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Statement by Dr.Bimal Jalan, Governor, Reserve Bank of India on Mid-Term Review of Monetary and Credit Policy for the year 2000-2001

The Statement on Mid-Term Review of Monetary and Credit Policy consists of three parts:
I. Mid-Term Review of Macro-economic and Monetary Developments in 2000-01;
II. Stance of Monetary Policy for the second half of 2000-01; and
III. Financial Sector Reforms and Monetary Policy Measures.

I. Mid-Term Review of Macro-economic and
Monetary Developments in 2000-01

Domestic Developments

2. On the basis of the meteorological reports available upto September 2000, it has been observed that the south-west monsoon was active and the quantum and distribution of rainfall were fairly satisfactory at the aggregate level. Of the 35 meteorological sub-divisions, 28 sub-divisions received excess or normal rainfall, which was the same as that of the last year. As some sub-divisions were affected by deficient rainfall or floods, the agricultural out-turn in 2000-01 remains somewhat uncertain. As of now, the output of foodgrains during the year is expected to remain close to that of last year. The total buffer stock of foodgrains stood at 40.8 million tonnes at the end of August 2000, which is higher by 38.3 per cent over the stock level of 29.9 million tonnes at the end of August 1999. The stocks of rice at 13.56 million tonnes are higher by 57.5 per cent, and those of wheat by 27.9 per cent. Overall, therefore, the outlook for agricultural supplies is comfortable during the year.

3. The industrial outlook presents a mixed picture. The increase in industrial production during the first four months of the current financial year was lower at 5.4 per cent than 5.9 per cent recorded during the corresponding period of the previous year. Manufacturing sector recorded a growth rate of 5.7 per cent upto July 2000 as compared with 6.7 per cent in the same period of last year. According to the use-based classification, basic goods production registered an accelerated growth rate of 4.7 per cent in comparison with 3.8 per cent during the same period of the previous year. Production in consumer goods sector also showed a better performance at 8.3 per cent compared with 2.5 per cent during the previous year. The intermediate goods sector recorded a lower growth of 5.2 per cent against 9.6 per cent during the previous year. The capital goods sector showed a negative growth of 0.3 per cent so far. The general deceleration observed in the Index of Industrial Production is partly attributable to the Central Statistical Organisation (CSO) incorporating the revised Wholesale Price Index (1993-94=100) as the deflator.

4. The CSO, in their recent release, has placed the real GDP growth in the first quarter (April-June) of 2000-01 at 5.8 per cent as against 6.9 per cent observed in the first quarter of 1999-2000. Taking the first quarter estimates into account, as per present indications, the real GDP growth during 2000-01 can be placed in the range of 6.0 – 6.5 per cent as against the projection of 6.5 – 7.0 per cent indicated in the April policy statement.

5. The rate of inflation on a point-to-point basis as on September 23, 2000 was 6.06 per cent as against 3.20 per cent a year ago. On an average basis, the annual inflation rate was at 4.96 per cent as against 4.37 per cent in the last year. Inflation as measured by rise in Consumer Price Index (CPI) for the month of August 2000 was 3.99 per cent as compared with 3.15 per cent in August 1999. On an average basis, the annual CPI inflation was, however, substantially lower at 3.25 per cent as against 10.16 per cent in the same period of last year.

6. The contribution to inflation has primarily arisen from the 'fuel, power, light and lubricants' group, the index of which recorded an increase of 25.9 per cent as on September 23, 2000 over the previous year. The increase in particular was in 'mineral oils'. This is a consequential impact of the substantial rise in international oil prices since September 1999. The increase in prices of other items among both the primary articles and the manufactured products, excepting fertilizers, were subdued. The inflation rate, excluding the effect of price increase in the fuel and petroleum group, works out to only 2.44 per cent on a point-to-point basis. While a close watch has to be kept on the inflation front, and the international oil prices continue to be a matter of particular concern, the overall demand/supply conditions in respect of sensitive commodities and manufactured goods remain comfortable. On the whole, as of now, the rate of inflation for the year as a whole is likely to be close to the average of last two years.

7. Growth of money supply during the current financial year upto September 22, 2000 was 6.6 per cent as against 6.8 per cent observed in the same period last year. On an annual basis (September 22, 2000 over September 24, 1999), M3 growth was lower at 13.6 per cent than 16.3 per cent observed in the comparable period of the preceding year. Aggregate deposits of scheduled commercial banks in the current financial year so far increased by Rs.59,603 crore (7.3 per cent) as compared with Rs.51,680 crore (7.2 per cent) in the same period last year. Assuming that the strong deposit accretion will continue, the increase in aggregate deposits during the current year will be of the order of Rs.1,25,000 crore as envisaged in the April policy statement. The monetary expansion during 2000-01 so far, is in the expected trajectory as indicated in the April policy statement, and the projected growth in M3 for 2000-01 is likely to remain around 15.0 per cent.

8. Reserve money in the current financial year upto September 29, 2000 increased by Rs.688 crore (0.2 per cent) as against an expansion of Rs.3,617 crore (1.4 per cent) in the comparable period of last year. Currency in circulation increased by 1.9 per cent as against 3.8 per cent in the corresponding period of the last year. On an annual basis, currency expansion was 9.9 per cent as against 14.8 per cent in the previous year. There has been a shift in the sources contributing to the reserve money expansion during this year. During 1999-2000, the reserve money expansion was mainly due to increase in net foreign exchange assets and RBI credit to commercial sector whereas during this year so far, it has been mainly due to increase in net RBI credit to the central government. There is a sharp decline in the RBI credit to commercial sector in the current year. Net foreign exchange assets of RBI in the current financial year have also declined by Rs.2,799 crore as against an increase of Rs.5,219 crore during the same period last year. Net RBI credit to the Government, however, increased substantially by Rs.10,588 crore as against Rs.308 crore in the corresponding period of last year. On the components side, bankers' deposits with RBI declined substantially by Rs.4,124 crore (primarily due to reduction in CRR). On the whole, the reserve money expansion is expected to remain moderate and significantly lower than last year.

9. There has been a significant pick up in the bank credit and other flows to the commercial sector from the banking system during the current year. Scheduled commercial banks' credit expanded by Rs.30,867 crore (7.1 per cent) upto September 22, 2000 as against an increase of Rs.11,821 crore (3.2 per cent) in the previous year. Food credit increased by Rs.6,398 crore as against Rs.3,716 crore in the previous year. Non-food bank credit increased by Rs.24,469 crore (6.0 per cent) as against an increase of Rs.8,105 crore (2.3 per cent) in the previous year. Together with the provisional data on investments in commercial paper, investments in bonds / shares / debentures of PSUs and private corporate sector, the flow of resources from scheduled commercial banks to the commercial sector increased by Rs.26,471 crore (5.6 per cent) as against Rs.13,647 crore (3.4 per cent) in the previous year. Banks' investments in instruments issued by financial institutions and mutual funds this year increased by Rs.171 crore as against Rs.1,773 crore last year. Total resource flow to the commercial sector including capital issues, GDRs and borrowings from financial institutions increased by Rs.58,838 crore as compared with Rs.34,235 crore in the previous year.

10. The significant expansion in resource flow from banks to the commercial sector has occurred despite some evidence of deceleration in the growth rate of industrial output in the past few months of the current year. The feedback received from select bankers indicates that there have been positive increases in stocks of fertilizers, sugar, petroleum and automobiles. There has been some pick up in infrastructure sector and working capital growth in financing bills receivables. Export growth has also been higher resulting in higher export credit. Data collected internally by RBI on additional limits of Rs.150 crore and above show a high year-on-year growth in limits for manufacture of silk and synthetic fibres, drugs and pharmaceuticals, fertilizers, light engineering, leasing and hire purchase, etc.

11. The Union Budget for 2000-01 placed the net market borrowings of the Central Government at Rs.76,383 crore and gross borrowings at Rs.1,17,704 crore. Upto October 6, 2000, the Central Government, keeping the normal pace, completed net borrowings of Rs.47,026 crore, and gross borrowings of Rs.77,183 crore. RBI continued to combine auction issues with acceptance by private placement of dated securities of the Government consistent with market conditions. In the current financial year so far, devolvement and private placements with RBI amounted to Rs.31,977 crore. However, the reserve money impact of this remained moderate due to decreases in RBI credit to commercial sector and net foreign currency assets. The commercial banks' investment in government securities this year showed an increase of Rs.23,934 crore against an increase of Rs.35,766 crore in the corresponding period of the previous year. However, in the aggregate, banks continued to hold government securities in excess of SLR prescription by a sizeable margin.

12. Government of India's fiscal deficit upto August 2000 this year is reported to be significantly lower at Rs.36,447 crore representing an improvement by 24.3 per cent compared to last year. This has been contributed by a substantial increase in revenue receipts of Rs.64,523 crore, an increase of 27.5 per cent over last year, and a marginal increase of 2.7 per cent in expenditure. This is encouraging. However, two major uncertainties which may finally affect the budgetary outlook are: the pace of progress in realising the projected receipts from disinvestments, and the budgetary outgo to meet the shortfall in the oil pool account. Notwithstanding these uncertainties, it is absolutely essential to contain the borrowing programme within the budgeted levels. In fact, a reduction in the borrowing programme would be desirable as it would make a positive contribution to keeping the interest rate outlook positive and stable.

13. Several initiatives have been taken recently in regard to the internal debt management policy. Consequently, there has been a lengthening of the maturity structure in the last two years. Reissues and price based auctions were also introduced in order to enable consolidation of securities. Combining private placement with strategic open market operations whenever appropriate, has enabled the conduct of the government borrowing programme without being unduly disrupted by unanticipated external and domestic developments. An internal debt management policy, however deft, cannot continuously handle a widening deficit without serious adverse consequences in the debt market. It is, therefore, necessary that a strong framework is put in place to build up positive expectations on the fiscal front and it is hoped that the proposed Fiscal Responsibility Legislation will address this issue.

External Developments

14. There have been marked changes in the external environment since April 2000 when the annual monetary and credit policy statement was presented. During the year 1999-2000, despite a sharp increase in oil prices, the foreign currency assets of India had increased by US $ 5.54 billion, and forex markets were generally stable. In the month of March 2000 alone, the increase in foreign exchange reserves was US $ 2.1 billion, and both exports and capital flows had registered substantial growth. The subsequent period, from about mid-May to early August 2000, however, proved to be difficult for management of the external sector. Forex markets were affected by considerable uncertainty with the rupee depreciating against the US dollar by 3.2 per cent between May 31 and September 29, 2000, and overall foreign exchange reserves declining by US $ 1.8 billion. Since the middle of August 2000, the situation has shown some improvement, and forex markets and reserve levels have been relatively stable.

15. As is well-known, in the very short-run, 'expectations' about the likely behaviour of a currency next day or over a week or fortnight can play a major role in determining its movement against foreign currencies, particularly the US dollar. Given the 'bandwagon' effect of any adverse movements, and the herd behaviour of market participants, expectations can often become self-fulfilling. This is particularly true of thin developing country market, where net volumes are relatively small. The day to day movement in currency markets is further complicated by volatility in private capital flows, which are highly sensitive to short-term domestic and international developments as well as future expectations. In view of these and other imponderables, it is not possible to come to a definitive conclusion about the relative role of different factors in explaining the behaviour of forex markets in India during May – August 2000. Some of the factors which had a bearing on developments during this period were:

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