2.63 Issuances of CP have increased in the recent period following large investments interest seen from mutual funds on account of the guidelines on non-SLR debt securities by banks. Furthermore, reduction in stamp duty on CP effective March 1, 2004 has also boosted its issuance. Though, the CP market is overwhelmingly dominated by first class prime rated issuers (i.e., P1+ and above of CRISIL or its equivalent), it has been found that their share in issuances of CP has declined from as much as 92 per cent during 2002-03 to 85 per cent in April-November 2004. Correspondingly, that of medium rated issuers has increased from 8 per cent to 15 per cent over this period. This increase in investment in medium rated issuers could be on account of investors' search for higher returns.

2.64 There has been a sharp increase in the volume of Forward Rate Agreements/Interest Rate Swaps (FRAs/IRS) during the current financial year so far, both in terms of the number of contracts and outstanding notional principal amount (Table 2.37). Also, the participation in the market has been broad based and includes select public sector banks, PDs and foreign and private sector banks. In a majority of

these contracts, the NSE-MIBOR and MIFOR were used as the benchmark rates. The other benchmark rates used included secondary market yields on the Government of India securities having residual maturity of one year and the primary cut-off yield on 364-day TBs.

2.65 CBLO was operationalised with effect from January 20, 2003 as a money market instrument through the CCIL. CBLO can have original maturity between one day and upto one year. Though regulatory provisions and accounting treatment for the CBLO are the same as those applicable to other money market instruments, it has been exempted from CRR subject to banks maintaining a minimum CRR of 3 per cent. Securities lodged in the Gilts Account of the banks maintained with the CCIL under the Constituents' Subsidiary General Ledger (CSGL) facility remaining unencumbered at the end of any day could be reckoned for SLR purposes by the concer ned bank. By November 2004, 79 members had been admitted to the CCIL's CBLO segment. Of this, 42 were active members. The daily average turnover in CBLO increased from Rs.47 crore in April 2003 to Rs.2,506 crore during March

2004. It has further increased to Rs.9,651 crore with weighted average rate working out to 5.48 per cent in November 2004. Initially, only one insurance company and few cooperative banks had been supplying funds in this market. Now, mutual funds have emerged as the largest suppliers of funds. On the demand side, apart from cooperative banks, public and private sector banks, the composition has also been changing with regular participation of PDs on account of softer borrowing costs in CBLO vis-à-vis call market.

Central Government Borrowings - 2004-05

2.66 The gross market borrowings by the Central Government during the year so far (up to December 15, 2004) amounted to Rs.87,046 crore (Rs.68,000 through dated securities and Rs.19,046 crore by way of 364-day Treasury Bills), substantially lower than that during the corresponding period of the previous year (Table 2.38). As indicated in the calendar for the first half (April 1, 2004-September 30, 2004), Rs.59,000 crore were to be issued. However, only Rs.54,000 crore were raised through dated securities during the first half. On September 20, 2004, an indicative calendar for issue of dated securities for the second half of the year (October 1, 2004-March 31, 2005) amounting to Rs.44,000 crore was released. Of the total issuances amounting to Rs.32,000 crore of dated securities scheduled during October 1, 2004 to December 8, 2004, Rs.14,000 crore were raised while the balance scheduled auctions for Rs.18,000 crore were cancelled. The weighted average yield of the dated securities issued during the current year so far (up to December 15, 2004) at 5.96 per cent was marginally higher than that of 5.80 per cent during the corresponding period of the previous year. The weighted average maturity of the dated securities issued during 2004-05 so far at 13.92 years has been lower than that of 15.67 years during the corresponding period of the fiscal 2003-04. The weighted average yield on the outstanding stock of government securities continued its declining trajectory. It fell to 8.92 per cent as on November 30, 2004 from 9.30 per cent as at end-March 2004 and 10.44 per cent as at end-March 2003. The weighted average maturity on the outstanding securities declined marginally to 9.65 years as on November 30, 2004 as compared with 9.78 years as at end-March 2004 but higher than that of 8.9 years as at end-March 2003.

2.67 Issuance of Floating Rate Bonds (FRBs), which serve as an instrument for management of interest rate risk by investors in the context of elongation of the maturity profile of Government debt, was continued in 2004-05. During the current year so

far (upto December 15, 2004), FRBs were issued in four tranches aggregating Rs.22,000 crore.

2.68 The notified amounts of 91-day and 364-day Treasury Bills for each auction were increased from Rs.500 crore and Rs.1,000 crore, respectively, to Rs.2,000 crore each, effective April 2004. The increase was on account of issuances under the MSS with a view to absorbing surplus liquidity from the market. However, taking into account the prevailing liquidity conditions in the market, the absorption under the MSS through the Treasury Bills was discontinued for a brief period during November 2004. Accordingly, the notified amount for 91-day and 364-day Treasury Bills was reduced to Rs. 500 crore and Rs. 1,000 crore, respectively for the auctions held between November 10, 2004 to December 1, 2004. The primary market cut-off yields of 91-day and 364-day Treasury Bills have edged up during the year so far. Yields have generally been above the Reserve Bank's liquidity absorption rate under the LAF since mid-June 2004.

2.69 The gross and net market borrowings allocated for States for the fiscal year 2004-05 (provisional) are placed at Rs.43,897 crore and Rs.38,774 crore, respectively. This is inclusive of the additional allocation of Rs.22,274 crore under the debt-swap scheme. During the current year so far (up to December 15, 2004), the State Governments have raised Rs.32,848 crore (Rs.31,963 crore through tap sale and Rs.885 crore through auction) under the market borrowing programme; of this, Rs.13,781 crore was raised under the debt-swap scheme. During the current year so far, the weighted average yield of State Government securities worked out to 6.32 per cent, higher than that of 6.20 per cent during the corresponding period of 2003-04.

2.70 During the current financial year, the rise in the secondar y market yield of gover nment securities reflected a number of factors such as higher than expected inflation, interest rate hikes by major central banks and sharp increases in the international crude oil prices. Consequently, 10-year yield rose to 6.73 per cent on August 11, 2004. However, the yields retracted to 6.16 per cent by end-August 2004 reflecting fiscal measures taken by the Government to rein in inflation, lower than anticipated hike in the MSS ceiling amount at Rs.80,000 crore, some moderation in global oil prices and one time permission by the Reserve Bank to banks to transfer the securities to Held-to-Maturity (HTM) category. The yields again increased on account of the hike in the CRR by 50 basis points in two stages on September 18, 2004 and October 2, 2004, sharp rise in international oil prices, hike in domestic energy prices, rise in domestic inflation and tightening of liquidity in November 2004. On November 8, 2004, the 10-year yield peaked at 7.31 per cent as compared with 5.15 per cent as at end-March 2004 (Chart II.19). Subsequently, yields fell on cancellation of scheduled auctions, fall in international oil prices and easing of liquidity conditions. On December 15, 2004, the 10-year yield was at 6.76 per cent. The yield spread of AAA-rated bonds over those of gilts has been broadly constant (Chart II.20).

2.71 The foreign exchange market has generally exhibited orderly conditions during 2004-05 so far (up to December 15, 2004). The exchange rate of the Indian rupee vis-à-vis the US dollar has moved within a range of Rs 43.57 - 46.46 per US dollar during the year 2004-05 so far (up to December 15, 2004). Reflecting large capital flows, the rupee appreciated vis-à-vis the US dollar during April 2004. It, however,

depreciated during May-August 2004, mainly on account of ebbing of capital flows and rising demand for foreign exchange due to high oil prices. In the subsequent months, with the revival of capital flows, the rupee appreciated vis-à-vis the US dollar. Overall, the Indian rupee depreciated by 1.6 per cent against the US dollar during April-December 15, 2004. The rupee also depreciated against the Pound Sterling, the Euro and the Japanese Yen by 6.2 per cent, 9.4 per cent and 0.7 per cent, respectively, during the same period (Chart II.21). During April-October 2004, in terms of monthly averages, while the 5-country (trade-weighted) REER of the rupee appreciated by 1.8 per cent, the NEER depreciated by 1.9 per cent.

2.72 The forward markets reflected the developments in the spot segment of the foreign exchange market. Reflecting excess supplies in the markets, the forward premia turned into discounts during April 2004. The forward rates, however, turned into premia thereafter, as the exchange rate depreciated against the US dollar, import demand picked up and international oil prices steadily edged up (Chart II.22).

2.73 During the current financial year so far (April-October 2004), the primary market showed a mixed trend. Resource mobilisation through public issues increased significantly in consonance with pick-up in the industrial activity. All the public issues floated

during April-October 2004 were equity issues belonging to the private sector excepting one issue from public sector (Table 2.39). On the other hand, the resource mobilisation through private placement as well as Euro issues registered a decline. The decline in resource mobilisation under private placement route was entirely due to the public sector. The public sector entities accounted for 62.7 per cent of total resource mobilisation through private placement as compared with 70.3 per cent during the corresponding period of the previous year.

Disbursements by the All-India Financial Institutions (AIFIs) increased during April-September 2004 mainly on account of the Life Insurance Corporation (LIC).

2.74 The resource mobilisation by mutual funds during April-October 2004 was considerably lower -it was only around one-fourth of that recorded during the corresponding period of the previous year. UTI mutual fund and also public sector mutual funds recorded net outflows (Table 2.40).

2.75 The stock market, which had witnessed a sustained and broad-based rally between end-May 2003 and February 2004, remained subdued during March-July 2004. This was on account of several domestic and international factors such as diversion of funds to primary market due to certain attractive Initial Public Offers (IPOs), uncertainty regarding the outcome of the general elections and its effects on the reform process, slowdown in institutional investments, rise in domestic inflation, rising

international crude oil prices and a strengthening dollar. The stock markets declined sharply on May 17, 2004 - the BSE Sensex declined by more than 11 per cent - due to a variety of domestic and international factors, viz., uncertainties on the political front after the general elections, declining trend in other East Asian markets and rising international crude oil prices. The stock markets, however, recovered immediately on the next trading day and the contagion effects to other segments of the financial markets were contained due to the effective and coordinated regulatory actions undertaken by the Reserve Bank and the Securities and Exchange Board of India (SEBI) as well as strong underlying fundamentals of the economy.

2.76 The stock markets also reacted sharply to the proposal of the Union Budget, 2004-05 to impose Securities Transaction Tax (STT) of 0.15 per cent on all securities transacted in the stock exchanges. The market sentiment revived subsequently on the statement by the Government to revise the STT. Notwithstanding the volatility in international crude oil prices, the stock markets have registered gains in recent months, mainly on account of sustained macroeconomic fundamentals, encouraging quarterly results of major corporates and strong investments by Foreign Institutional Investors’ (FIIs) in equities. The BSE Sensex reached the historic high of 6,402.29 on December 15, 2004. Turnover, market capitalisation as well as the price-earning ratio, on both the Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) in the current year so far, have been higher than those in the corresponding period of the previous year. The volatility was much lower (Table 2.41).

2.77 Most of the sectoral indices, including those of technology, banking and Public Sector Units (PSU) registered a downtrend during April-May 2004, but witnessed a revival subsequently. Banking scrips gained after the Supreme Court upheld the validity of the new securitisation law paving the passage for higher recoveries in the banking sector. They also benefited from the relaxation made by the Reserve Bank in the rules governing the investment portfolio of banks. The FMCG scrips gained on hopes of a rise in demand for these products in the near future (Chart II.23).

2.78 In view of the turnaround since August 2004 onwards, the investments by FIIs in equities are now quite close to that in the corresponding period of the previous year. FIIs have, however, turned net sellers in debt during the current financial year so far. In contrast, the mutual funds have remained net sellers

in equities but net buyers in debt during the current financial year so far (Table 2.42).

2.79 The derivatives segment continued to attract larger volumes. The total turnover in the derivative markets on the NSE during April-November 2004 was more than double the turnover in cash markets (Table 2.43). In response to a demand from market participants for shorter maturity options, BSE decided to offer, effective September 13, 2004, weekly options series with maturity of one week and two weeks in addition to the existing monthly options series.

2.80 Against the backdrop of strong macroeconomic performance, nearly all segments of the financial sector registered significant improvement in their operations, profitability and financial health during 2003-04. The spread of the Scheduled Commercial Banks (SCBs) continued to improve during 2003-04 (Table 2.44). The net profits of the SCBs registered strong growth on the back of a sharp increase in non-interest income, in particular trading profits, in a declining interest rate scenario. The soundness indicators also registered an improvement. The capital to risk-weighted assets ratio (CRAR) improved marginally to 12.9 per cent from 12.7 per cent during 2002-03. Only two banks accounting for a negligible 0.5 per cent of the assets of the SCBs could not satisfy the stipulated 9.0 per cent CRAR. The gross non-performing assets (NPAs) of the banking system declined in absolute terms for the second year in succession despite the switchover to 90-days delinquency norm. The net NPAs to net advances ratio came down sharply to 2.9 per cent from 4.4 per cent during 2002-03 with the range of net NPAs varying between 1.5 per cent for foreign banks and 3.0 per cent for the public sector banks. Improved risk management practices, greater recovery efforts, impact of the Securitisation

2.81 As regards the scheduled urban co-operative banks (UCBs), the policy induced changes - in particular, higher investments in the Government securities - led to a significant improvement in their asset quality and profitability during 2003-04. The net profits of the scheduled UCBs showed a turnaround (Table 2.45).

Their NPAs declined both in absolute as well as percentage terms. The Tier-I capital also registered a turnaround to Rs.297 crore from a negative Rs.10 crore during 2002-03. The performance of the rural cooperatives, however, remained below potential. While profitability of the state co-operative banks increased marginally during 2002-03, the central co-operative banks continued to register losses. The NPAs of rural co-operative banks continued to remain high.

2.82 The income and expenditure of the select AIFIs declined leading to an unchanged profit ratio in 2003-04. The CRAR of all the AIFIs, except IFCI and IIBI, remained well above the regulatory minimum. The net NPAs, however, increased during 2003-04 (Table 2.46).

2.83 The lead data on the performance of the major Non-Banking Financial Companies (NBFCs) (other than RNBCs) holding public deposits of Rs.20 crore and above, accounting for three - fourth of sectoral assets, indicates some changes in their structure of assets and liabilities (Table 2.47). There was a marginal increase in their public deposits during 2003-04 accompanied by a larger recourse to bank loans, partly driven by the softening of the lending rates. In terms of deployment of funds, only loans and advances recorded a marginal increase in contrast to declines in the other areas of business. Investment pattern of Residuary Non-Banking Companies (RNBCs) shifted towards unencumbered approved securities during 2002-03, indicating an improvement in the risk profile of their investment portfolio (Table 2.48).

2.84 The financial health of the NBFCs improved during 2002-03. The decline in their income was more than compensated by the fall in expenditure resulting in a turnaround in their financial performance from the losses witnessed during the previous two years. Reduced interest costs on the back of a softening interest rate regime and a rise in the fee-based income resulted in profits during 2002-03. The gross and net NPAs declined during 2002-03. The CRAR of most NBFCs remained well above the 30 per cent. Only a few NBFCs reported CRAR lower than the stipulated minimum of 12 per cent.

2.85 Global economic activity strengthened further during 2004. According to the International Monetary Fund (IMF), global GDP growth is projected at around 5.0 per cent during 2004, 0.3 percentage points higher than its April 2004 estimate. At this level, global GDP growth would be the highest in the past three decades as the growth pick-up in industrial countries is supported by rapid expansion in emerging markets, notably China. While global growth in the first quarter was much stronger than expected earlier, the momentum of the recovery has, however, slowed thereafter as GDP in major countries such as the US and Japan fell below expectations (Chart II.25). GDP growth in China also eased, which is considered a welcome development, given the concerns of overheating. The recovery in the euro area remains relatively weak and is heavily dependant on external demand. Notwithstanding the firming up of economic activity, the

sharp rise in international crude oil prices poses the main downward risk to global economic prospects. According to estimates by the IMF, a sustained increase of US $ 5 per barrel in crude oil prices can reduce global growth by about 0.3 percentage point with a lag of one year (see Chapter V). Another source of downside risk is the global macroeconomic imbalances which increased further, as the US current account deficit continued to widen matched by higher surpluses in Japan, the Euro Area and the emerging economies of Asia (see Chapter IV).

2.86 The growth in world trade volume, which accelerated during 2004, is expected to moderate during 2005 (Chart II.26). Growth in trade prices is expected to decelerate further during 2005. Private capital flows (net) to developing markets during 2004 are projected to be lower than that during 2003 and are expected to fall even further in 2005. In contrast to the falling trend in total capital flows, foreign direct investment flows have been rising. Emerging Asian countries are expected to see a further build up in their reserves during 2005.

2.87 India's merchandise exports exhibited a robust growth during 2004-05 indicative of growing competitiveness of the manufacturing sector. According to the Directorate General of Commercial Intelligence and Statistics (DGCI&S), merchandise exports during April-November 2004 posted a growth of 24 per cent in US dollar terms, substantially higher than the annual target of 16 per cent as well as that

recorded in the corresponding period of the previous year. The growth rate of India’s exports during 2004 (January - August) remained higher than that of major exporting nations (Table 2.49).

2.88 Merchandise imports continued to record a strong growth during 2004-05. Both oil and non-oil imports contributed to this increase (Table 2.50). Non-oil imports posted a strong growth of 26.8 per cent with the firming up of industrial activity. Oil imports

swelled by 56.0 per cent largely due to the sharp increase in international crude oil prices. The average international crude oil price (Dubai variety) increased by 38 per cent to US $ 35.2 per barrel during April-November 2004. As overall import growth outstripped export growth, trade deficit widened to US $ 17.9 billion during April-November 2004.

2.89 Commodity-wise data show that the growth in exports was spread across all the major commodity-groups. Primary products exhibited a sharp turnaround with substantial contributions from major agricultural commodities (such as tea, wheat, cotton, tobacco, cashew, spices and oil meal), ores and minerals. Exports of manufactured products maintained the tempo of high growth with gems and jewellery, engineering goods and chemicals as the key drivers. Among the engineering goods, exports of transport equipments surged by 74.9 per cent during April-July 2004. Increase in textile exports mainly emanated from readymade garments. Exports of petroleum products posted a sharp increase during April-July 2004, benefiting from higher international oil prices (Table 2.51).

2.90 Destination-wise, exports to almost all the major regions/country groups recorded marked improvement. Exports to the Asian countries maintained their rising profile. Among the major partner countries, sharp increases were recorded in respect of the UK, the US, China, Hong Kong, UAE and Singapore (Table 2.52).