labels: rbi, economy - general, banking & finance policies
Mid-term Review of the macro-economy news
Our Economy Bureau
29 October 2002

...Positives

7) Interest Rates remain low The relatively lower inflation rates in the recent period have helped in creating a favourable environment for moving towards softer interest rates in the economy.

By and large, in line with the announced policy of the Reserve Bank, in the recent period, there has been substantial reduction in interest rates on various types of paper. The reduction in interest rates has been across all maturities, from the short-term money market and Treasury bill rates to long-term securities. This, combined with a benign inflationary environment augurs well for industrial recovery and sustained growth in the economy. During 2002-03 so far, financial markets in India have been generally stable, liquidity has been adequate, and the interest rate environment has also been favourable to promote investments. There are emerging signs of an upturn in industrial output as reflected in positive growth in the capital goods sector and infrastructure industries. A steady increase in net foreign currency assets of the Reserve Bank combined with lower than anticipated level of real economic activity, created a situation of excess liquidity during most part of the current year so far. The Reserve Bank, therefore, had to actively manage liquidity not only through outright OMO sales of securities but also through its daily Liquidity Adjustment Facility (LAF). The average daily absorption through repo transactions under LAF during the year (upto October 25, 2002) amounted to about Rs.14, 800 crore.

Reflecting easy liquidity conditions, interest rates continued to maintain their downward trend. The overnight average call money rate moved down from 6.58 per cent in April 2002 to 5.75 per cent by July 2002 and has since remained around that level. The repo rate was also reduced from 6.0 per cent to 5.75 per cent on June 27, 2002. The 91-day Treasury Bill rate, after firming upto 7.0 per cent by mid-May, dipped below the repo rate to 5.68 per cent in the auction of September 4, 2002. Similarly, the 364-day Treasury bill rate has also declined from 6.99 per cent to 5.86 per cent over the same period. The weighted average discount rate on Commercial Paper (CP) of 61 to 90-day maturity declined sharply by as much as 293 basis points from 9.46 per cent in end-March 2002 to 6.53 per cent by mid-October 2002.

The government securities market also continued to show a softening trend. The yield on government securities with 1-year residual maturity declined from 6.10 per cent at end-March 2002 to 5.92 per cent by October 25, 2002. The yield on government securities with 10-year residual maturity showed a similar decline from 7.36 per cent to 7.07 per cent. The April 2002 policy Statement had mentioned the widening spread between AAA rated corporate bonds and government securities during 2001-02 reflecting 'flight to quality'. This spread has, however, narrowed considerably over the last six months in the wake of the improved industrial outlook.

In recent years, there has been a persistent downward trend in the interest rate structure reflecting moderation of inflationary expectations and comfortable liquidity situation. Changes in policy rates reflected the overall softening of interest rates as the Bank Rate has been reduced in stages from 8.0 per cent in July 2000 to 6.5 per cent by October 2001, which is the lowest rate since May 1973. Similarly, the repo rate has been moderated from 8.0 per cent in March 1999 to 5.75 per cent in June 2002.

imultaneously, the weighted average call money rate has come down from over 13.06 per cent in August 2000 to 5.74 per cent by October 2002.

Similarly, the cut-off yields on 91-day and 364-day Treasury Bills have declined from 10.47 per cent and 10.91 per cent in August 2000 to 5.72 and 5.80 per cent, respectively, by October 2002. While the weighted average discount rate on 3-month CP declined from 12.1 per cent in August 2000 to 6.53 per cent in mid-October 2002, typical interest rate on 3-month CD fell from 10.25 per cent in August 2000 to 6.2 per cent in September 2002.

The yields on government securities with 1-year and 10-year residual maturities fell from 10.82 per cent and 11.47 per cent in August 2000 to 5.92 per cent and 7.07 per cent, respectively, by October 25, 2002. The yield on AAA rated corporate bonds with 5-year residual maturity has declined from 12.15 per cent in September 2000 to 7.0 per cent by October 2002. The interest rates on term deposits of public sector banks over one year have declined from 8.0 - 10.5 per cent in September 2000 to 6.5 - 8.25 per cent by October 2002. Similarly, the PLRs of public sector banks have declined from 11.75 - 13.0 per cent to 10.0 - 12.5 per cent.

By and large, in line with the announced policy of the Reserve Bank, in the recent period, there has been substantial reduction in interest rates on various types of paper. The average lending rates of banks are also lower, although to a lesser extent. The reduction in interest rates has been across all maturities, from the short-term money market and Treasury Bill rates to long-term securities. This, combined with a benign inflationary environment, is a welcome development, which augurs well for industrial recovery and sustained growth in the economy.

8) Government borrowing at a substantially lower cost The Union Budget for 2002-03 placed the net and gross market borrowings of the Central Government at Rs.95, 859 crore and Rs.1, 42,867 crore, respectively. The Central Government completed net market borrowings of Rs.74, 065 crore (77.3 per cent of the budgeted amount) and gross borrowings of Rs.1, 10,032 crore (77.0 per cent of the budgeted amount) upto October 25, 2002. Because of the existing liquidity conditions in the market and low inflation, the Government has been able to borrow at a substantially lower cost during 2002-03. The weighted average yield on government borrowings through dated securities at 7.52 per cent this year, was significantly lower by 192 basis points than 9.44 per cent last year. As part of the debt management strategy, RBI continued to combine auction issues with acceptance by private placement of dated securities consistent with market conditions. The total private placement of dated securities with RBI during the current year (upto October 25, 2002) was Rs.23, 200 crore. The monetary impact of private placement, however, was neutralised by conduct of outright OMO sales of government securities to the tune of Rs.27, 000 crore (upto October 25, 2002).

9) Fiscal deficit lower The gross fiscal deficit of the Central Government, at Rs.55, 496 crore upto August 2002, was lower by about 1.0 per cent over the corresponding period of last year and constituted about 41 per cent of the budget estimate for the current year. Similarly, revenue deficit at Rs.45, 525 crore accounted for about 48 per cent of the budget estimate for the whole year.

10) Drought is over The threat of a drought is over after good rains in August-September 2002 although kharif crops are hit. A good Rabi crop is expected to minimise the losses. Production of non-foodgrains is likely to show a positive growth.

11) Inflation remains moderate Inflation been moderate despite rise in energy prices and poor kharif crop production due to a poor monsoon.

Annual inflation, as measured by variations in the Wholesale Price Index (WPI) (base: 1993-94=100) on a point-to-point basis, was 2.8 per cent on October 12, 2002 as against 3.0 per cent a year ago. On an average basis, it was even lower at 2.3 per cent as against 6.3 per cent in the previous year. Annual inflation, as measured by variations in the Consumer Price Index (CPI) for industrial workers on a point-to-point basis, was 3.9 per cent in August 2002 as against 5.2 per cent a year ago.

Inflation in the current year is more evenly spread across major sub-groups. Annual inflation on 'fuel, power, light and lubricants' sub-group (weight: 14.2 per cent) was lower at 4.0 per cent this year as compared with 5.6 per cent last year. The annual inflation rate, excluding the impact of price increases witnessed in this energy related sub-group, at 2.5 per cent was slightly higher than that of 2.4 per cent in the preceding year. While prices of primary articles (weight: 22.0 per cent) recorded a lower increase of 2.2 per cent as against 4.0 per cent last year, manufactured products (weight: 63.7 per cent) registered a higher increase of 2.7 per cent as against 1.8 per cent last year. Among primary articles, the increase in prices was mainly due to an increase in prices of oilseeds. In manufactured products, the increase in prices of edible oils was relatively high.

The deficiency in rainfall, which was more pronounced in the first two months of this year's monsoon season, exerted pressure on the prices of many agricultural commodities. Whereas a large stock of foodgrains and comfortable foreign exchange position will help supply management, the prices of 'fuel, power, light and lubricants' sub-group are likely to be affected adversely by increase in international oil prices. On balance, the domestic inflation outlook still looks comfortable and the inflation rate is likely to be around 4.0 per cent, which is in line with the expectations in the annual policy Statement of 2002-03.

WPI Growth (% YoY)

Weight

Sep. 28, 2002

Sep. 29, 2001

Sep. 30, 2000

Sep. 25, 1999

ALL COMMODITIES

100.00

3.3

3.3

7.6

1.9

Primary Articles

22.02

2.3

6.4

1.1

2.4

(i) Fruits and Vegetables

2.92

0.4

26.0

-3.3

-19.2

Fuel, Power, Light and Lubricants

14.23

5.8

3.8

36.9

5.3

Manufactured Products

63.75

2.8

1.9

2.7

0.8

(i) Sugar, Khandsari & Gur

3.93

-6.9

-5.0

-0.6

-5.8

(ii) Edible Oils

2.76

20.7

14.6

-18.1

-16.0

(iii) Cement

1.73

-2.6

11.4

1.4

-1.9

(iv) Iron & Steel

3.64

6.3

-1.2

1.0

1.2

Source: Office of the Economic Adviser, Ministry of Commerce & Industry, Government of India.

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Mid-term Review of the macro-economy