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III. Monetary and Liquidity Conditions

Monetary Survey

Monetary conditions have remained comfortable during 2005-06 so far despite a sustained pick-up in credit demand from the commercial sector. Banks were able to finance the higher demand for commercial credit by curtailing their incremental investments in Government securities. Strong growth in deposits in the current fiscal year and higher investments by non-bank sources in Government securities also enabled banks to meet credit demand. Concomitantly, reserve money expansion was high, reflecting a lower order of sterilisation operations by the Reserve Bank. Broad money (M3) growth, on a year-on-year basis, was above the indicative trajectory of 14.5 per cent projected in the Annual Policy Statement (April 2005) (Chart 11). Expansion in the residency-based new monetary aggregate (NM3) – which excludes foreign currency non-resident deposits – was higher than M3 on account of net outflows under foreign currency deposits and continued access of banks to call/term borrowings (Table 15).

Currency demand fell in the second quarter in line with the trend in the previous year. Year-on-year growth in currency, which was lower than a year ago till mid-September 2005, however, edged up during the last fortnight of September (Chart 12).

Table 15: Monetary Indicators

           

(Amount in Rupees crore)

                   

Item

     

Outstanding

 

Variation (year-on-year)

       

as on September

       
           

2004

2005

         

30, 2005

       
           

Amount

Per cent

Amount

Per cent

1

       

2

3

4

5

6

I.

Reserve Money*

 

5,17,693

66,894

18.0

78,521

17.9

II.

       

24,65,763

2,69,186

14.6

3,51,296

16.6

 

Broad Money (M3)

           
 

a)

Currency with the Public

 

3,63,925

36,746

12.9

42,534

13.2

 

b)

Aggregate Deposits

 

20,96,624

2,29,581

14.8

3,10,587

17.4

   

i)

Demand Deposits

 

3,32,074

35,577

15.8

70,821

27.1

   

ii)

Time Deposits

 

17,64,550

1,94,004

14.6

2,39,767

15.7

   

of which: Non-Resident Foreign Currency Deposits

76,507

4,373

6.0

-214

-0.3

III.

       

24,28,068

2,80,460

15.7

3,58,217

17.3

 

NM3

             
   

of which: Call Term Funding from Financial Institutions

42,168

11,039

57.3

11,851

39.1

IV.

a)

     

25,23,954

2,97,864

16.1

3,74,434

17.4

   

L1

             
   

of which: Postal Deposits

 

95,885

17,404

28.0

16,217

20.4

 

b)

     

25,25,605

2,98,629

16.1

3,69,290

17.1

   

L2

             
   

of which: FI Deposits

 

1,651

765

12.7

-5,144

-75.7

 

c)

     

25,45,445

2,97,505

15.8

3,69,886

17.0

   

L3

             
   

of which: NBFC Deposits

 

19,840

-1,124

-5.5

596

3.1

V.

Major Sources of Broad Money

           
 

a)

Net Bank Credit to the Government (i+ii)

7,42,354

29,127

4.1

-4,648

-0.6

   

i)

Net Reserve Bank Credit to Government

-33,950

-67,737

 

-42,644

 
     

of which: to the Centre

 

-33,909

-64,453

 

-41,776

 
   

ii)

Other Banks’ Credit to Government

7,76,304

96,863

15.1

37,996

5.1

 

b)

Bank Credit to Commercial Sector

14,07,816

1,82,459

19.6

2,95,557

26.6

   

of which: Scheduled Commercial Banks’ Non-food Credit

11,83,909

1,79,586

24.9

2,83,553

31.5

 

c)

Net Foreign Exchange Assets of Banking Sector

6,60,700

1,47,770

34.2

81,075

14.0

                   

* : As on October 14, 2005. FIs: Financial Institutions. NBFCs: Non-banking Financial Companies.
Note:1. Data are provisional.
2. Select aggregates are adjusted for the effect of conversion of a non-banking entity into a banking entity effective
October 11, 2004.

Growth in demand deposits remained high in tandem with the sustained pick-up in non-food credit and a buoyant primary capital market, with funds getting temporarily parked in demand deposits (Table 16).

 

Table 16: Monetary Aggregates – Variations

             

(Rupees crore)

                 
       

2004-05

 

2005-06

Item

2004-05

Q1

Q2

Q3

Q4

Q1

Q2

                 

1

 

2

3

4

5

6

7

8

                 
 

(=1+2+3 = 4+5+6+7-8)

2,48,262

69,831

16,999

53,459

1,07,974

1,05,850

1,09,544

M3

               
                 

Components

             

1.

Currency with the Public

40,797

14,540

-3,098

15,422

13,933

19,671

-11,514

2.

Aggregate Deposits with Banks

2,06,106

56,754

19,342

37,725

92,284

87,737

1,20,764

 

2.1 Demand Deposits with Banks

25,391

-14,038

2,094

15,721

21,614

11,401

36,657

 

2.2 Time Deposits with Banks

1,80,716

70,792

17,248

22,004

70,671

76,337

84,107

3.

‘Other’ Deposits with RBI

1,359

-1,463

755

311

1,756

-1,558

294

Sources

             

4.

Net Bank Credit to Government Sector

15,002

12,986

-11,798

-4,524

18,338

6,980

-10,339

 

4.1 RBI’s Net Bank Credit to Government Sector

-62,882

-34,143

-6,179

184

-22,744

9,275

-25,251

 

4.1.1 RBI’s Net Credit to Central Government

-60,177

-30,029

-4,499

203

-25,852

14,600

-25,251

 

4.2 Other Bank Credit to Government Sector

77,884

47,129

-5,619

-4,708

41,082

-2,295

14,912

5.

Bank Credit to Commercial Sector

2,64,389

38,057

40,093

1,07,789

78,451

64,221

95,737

6.

Net Foreign Exchange Assets of Banking Sector

1,22,669

49,206

-1,335

32,891

41,907

-13,378

24,823

 

6.1 Net Foreign Exchange Assets of RBI

1,28,377

57,525

-5,260

31,462

44,651

-14,595

24,823

7.

Governments’ Net Currency Liabilities to the Public

152

37

9

89

17

47

26

8.

Net Non-Monetary Liabilities of Banking Sector

1,53,949

30,454

9,969

82,787

30,739

-47,979

703

                 

Memo:

             

1.

Non-resident Foreign Currency Deposits

802

953

-189

-654

692

-494

596

2.

SCBs’ Call-term Borrowing from Financial Institutions

44,853

5,409

530

35,464

3,451

643

7,178

3.

Overseas Borrowing by Scheduled Commercial Banks

8,529

3,012

-658

6,267

-90

1,788

6,168

Note: Data include effect of conversion of a non-banking entity into a banking entity on October 11, 2005.

Year-on-year (y-o-y) growth in time deposits as on September 30, 2005 at 15.7 per cent was higher than a year ago, benefiting from modest increases in deposit rates and reflecting base effects of a low growth during the previous year. There was some deceleration in growth of small savings to 20.6 per cent by end-August 2005 from 23.3 per cent in December 2004. Nonetheless, the growth of small savings still remains substantially higher than that of time deposits reflecting both higher interest rates and tax incentives (Chart 13).

Food credit recorded a decline from its end-March 2005 level in line with a lower order of procurement of foodgrains. On the other hand, commercial sector’s demand for bank credit continued to remain strong reflecting a strengthening of the industrial recovery and demand for housing credit. Accordingly, scheduled commercial banks’ non-food credit, on a year-on-year basis, registered a growth of 31.5 per cent as on September 30, 2005 on top of a base as high as 24.9 per cent a year ago. Incremental credit-deposit ratio of SCBs remained above 100 per cent between November 2004 and August 2005 (Chart 14). Latest available data indicate that credit pick-up during April-August 2005 was quite broad-based. The high growth of credit to the priority sector reflected largely the sharp growth in agricultural credit as well as small housing loans (up to Rs.15 lakh). Amongst industries, credit to iron and steel, other metal and metal products, engineering, automobiles, cement, construction, paper, rubber, tobacco, textiles and gems and jewellery recorded an upsurge (see Table 35).

In addition to bank credit, industry has also increasingly relied upon non-bank sources of funds in recent years. Equity issuances continued to be steady during April-September 2005, benefiting from buoyancy in capital markets. Mobilisation through issuances of commercial papers also remained strong. Funds raised through external commercial borrowings (ECBs), which were large during 2004-05, moderated. This was mainly on account of turnaround in short-term trade credits as oil companies increased their recourse to domestic financing (Table 17).

Sustained high growth in commercial credit was funded by the banks mainly by restricting their incremental investments in Government securities. Incremental investments by commercial and co-operative banks in the Government papers at Rs.12,617 crore in the current fiscal (up to September 30) were less than one-third of

Table 17: Select Sources of Funds to Industry

               

(Rupees crore)

Item

     

2004-05

 

2005-06

 
       

Q1

Q2

Q3

Q4

Q1

Q2

 

1

     

2

3

4

5

6

7

 

A.

Bank Credit to Industry

6,636

11,186

13,733

21,680

11,148

14,698

@

B.

Flow from Non-banks to Corporates

             
 

1.

Capital Issues* (i+ii)

228

4,529

3,214

2,495

1,254

4,977

 
   

i) Non-Government Public Ltd. Companies (a+b)

228

4,529

530

2,495

1,254

4,977

 
   

a) Bonds / Debentures

0

0

0

0

118

0

 
   

b) Shares

 

228

4,529

530

2,495

1,136

4,977

 
   

ii) PSUs and Government Companies

0

0

2,684

0

0

0

 
 

2.

ADR / GDR / FCCBs +

770

597

872

721

789

739

 
 

3.

External Commercial Borrowings (ECBs) $

12,199

3,860

11,084

11,744

3,026

-

 
 

4.

Issue of CPs

 

1,819

421

1,901

963

3,562

1,928

 

C.

Depreciation Provision

5,504

5,836

5,731

6,106

7,137

-

 

D.

Profit after Tax

 

10,396

13,004

13,196

16,798

16,726

-

 

*: Gross issuances excluding issues by banks and financial institutions.
Figures are not adjusted for banks’ investments in capital issues, which are
not expected to be significant.
+: Global Depository Receipts (GDRs)/American Depository Receipts (ADRs)
and Foreign Currency Convertible Bonds (FCCBs)excluding issuances by banks
and financial institutions.
$: Including short-term credit.
@ :Data pertain to July-August 2005.
Note:Data are provisional.

their incremental investments in the corresponding period of the previous year. Consequently, commercial banks’ holding of Government securities fell below 36 per cent of their net demand and time liabilities (NDTL) as on September 30, 2005 from nearly 40 per cent a year ago, but still substantially in excess of the statutory requirement of 25 per cent (Chart 15).

Reserve Money Survey

Reserve money growth as on October 14, 2005 at 17.9 per cent was almost the same as that a year ago (18.0 per cent), although the growth rate during 2005-06 till October 7, 2005 had remained consistently above that of 2004-05 (Chart 16). The higher growth in reserve money, despite broadly a similar order of accretion to the

Reserve Bank’s net foreign exchange assets (NFEA) (net of revaluation) during the current fiscal, primarily reflected the relatively lower order of sterilisation operations. This, in turn, reflected a lower appetite for Government securities by the banking system in view of strong credit demand from the commercial sector. The higher order of expansion in the reserve money was also due to the impact of the increase in the cash reserve ratio (CRR) by 50 basis points during September-October 2004.

The Reserve Bank’s foreign currency assets (net of revaluation) increased by Rs.29,544 crore during fiscal 2005-06 (up to October 14), comparable to that of Rs.30,604 crore during the corresponding period of 2004-05. Most of the increase in the NFEA was concentrated in the second quarter of the fiscal and consequently the quarter also witnessed liquidity absorption operations (Chart 17 and Table 18).

Table 18: Variation in Major Components and Sources of Reserve Money

                 
             

(Rupees crore)

                 

Item

2004-05

2005-06

 

2004-05

 

2005-06

   

(up to

           
   

Oct. 14)

Q1

Q2

Q3

Q4

Q1

Q2

                 

1

2

3

4

5

6

7

8

9

                 

Reserve Money

52,623

28,557

-6,812

-6,285

31,546

34,174

6,856

159

Components

               

1. Currency in Circulation

41,633

22,516

14,317

-4,166

16,467

15,015

19,556

-10,378

2. Bankers’ Deposits with RBI

9,631

7,431

-19,665

-2,874

14,769

17,401

-10,680

9,780

3. Other Deposits with RBI

1,359

-1,389

-1,463

755

310

1,757

-2,021

757

Sources

               

1. RBI’s net credit to Government

-62,882

6,641

-34,143

-6,179

184

-22,744

9,275

-25,251

of which: to Central Government

-60,177

11,897

-30,029

-4,499

203

-25,852

14,600

-25,251

2. RBI’s credit to banks and commercial sector

-833

-1,377

-2,985

-740

3,726

-835

1,155

-1,869

3. NFEA of RBI

1,28,377

24,272

57,525

-5,260

31,462

44,651

-14,595

24,823

4. Government’s Currency Liabilities to the Public

152

73

37

9

89

17

63

10

5. Net Non-Monetary Liabilities of RBI

12,191

1,052

27,245

-5,885

3,916

-13,085

-10,957

-2,446

                 

Memo:

               
                 

1. Net Domestic Assets

-75,754

4,285

-64,336

-1,025

84

-10,477

21,450

-24,664

2. FCA adjusted for revaluation

1,15,044

29,544

33,160

-3,413

29,858

55,440

5,034

23,665

3. Net Purchases from Authorised Dealers

91,105

17,878 *

30,032

-9,789

22,771

48,091

0

17,878 *

4. NFEA/Reserve Money (per cent) (end-period)

125.3

123.1

126.1

126.7

124.9

125.3

120.6

125.6

5. NFEA/Currency (per cent) (end-period)

166.2

162.9

158.8

159.2

160.7

166.2

154.1

164.9

                 

* : Up to August 26, 2005. NFEA : Net Foreign Exchange Assets. FCA : Foreign Currency Assets.
Note : Data are based on March 31 for Q4 and last reporting Friday for all other quarters.

Liquidity absorption operations during 2005-06 so far have mainly been in the form of reverse repo operations under the liquidity adjustment facility (LAF) in contrast to a heavy reliance on issuances under the market stabilisation scheme (MSS) during the comparable period of the preceding year (Chart 18).

In the absence of any subscription to the Government’s market borrowing programme, the Reserve Bank’s net credit to the Centre reflected liquidity management operations of the Bank (Table 19). The Reserve Bank’s net credit to the Centre increased by Rs.11,897 crore during 2005-06 (up to October 14) as against a substantial decline of Rs.21,395 crore during the comparable period of 2004-05.

Table 19: Net Reserve Bank Credit to the Centre - Variations

               

(Rupees crore)

                   

Item

2004-05

2005-06

 

2004-05

 

2005-06

     

(up to

           
     

Oct. 14)

Q1

Q2

Q3

Q4

Q1

Q2

                   

1

 

2

3

4

5

6

7

8

9

                   

Net Reserve Bank Credit to the

               

Centre (1+2+3+4-5)

-60,177

11,897

-30,029

-4,499

203

-25,852

14,600

-25,251

1.

Loans and Advances

0

0

3,222

-3,222

0

0

0

0

2.

Treasury Bills held by the Reserve Bank

0

0

0

0

0

0

0

0

3.

Reserve Bank’s Holdings of

               
 

Dated Securities

12,323

6,952

-2,900

22,176

14,095

-21,048

8,221

-17,243

4.

Reserve Bank’s Holdings of

               
 

Rupee Coins

58

119

175

-11

-93

-15

-40

-33

5.

Central Government Deposits

72,558

-4,826

30,525

23,443

13,799

4,791

-6,419

7,974

                   

Memo *

               
                   

1.

Market Borrowings of Dated

               
 

Securities by the Centre #

80,350

84,000

28,000

26,000

14,000

12,350

42,000

39,000

2.

Reserve Bank’s Primary

               
 

Subscription to Dated Securities

1,197

0

0

847

0

350

0

0

3.

Repos (+) / Reverse Repos (-) (LAF),

               
 

net position

15,315

10,075

-26,720

34,205

27,600

-19,770

9,660

-14,835

4.

Net Open Market Sales £

2,899

2,521

429

427

871

1,171

1,543

941

5.

Mobilisation under MSS

64,211

4,065

37,812

14,444

353

11,602

7,469

-4,353

6.

Primary Operations $

-6,625

37,485

37,353

-30,484

-36,984

23,490

18,205

15,167

* : At face value. #: Excluding Treasury Bills.
£ : Excluding Treasury Bills and including operations under Consolidated Sinking Funds (CSF) and Other
Investments.
$ : Adjusted for MSS and Centre’s surplus investment.
Note: Quarterly variations are based on March 31 for Q4 and last reporting Fridays for other quarters.

Liquidity Management

During 2005-06 so far (up to October 14, 2005), the Reserve Bank’s operations to absorb liquidity from the system have been relatively moderate in view of the marked increase in merchandise trade deficit and the pick-up in domestic credit demand. Liquidity management operations during 2005-06 so far can be analysed in terms of three phases (Table 20). The first period –beginning end-March 2005 up to July 22, 2005 – did not witness purchases from the foreign exchange market by the Reserve Bank reflecting a sharp widening of the trade deficit. Moreover, the period also witnessed FII outflows during April-May 2005. Although FII inflows bounced back during June 2005, foreign

Table 20: Phases of Reserve Bank’s Liquidity Management Operations

               

(Rupees crore)

                   
         

2004-05

   

2005-06

 
                   

Item

March 27 -

May 15 -

October 30,

April 1 -

July 23 -

August 13 -

       

May 14,

October 29,

2004 -

July 22,

August 12,

October 14,

       

2004

2004

March 31,

2005

2005

2005

           

2005

     
                   

1

     

2

3

4

5

6

7

                   

A. Drivers of Liquidity (1+2+3)

37,170

-24,746

44,009

-6,959

28,014

-24,455

   

1.

RBI’s Foreign Currency Assets

           
     

(adjusted for revaluation)

37,919

-4,614

83,662

6,412

19,348

3,785

   

2.

Currency with the Public

-20,021

6,365

-25,622

-14,828

-1,307

-5,360

   

3.

Others (residual)

19,272

-26,497

-14,031

1,457

9,973

-22,880

     

3.1 Surplus cash balances of the

           
     

Centre with the Reserve Bank

15,355

-18,481

-7,721

6,053

5,972

-12,666

B.

 

Management of Liquidity

           
   

(4+5+6+7)

-40,148

37,960

-31,852

1,329

-24,567

35,090

   

4.

Liquidity impact of LAF Repos

-12,095

66,040

-11,875

8,845

-26,565

27,795

   

5.

Liquidity impact of OMO (net)*

-277

-769

-1,853

0

0

0

   

6.

Liquidity impact of MSS

-27,776

-27,311

-9,124

-7,516

1,998

7,295

   

7.

First round liquidity impact

           
     

due to CRR change

0

0

-9,000

0

0

0

C.

 

Bank Reserves # (A+B)

-2,978

13,214

12,157

-5,630

3,447

10,635

                   

+:Indicates injection of liquidity into the banking system.
-:Indicates absorption of liquidity from the banking system.
#:Includes vault cash with banks and adjusted for first round liquidity impact due to CRR change.
*:Adjusted for operations under Consolidated Sinking Funds (CSF) and Other Investments.

exchange markets were more or less balanced reflecting pressures from the trade deficit. During this phase, in the face of sustained credit demand, banks curtailed their incremental investments in the Government securities and reduced their operations under the Reserve Bank’s reverse repo window. Consequently, the Reserve Bank injected primary liquidity through reversal of reverse repo operations.

During July 23 - August 12, following the revaluation of the Chinese currency, there were large foreign exchange inflows. Moreover, there was a reduction in the Centre’s surplus investment balances. As a result, the balances under LAF reverse repo increased sharply from Rs.10,485 crore as on July 22 to Rs.37,050 crore as on August 12, peaking at Rs.50,610 crore on August 3, 2005. In the subsequent period (August 13 – October 14), again, accretion to the Reserve Bank’s foreign exchange assets (net of revaluation) slowed down. Government surplus balances with the Reserve Bank started bouncing back leading to locking up of liquidity. Accordingly, the period witnessed injection of liquidity through reversal of reverse repos as balances under LAF were unwound (Table 21 and Chart 19).

Table 21: Liquidity Overhang

     

(Rupees crore)

         

Outstanding as on

LAF

MSS

Centre’s Surplus

Total

last Friday/March 31

   

with the RBI @

(2 to 4)

         

1

2

3

4

5

         

2004

       

April

73,075

22,851

0

95,926

May

72,845

30,701

0

1,03,546

June

61,365

37,812

0

99,177

July

53,280

46,206

0

99,486

August

40,640

51,635

7,943

1,00,218

September

19,245

52,255

21,896

93,396

October

7,455

55,087

18,381

80,923

November

5,825

51,872

26,518

84,215

December

2,420

52,608

26,517

81,545

         

2005

       

January

14,760

54,499

17,274

86,533

February

26,575

60,835

15,357

1,02,767

March

19,330

64,211

26,102

1,09,643

April

27,650

67,087

6,449

1,01,186

May

33,120

69,016

7,974

1,10,110

June

9,670

71,681

21,745

1,03,096

July

18,895

68,765

16,093

1,03,753

August

25,435

76,936

23,562

1,25,933

September

24,505

67,328

34,073

1,25,906

October*

9,255

68,276

26,743

1,04,274

         

* As on October 14, 2005.
@ : Excludes minimum cash balance with the RBI.

Stable and comfortable liquidity conditions kept the call money rates close to the level of the reverse repo rate (Chart 20). With the increase in the fixed reverse repo rate from 4.75 per cent to 5.00 per cent, effective April 2005, call rates also edged up in the subsequent period. In view of comfortable liquidity

 

 

 

conditions, the Reserve Bank conducted LAF repos only on four occasions during 2005-06 (June 28, June 30, September 28 and September 29, 2005) of Rs.210 crore, Rs.575 crore, Rs.1,640 crore and Rs.1,000 crore, respectively. On a net basis, the Reserve Bank, however, absorbed liquidity even on those four days.

 

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