Global market sentiments have improved following policy interventions in the euro area and positive data from the US. Risks to EDEs capital flows from the deleveraging by European banks, although
still prevalent, appear to have moderated in the wake of the ECB’s initiatives to extend liquidity support. Taking cues from favourable international developments, Indian financial markets revived
in Q4 of 2011-12. The revival, however, has been primarily liquidity driven and expectations led.
For the recovery to be sustained, macroeconomic fundamentals need to improve.
Stress in euro area eases, but firewalls remain weak
V.1 The imminent risks of a region-wide
spread of contagion from the adverse feedback
loop between the banks’ balance sheet and
sovereign debt in the euro area that conditioned
the global markets in Q3 of 2011-12 somewhat
waned in the following quarter. Though risks
from falling growth and high unemployment in
parts of the euro area remain, funding pressures of the euro area banks have eased for the time
being. This follows the European Central Bank
(ECB)’s actions to infuse liquidity coupled with
the individual sovereigns’ policy initiatives.
Under the long-term refinancing operations (LTRO) of the ECB in December 2011 and
February 2012, around €1 trillion has been
injected.
V.2 Yet another major development in the region has been the completion of the sovereign
bond swap in Greece, amounting to €177 billion
of debt, aimed at reducing the debt burden and
financial stress. The agreement on a second
bailout for Greece valued at €130 billion (which
is backed by €28 billion contribution from the
IMF) has also helped in improving global
market sentiments.
V.3 Some revival in the euro area term money
markets and interbank activity was seen,
indicating that the pressure on euro area banks
may have temporarily eased. Market perception
of falling sovereign credit risk is evident from
the decline in sovereign spreads and improved
equity market performance (Chart V.1).
|
V.4 Notwithstanding the reduction in financial market stress, euro area firewalls remain weak. Euro area member states have agreed to increase the size of the firewall to about € 800 billion
(US$ 1 trillion). As a result, concerns about the
adequacy of the firewall may have somewhat
eased. However, in view of the mild recession
the euro area is currently experiencing,
widespread austerity measures could have implications for economic growth and tax
revenue. Although the LTROs have pumped in
a large amount of liquidity in the euro area banking system, a large part of this liquidity is
finding its way to the overnight deposit facility
of the ECB (Chart V.2a).Therefore, the amount of onward transmission of credit remains to be
seen. It is possible that in search of yields a part
of this liquidity is being channeled into
emergining and developing economies’(EDEs) equity markets. Consequently, FII inflows into
equity markets of EDEs have increased in 2012
so far (Chart V.2b).
Ongoing easy monetary policy in AEs possibly enhances capital inflows to EDEs
V.5 Elsewhere in the advanced economies (AEs), central banks continue with easy
monetary policies that enhance global liquidity.
The Bank of England decided to purchase an
additional £50 billion worth of government
securities, while the Bank of Japan announced
an increase in its asset purchase programme.
The Fed, aside from continuing with its policy
stance of excessively low interest rates,
observed that the majority of the large US banks display robust health in the face of conservative stress tests, and are capable of meeting the
requisite capital adequacy norms even under
adverse conditions. All these factors coupled
with better than expected recovery in the US
growth have temporarily helped reduce the stress in global financial markets and could have channeled FII flows into EDEs in search of higher yields.
Pressures ease in domestic markets, but some volatility persists
V.6 Despite the slowdown in domestic growth
and the recent oil price increase, Indian equity
markets stayed upbeat in Q4 of 2011-12,
conditioned by the revival in global markets,
the surge in FII inflows and the decline in
domestic inflation. Reflecting the prevailing
structural liquidity deficit coupled with outflows for advance tax payment by companies, money
market rates remained elevated. The yields on
government bonds fell for most part of the
quarter, although the trend reversed following
the budget announcements of higher borrowing
in 2012-13. Policy measures taken by the Reserve Bank have reduced volatility in the
currency markets.
Money market rates remained elevated reflecting deficit liquidity conditions
V.7 In view of the tight liquidity conditions
in the system, call rate remained at levels above
the policy (repo) rate during H2 of 2011-12 (Chart V.3). Following the CRR cut in January
2012, the call rate that had risen to 9.0 percent
in December 2011 declined slightly. However,
it again moved up in March 2012 following tight
liquidity conditions on account of quarterly
advance tax payments. The rates in the collateralised segments (i.e., CBLO and market
repo) moved in tandem with call rate, albeit at
a lower level, during Q4. The prevailing deficit
liquidity conditions prompted a few banks to
access funds from the MSF window.
V.8 During 2011-12, while the share of call
money in total overnight money market volume
increased, that of collateralised segments
declined. In the collateralised segment, banks and primary dealers remained the major groups
of borrowers, and mutual funds (MFs) dominated
as lenders (Table V.1).
Table V.1: Average Daily Volumes in Domestic Financial Markets |
(` billion) |
|
Money Market |
Bond Market |
Forex
Market
Inter-bank
(US$ bn) |
Stock Market## |
LAF |
Call Money |
Market Repo |
CBLO |
Commercial Paper* |
Certificates
of Deposit* |
G-Sec@ |
Corporate Bond # |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
10 |
11 |
Mar-11 |
-809.63 |
112.78 |
151.34 |
432.01 |
803.05 |
4,247.40 |
81.44 |
22.69 |
22.21 |
148.18 |
Jun-11 |
-741.25 |
115.62 |
166.50 |
413.13 |
1,046.89 |
4,237.67 |
128.44 |
23.35 |
24.05 |
127.99 |
Sep-11 |
-559.20 |
137.82 |
138.93 |
451.19 |
1,446.21 |
3,834.72 |
123.20 |
22.44 |
22.38 |
137.57 |
Dec-11 |
-1,166.62 |
148.80 |
99.47 |
264.93 |
1,341.49 |
4,030.03 |
205.72 |
30.03 |
17.80 |
108.64 |
Jan-12 |
-1,292.32 |
172.60 |
89.12 |
279.59 |
1,498.83 |
3,909.39 |
233.44 |
24.52 |
17.70 |
131.46 |
Feb-12 |
-1,405.26 |
141.55 |
121.69 |
331.22 |
1,613.94$ |
4,028.85 |
157.93 |
35.74 |
17.68 |
198.36 |
Mar-12 |
-1,574.26 |
175.10 |
111.75 |
379.82 |
|
|
98.58 |
26.12 |
|
151.90 |
*: Outstanding position. @: Average daily outright trading volume in Central Government dated securities.
#: Average Daily Trading in Corporate Bonds. ##: Average daily Turnover in BSE and NSE.
^: As at mid-June 2011. $: Feb 15, 2012.
Note: In col. 2, (-) ve sign indicates injection of liquidity while (+) ve sign indicates absorption of liquidity. |
V.9 The weighted average effective interest
rates (WAEIR) on certificates of deposits (CDs) firmed up during Q4 of 2011-12. The increase
was significant towards the end of February
2012, due to tight liquidity conditions and lower
rollover of CDs by MFs.
V.10 In the primary g-sec market, the yields
on auction Treasury Bills (TBs) generally firmed
up till March 2012 in line with the large issuance and tight liquidity conditions.
Yields harden following the announcement of higher government borrowing programme
V.11 In the secondary market, the g-sec yield
declined initially and was range-bound for most
of Q4 reflecting improved sentiment on account of the OMO purchases by the Reserve Bank, an
increase in the ceiling for investment in
government securities by foreign institutional
investors (FIIs) and expectation of moderation
in inflation. The divergent trend in yield
movements of TBs and dated securities resulted
in an inverted yield curve during the period.
This largely reflected the large issuances of TBs at the short-end of the yield curve. Following the Union Budget announcement of a higher than anticipated market borrowing programme
and the subsequent issuance of auction calendar
for dated securities, the 10 year yield rose
steadily to 8.63 percent by March 30, 2012 as
compared to 8.54 percent as on December 30,
2011 (Chart V.4).
|
V.12 According to SEBI data, FIIs made
investment in debt worth `189.3 billion in Q4
of 2011-12. MFs also bought debt worth `1317.8 billion during the same period.
V.13 The gross market borrowing programme
of the central government through dated securities during 2011-12 to the tune of `5,100
billion, a 16.7 percent hike over the previous
year, was successfully completed. The bid-cover ratio stood in the range of 1.39-5.12 as against
1.39-3.87 during the previous year. The cash
balance of the central government transited into
surplus from WMA/OD since February 7, 2012.
V.14 During 2011-12, 24 states and the UT of
Puducherry raised `1,586 billion on a gross
basis which was almost 52 percent higher than
that during the previous year. The weighted
average yield firmed up to 8.79 percent from
8.39 percent during the previous year.
Base rate remains sticky reflecting higher cost of funds
V.15 During Q4 of 2011-12, deposit rates of
SCBs remained mostly unchanged from their
peak levels attained in H1 of 2011-12. Lending
rates marginally notched up and seem to have
plateaued in H2 of 2011-12 in line with the peaking of the policy rate cycle. Despite tight
liquidity conditions, successive policy rate hikes and high cost of funds for banks, the base rate
remained sticky on account of the slow down
in non-food credit growth during H2 of 2011-12
(Table V.2).
Table V.2: Deposit and Lending Rates of Banks |
(percent) |
1 |
Mar-2011 |
Jun-2011 |
Sep-2011 |
Dec-2011 |
Mar-2012 |
2 |
3 |
4 |
5 |
6 |
1. Domestic Deposit Rate (1-3 year tenor) |
|
|
|
|
|
Public Sector Banks |
8.00-9.75 |
8.25-9.75 |
8.55-9.75 |
8.55-9.75 |
9.00-9.75 |
Private Sector Banks |
7.75-10.10 |
8.00-10.50 |
8.00-10.50 |
8.00-10.50 |
8.00-10.50 |
Foreign Banks |
3.50-9.10 |
3.50-10.00 |
3.50-9.75 |
3.50-9.75 |
3.50-9.75 |
2. Base Rate |
|
|
|
|
|
Public Sector Banks |
8.25-9.50 |
9.25-10.00 |
10.00-10.75 |
10.00-10.75 |
10.00-10.75 |
Private Sector Banks |
8.25-10.00 |
8.50-10.50 |
9.70-11.00 |
10.00-11.25 |
10.00-11.25 |
Foreign Banks |
6.25-9.50 |
6.25-9.50 |
6.25-10.75 |
6.25-10.75 |
6.25-11.85 |
3. Median Lending Rate* |
|
|
|
|
|
Public Sector Banks |
8.88-14.00 |
9.50-14.50 |
10.50-15.25 |
10.25-15.25 |
- |
Private Sector Banks |
9.00-14.50 |
9.25-15.00 |
9.00-15.25 |
10.00-15.50 |
- |
Foreign Banks |
7.70-14.05 |
7.70-14.50 |
9.13-14.75 |
9.50-14.38 |
- |
* : Median range of interest rates at which at least 60 percent of business has been contracted.
-: Not Available.
Note: Bank group-wise variations in deposit/lending interest rates worked out from the table would differ from those reported in the
text as the latter are based on bank-wise and tenor-wise variations in deposit interest rates and bank-wise variations in case
of lending rates. |
Rupee stays volatile on CAD concerns and
global uncertainty
V.16 The policy measures undertaken to
improve capital inflows have generally yielded
the intended results, thereby enabling smoother financing of higher CAD. This, in turn, has led
to the movement of the exchange rate in a narrow
range from the last week of January 2012. The rupee moved up to 51.4 per US dollar as on April 13, 2012 from a low of 54.2 per US dollar
recorded on December 15, 2011 (Chart V.5).
V.17 A notable aspect of capital flows was that both debt and equity flows improved during Q4
led by policy measures, global liquidity
conditions and investor perception. However,
rising crude oil prices due to geo-political
factors, and increased dollar demand led to a
moderate depreciation of rupee since the first
week of March 2012.
Secondary equity markets improve with renewed FII inflows
V.18 The Indian equity market saw a strong
pick up in Q4 on the back of renewed FII
support, a fall in inflation and firm trends in the
global equity markets (Chart V.6). This recovery
was broad-based, with all major sectoral indices
moving up in line with the Sensex. According
to SEBI data, FIIs bought shares worth `453.4
billion in Q4 of 2011-12; on the other hand, MFs sold shares worth ` 54.4 billion. FIIs have been
the major contributors to the rally, presumably
on account of higher global liquidity driven by
the easy monetary policy pursued by AEs, the ECB’s long term lending programme and
increase in the size of asset purchase programme by some AE central banks. However, in April
2012 so far (up to April 11) the Indian equity
market declined in line with global markets.
The primary markets show incipient signs of recovery
V.19 Almost dormant in Q3, the primary
market witnessed a few issuances in the equity
segment in Q4, indicating a slow recovery on
the backdrop of the equity indices recovering
from lower levels. However, the primary
market sentiment still remains cautious on
account of lower risk appetite of investors in
the primary market following the negative
returns on initial public offers (IPOs) during
previous quarters (Chart V.7). On the supply
side, corporates too abstained from the primary
market for resource mobilisation due to the uncertain macroeconomic environment and
investor sentiments (Table V.3).
|
|
V.20 Certain policy announcements in the
Union Budget 2012-13 may help to revive the
primary market. These include simplification in
the issuance process of IPOs and the introduction
of the Rajiv Gandhi Equity Savings Scheme.
According to SEBI data, private placement
increased to `2.4 trillion during 2011-12 (up to
February) from `2.0 trillion during the
corresponding period of the previous year.
Housing price increases remain contained
V.21 The Reserve Bank’s quarterly House Price Index (HPI), based on official data on
property transaction from 9 cities, indicates that during Q3 of 2011-12, house price increased for all cities, barring Kolkata on an annual basis.
However, price increases moderated in Mumbai,
Jaipur and Kanpur (Chart V.8). The number of
transactions on an annual basis declined in
Mumbai, Bengaluru and Kanpur, while the y-o-y increase moderated in Ahmedabad and
Jaipur.
Table V.3: Resource Mobilisation from Capital Market |
(` billion) |
Category |
2009-10 |
2010-11 |
2011-12 |
1 |
2 |
3 |
4 |
A. Prospectus and Rights Issues* |
326 |
376 |
129 |
1. Private Sector (a+b) |
255 |
244 |
83 |
a) Financial |
3 |
39 |
9 |
b) Non-financial |
252 |
205 |
74 |
2. Public Sector |
71 |
132 |
46 |
B. Euro Issues |
160 |
94 |
27 |
C. Mutual Fund Mobilisation (net)@ |
831 |
-494 |
617$ |
1. Private Sector |
549 |
-192 |
495$ |
2. Public Sector # |
282 |
-302 |
123$ |
*: Excluding offer for sale. @: Net of redemptions.
#: Including UTI MF. $: Apr-Feb.
Source: Mutual Fund data are sourced from SEBI and exclude funds mobilised under Fund of Funds Schemes. |
Risks of disruptive movements in financial markets remain from euro area and financialisation of commodities
V.22 Notwithstanding the signs of stabilisation
over the past quarter, risks that stress in financial markets could return in 2012-13 remain.The
focus has shifted to Spain, which faces high
borrowing cost due to the burgeoning budget
deficit. Recession looms large in Spain and this
also raises concerns about possible contagion. Debt sustainability of Portugal and Greece
remain fragile. The adequacy of the lending
capacity of the European Financial Stability
Facility (EFSF) is uncertain, given the size of
debt of Italy and Spain.
|
V.23 The recent surge in crude oil prices due
to geo-political tensions has emerged as a new
risk factor to global and domestic financial markets. Volatile oil trades can occur in coming
months given the uncertainty about the ongoing
political initiatives. Furthermore, the EU sanctions on Iran may kick in only from July
2012. The financialisation of commodity
markets has been considerable and with daily
trading volumes of over US$ 1 trillion in oil
markets alone, the uncertainty about oil price
movement in 2012-13 remains. While as a baseline, global oil prices in 2012-13 could
average around current levels, the upside risks
are greater than the downside risks due to tighter
inventory levels and lower spare capacities,
which could result in supply shortages (Chart V.9). Should these upside risks materialise, the negative spillovers on Indian
markets could be large given their impact on
India’s inflation and with lag on growth, as also
its fiscal and external sector positions.
V.24 In March 2012, both the US Energy
Information Agency (EIA) and OPEC revised
their 2012 oil demand projections downwards.
While the spike in oil prices largely reflected
concerns about supply disruption from Iran and
the Strait of Hormuz through which 20 percent
of global oil supplies (about 17 million barrels)
pass each day, price movements in 2012-13
could continue to be impacted by the July event.
If the geo-political tensions recede, high crude
oil prices may not be sustained, given the weak
global growth outlook. Sustained high oil prices
could themselves dampen the already weak
global growth outlook. Nonetheless tight supply-demand conditions, alongside the presence of
large liquidity in the global economy leave the
commodity price outlook highly uncertain.
|