002 to 3.6 per cent in January 2003.

2.87 In the swap segment of the foreign exchange market, the forward premia hardened for all the three maturities (one- three- and six-month) during April-May 2002, partly reflecting uncertainties generated by border tensions. With the return of stability in the spot segment of the foreign exchange market resulting from steady supply of US dollar, the forward premia for all three maturities declined steadily during the next nine months (June 2002 – February 2003). In terms of monthly averages, the three-month and the six-month forward premia declined from 6.23 per cent and 6.19 per cent, respectively, in May 2002 to 3.55 per cent, each, in February 2003 (Chart II.44).

2.88 During 2002-03 so far, both the primary and secondary segments of the capital market remained generally subdued on account of several domestic and external factors. Financial assistance sanctioned and disbursed by the all-India Financial Institutions (AIFIs) also declined sharply.

2.89 The public issues market continued to witness depressed conditions during 2002-03 (up to January 2003) as the resource mobilisation aggregating Rs.3,259 crore from 12 issues was lower than Rs.4,375 crore raised through 17 issues during 2001- 02 (up to January 2002) and Rs.7,112 crore raised through 24 issues during 2001-02 (Chart II.45). During 2002-03 (up to January 2003), there were five issues aggregating Rs.1,049 crore from the non-Government public limited companies (private sector) and seven issues aggregating Rs.2,210 crore by the public sector entities in the financial sector. The entire resource mobilisation during 2001-02 (up to January 2002) was accounted for by private sector companies.

2.90 The share of equity in the total resource mobilisation increased sharply to 37.0 per cent during 2002-03 (up to January 2003) as compared with 19.6 per cent during the corresponding period of the previous year, following floatation of equity issues from the banks in the public sector (Chart II.46). All the issues during 2002-03 (up to January 2003) were mega issues (Rs.100 crore and above) (except one issue of Rs.36 crore) with the average size of the issues correspondingly working out to Rs.272 crore as compared with Rs.257 crore during the corresponding period of the previous year.

2.91 The private placement market, which has become quite popular in recent years, witnessed some slowdown in resource mobilisation during April-December, 2002. The resource mobilisation from the private placement market, at Rs.46,647 crore was 5.6 per cent lower than Rs.49,437 crore raised during the comparable period of the previous year due to a decline in resource mobilisation by the AIFIs and state-level undertakings in the public sector.

2.92 Resource mobilisation through ADRs, GDRs and FCCBs from the international capital market, at Rs.3,314 crore during 2002-03 (up to January 2003), was 41.5 per cent higher than Rs.2,341 crore raised during the corresponding period of the previous year.

2.93 According to the data available with SEBI, net resource mobilisation by mutual funds (including UTI), at Rs.16,612 crore during 2002-03 (up to January 2003), was 45.9 per cent higher than Rs.11,389 crore during the comparable period of the previous year, mainly due to the sizeable funds raised under debt-oriented schemes. The Unit Trust of India (UTI), however, witnessed a net outflow of Rs.8,720 crore during 2002-03 (up to January 2003).

2.94 Financial assistance sanctioned and disbursed by the term-lending institutions, at Rs.13,933 crore and Rs.12,185 crore, respectively, declined sharply by 49.7 per cent and 45.6 per cent, respectively, during 2002-03 (up to January 2003) as compared with the declines of 24.8 per cent and 11.5 per cent (excluding ICICI), respectively, during the corresponding period of the previous year.

2.95 The stock markets witnessed subdued conditions due to several factors, such as, border tensions, inadequate monsoon and subdued trends in international markets, especially following the discovery of accounting discrepancies in some major US companies and international disturbances (Chart II.47).

2.96 The stock markets began 2002-03 on a positive note, led by a rally in PSU scrips following disinvestment initiatives by the Government but soon turned bearish by end-May 2002 as border tensions mounted. The markets recovered partly in early June 2002 as border tensions abated but the BSE Sensex fell below the 3000-mark by end-July 2002, reflecting monsoon uncertainties and weakening of international markets following the discovery of accounting discrepancies in large US firms (Chart II.48).

2.97 After a brief spell of recovery in August, the markets declined again by October, on account of lower than expected quarterly results and uncertainties regarding PSU disinvestment. The market sentiment turned positive by early November 2002 mainly due to a revival of PSU disinvestment initiatives by the Government, bargain buying by institutional investors, especially in technology scrips and a revival in international markets. A downtrend set in again from end-January 2003 as the market sentiment was affected by the Middle East crisis. Bank scrips were in the limelight following the permission to increase FDI in private sector banks and increase in profitability. PSU stocks also became attractive on account of disinvestment initiatives by the Central Government. In contrast with a 5.4 per cent decline in the BSE Sensex during 2002-03 (up to February 2003), the BSE-500 registered only a marginal decline of 0.3 per cent over the same period reflecting buying interest in PSU scrips and mid-caps outside the ambit of the narrow blue-chip indices.

2.98 The volatility in share prices, as measured by the coefficient of variation, at 5.0 per cent during 2002- 03 (up to February 2003), was lower than 7.2 per cent during the corresponding period of the previous year. Foreign institutional investors’ (FIIs) net investments in equity markets declined to Rs.2,376 crore during 2002-03 (up to February 2003) as compared with Rs.5,785 crore during the corresponding period of the preceding year. The mutual funds remained net sellers in equity markets during 2002-03 so far.

2.99 The derivative segment continued to expand with the total turnover rising to Rs.50,080 crore during February 2003 from Rs.20,535 crore during March 2002 (Chart II.49).

Scheduled Commercial Bank s ²

2.100 The operating profits of scheduled commercial banks (SCBs) during 2001-02 increased by 50.9 per cent to Rs.29,814 crore. Notwithstanding higher provisioning and contingencies, the net profits in 2001-02 increased by 80.7 per cent to Rs.11,572 crore.

2.101 This increase in bank profitability may be attributed to a softer interest regime resulting in gains from treasury operations coupled with containment in operating expenses. Among the major financial parameters, the growth in income during 2001-02 was 14.4 per cent while that in expenditure was 11.0 per cent. The growth in other income accelerated to 41.6 per cent from 8.8 per cent in the previous year while operating expenditure declined by 1.4 per cent to Rs.33,696 crore, thereby boosting the net profit. The ratio of net profits to total assets of SCBs increased to 0.75 per cent as at end-March 2002 from 0.49 per cent, a year ago. The decline in lending rates together with an increase in competitive pressures impacted on the bottomline as reflected in the decline in net interest income to 2.6 per cent as at end-March 2002 from 2.8 per cent as at end-March 2001 (Chart II.50).

2.102 The ratio of gross non-performing assets (NPAs) to total assets of SCBs declined to 4.6 per cent as at end-March 2002 from 4.9 per cent as at end-March 2001, while net NPAs to total assets declined to 2.3 per cent from 2.5 per cent. For the same period, the ratio of gross NPAs to gross advances declined to 10.4 per cent from 11.4 per cent in 2000-01 and net NPAs to net advances declined to 5.5 per cent from 6.2 per cent (Chart II.51).

2.103 As at end-March 2002, 85 out of 97 SCBs recorded a capital to risk-weighted asset ratio (CRAR) in excess of 10 per cent, seven banks had CRAR between 9 per cent and 10 per cent, while five banks had CRAR below the 9 per cent mark. The corresponding distribution of banks in the previous year was 84 banks, 11 banks and five banks, respectively.

2.104 The Reserve Bank undertook several measures to enhance soundness of the banking sector alongside the deregulation of interest rates and balance sheet restrictions, especially in respect of the investment portfolio (Table 2.17). The Mid-Term Review of Monetary and Credit Policy of October 2002 revised norms for loan classification, according to which, effective March 31, 2005, an asset would be classified as doubtful if it remained in the substandard category for 12 months (instead of 18 months earlier). The additional provision need to be phased in over a four-year period, commencing from the year ending March 31, 2005.