publications

PDF document (183 kb)
Date : May 02, 2011
IV. Monetary and Liquidity Conditions

Tight liquidity conditions prevailing during the third quarter of 2010-11 eased somewhat during the fourth quarter mainly on account of softening of both structural and frictional stress factors. The deficit liquidity conditions strengthened monetary transmission, which was reflected in higher deposit as well as lending rates of banks, and in turn improved deposit growth and induced slight moderation in credit growth. The anti-inflationary thrust of monetary policy, however, continued to remain non-disruptive of the growth momentum.

Monetary conditions remain consistent with the anti-inflationary bias

IV.1 During 2010-11, the monetary and liquidity conditions remained consistent with the anti-inflationary stance. The monetary policy stance of the Reserve Bank shifted to tightening mode since October 2009 in response to rising inflationary pressures. The calibrated policy actions so far have not been disruptive to growth. The Reserve Bank increased cash reserve ratio by 100 basis points (bps), reverse repo rate by 250 bps, and the repo rate by 200 bps since February 2010 so far. A shift from absorption mode to injection mode in the liquidity adjustment facility (LAF) implies effective rise in policy rates by 350 bps since February 2010 (Table IV.1).

IV.2 During 2010-11, the Reserve Bank articulated a net liquidity level of ±1 per cent of net demand and time liabilities (NDTL) of banks as ideal for effective monetary transmission. The persistence of deficit liquidity conditions in Q4 of 2010-11 helped in further strengthening the monetary policy transmission. However, inflation continues to remain at elevated levels. The Reserve Bank strove to maintain the difficult balance between ensuring sufficient liquidity for smooth functioning of markets on the one hand and sustaining the anti-inflationary monetary policy stance on the other.

Table IV.1 : Movements in Key Policy Rates in India

(Per cent)

Effective since

Reverse Repo Rate

Repo Rate

Cash Reserve Ratio

1

2

3

4

October 11, 2008

6.00

9.00

6.50 (–2.50)

October 20, 2008

6.00

8.00 (–1.00)

6.50

October 25, 2008

6.00

8.00

6.00 (–0.50)

November 3, 2008

6.00

7.50 (–0.50)

6.00

November 8, 2008

6.00

7.50

5.50 (–0.50)

December 8, 2008

5.00 (-1.00)

6.50 (–1.00)

5.50

January 5, 2009

4.00 (-1.00)

5.50 (–1.00)

5.50

January 17, 2009

4.00

5.50

5.00 (–0.50)

March 4, 2009

3.50 (-0.50)

5.00 (-0.50)

5.00

April 21, 2009

3.25 (-0.25)

4.75 (-0.25)

5.00

February 13, 2010

3.25

4.75

5.50 (+0.50)

February 27, 2010

3.25

4.75

5.75 (+0.25)

March 19, 2010

3.50 (+0.25)

5.00 (+0.25)

5.75

April 20, 2010

3.75 (+0.25)

5.25 (+0.25)

5.75

April 24, 2010

3.75

5.25

6.00 (+0.25)

July 2, 2010

4.00 (+0.25)

5.50 (+0.25)

6.00

July 27, 2010

4.50 (+0.50)

5.75 (+0.25)

6.00

September 16, 2010

5.00 (+0.50)

6.00 (+0.25)

6.00

November 2, 2010

5.25 (+0.25)

6.25 (+0.25)

6.00

January 25, 2011

5.50 (+0.25)

6.50 (+0.25)

6.00

March 17, 2011

5.75 (+0.25)

6.75 (+0.25)

6.00

Note : 1. Reverse repo indicates absorption of liquidity and repo indicates injection of liquidity.
2. Figures in parentheses indicate change in policy rates in percentage points.

Liquidity conditions soften as structural and frictional liquidity drivers ease

IV.3 After a phase of significant tightness, both structural and frictional drivers of deficit liquidity conditions softened relatively during the fourth quarter of 2010-11 (Table IV.2). Liquidity conditions had switched to deficit mode since end-May 2010, due to large increase in government balances with the Reserve Bank (resulting from 3G/BWA auctions and the first installment of quarterly advance tax payments). The Reserve Bank initiated several policy measures to ease the liquidity pressure viz., allowing SCBs to avail of additional liquidity support under the LAF and conducting second LAF (SLAF) on a daily basis.

Table IV.2 : Liquidity Position

(` crore)

Outstanding as on
Last Friday

LAF

MSS

Centre’s Surplus@

Total

1

2

 3

4

5=(2+3+4)

2009

 

 

 

 

April

1,08,430

70,216

-40,412

1,38,234

May

1,10,685

39,890

-6,114

1,44,461

June

1,31,505

22,890

12,837

1,67,232

July

1,39,690

21,063

26,440

1,87,193

August

1,53,795

18,773

45,127

2,17,695

September

1,06,115

18,773

80,775

2,05,663

October

84,450

18,773

69,391

1,72,614

November

94,070

18,773

58,460

1,71,303

December

19,785

18,773

1,03,438

1,41,996

2010

 

 

 

 

January

88,290

7,737

54,111

1,50,138

February

47,430

7,737

33,834

89,001

March*

990

2,737

18,182

21,909

April

35,720

2,737

-28,868

9,589

May

6,215

317

-7,531

-999

June

-74,795

317

76,431

1,953

July

1,775

0

16,688

18,463

August

11,815

0

20,054

31,869

September

-30,250

0

65,477

35,227

October

-1,17,660

0

86,459

-31,201

November

-1,03,090

0

93,425

-9,665

December

-1,13,415

0

1,44,437

31,022

2011

 

 

 

 

January

-76,730

0

1,18,371

41,641

February

-72,005

0

77,397

5,392

March*

-1,06,005

0

16,416

-89,589

April 22

-16,405

0

-48,401

-64,806

@ : Excludes minimum cash balances with the Reserve Bank in case of surplus.
* : Data pertain to March 31.
Note: 1. Negative sign in column 2 indicates injection of liquidity through LAF.
2. Negative sign in column 4 indicates WMA /OD availed by the central government.

IV.4 Liquidity conditions eased in August 2010, mainly on account of large pre-scheduled public debt redemptions. After a brief period of surplus liquidity, the LAF again switched to deficit mode from the second week of September 2010 on account of quarterly advance tax payments. Structural factors like imbalances between deposit and credit growth coupled with high currency demand added to the pressure on liquidity. During the third quarter, the Reserve Bank undertook open market operation (OMO) purchases and other measures to ease the liquidity pressures.

IV.5 Liquidity conditions eased marginally during the last quarter of 2010-11 due to pickup in government spending and staggered OMOs carried out by the Reserve Bank since mid-December (Table IV.3). During 2010-11, the Reserve Bank purchased government securities of around ` 67,000 crore under OMO auctions. Notwithstanding the quarterly advance tax payouts in mid-March 2011, which again contributed to temporary tightness, the liquidity deficit remained capped on account of higher government expenditure during the month.

IV.6 During first week of April 2011, the LAF was in reverse repo mode, partly reflecting increased government spending. However, since April 11, it has reverted to deficit mode.

IV.7 The monetary transmission is usually substantially more effective in a deficit liquidity situation than in a surplus liquidity situation. An empirical exercise carried out by the Working Group on Operating Procedures of Monetary Policy (Chairman: Shri Deepak Mohanty) suggests that under deficit liquidity conditions, money market rates respond immediately to policy shock.

IV.8 The recent episodes of large government surplus cash balances emerging as a major autonomous factor influencing the liquidity points towards a need for better cash management by the government (Chart IV.1). In this context, the above Working Group suggested a scheme of auctioning of government surplus cash balances at the discretion of the Reserve Bank to be put in place in consultation with the government.

Table IV.3 : Reserve Bank’s Liquidity Management Operations

(` crore)

Item

2009-10

2010-11

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

1

2

3

4

5

6

7

8

9

A. Drivers of Liquidity (1+2+3+4)

-45,110

-44,513

-66,785

55,055

-1,05,124

26,981

-1,12,597

73,540

1. RBI’s net Purchase from Authorised Dealers

 -15,874

2,523

436

910

816

751

5,991

0

2. Currency with the Public

-18,690

-9,020

-43,224

-31,109

-58,757

180

-42,613

-45,487

3. a. Centre’s surplus balances with RBI

3,382

-67,938

-22,663

85,257

-58,249

10,953

-78,960

1,28,021

3. b. WMA and OD

0

0

0

0

0

0

0

0

4. Others (residual)

-13,928

29,922

-1,334

-3

-8,994

15,097

2,985

-8,994

B. Management of Liquidity (5+6+7+8)

-21,674

62,376

89,870

1,618

67,255

-41,456

1,34,075

15,771

5. Liquidity impact of LAF

-1,30,020

25,390

86,330

18,795

75,785

-44,545

83,165

-7,410

6. Liquidity impact of OMO* (net)

43,159

32,869

3,540

2,787

1,550

2,772

50,910

23,181

7. Liquidity impact of MSS

65,187

4,117

0

16,036

2,420

317

0

0

8. First round impact of CRR change

0

0

0

-36,000

-12,500

0

0

0

C. Bank Reserves # (A+B)

-66,784

17,863

23,085

56,673

-37,869

-14,475

21,478

89,311

(+) : Injection of liquidity into the banking system.
(-) : Absorption of liquidity from the banking system.
* : Includes oil bonds but excludes purchases of government securities on behalf of State Governments.
# : Includes vault cash with banks and adjusted for first round liquidity impact due to CRR change.
Note : Data pertain to March 31 for Q4 and last Friday for all other quarters.

Structural drivers respond to policy signals amidst tight liquidity

IV.9 The monetary policy transmission was weak till May 2010 due to overhang of large surplus liquidity that had to be infused following the global financial crisis. The antiinflationary policy actions of the Reserve Bank that operated through raising the policy rates contributed to keeping liquidity and monetary conditions in line with the policy objective. In a tight liquidity environment, it was expected that higher deposit rates would improve the growth of deposits while higher lending rates would moderate the demand for credit. During Q4 of 2010-11, effective transmission of monetary policy was reflected in higher deposit as well as lending rates of banks and higher issuances of bulk deposits by way of CDs. As a result, credit growth decelerated, while deposit growth accelerated, thereby narrowing the divergence between credit and deposit growth rates (Chart IV.2). The easing of liquidity conditions was reflected in the decline in the LAF injection.

1

2

Money supply growth remains below the indicative trajectory

IV.10 Even as reserve money growth remained strong, the money supply (M3) growth during 2010-11 generally remained below the indicative trajectory set out in the Annual Policy Statement for 2010-11 (Table IV.4). This was due to lower growth in aggregate deposits and reduction in money multiplier emanating from higher currency demand.

Table IV.4 : Monetary Indicators

(Y-o-Y growth in per cent)

 

2009-10

2010-11

1

2

3

Broad Money (M3)

16.8

15.9

Narrow Money (M1)

18.2

9.6

Main Components of M3

 

 

Currency with the Public

15.3

19.1

Aggregate Deposits

17.2

15.4

of which : Demand Deposits

22.0

-0.6

Time Deposits

16.4

18.2

Main Sources of M3

 

 

Net Bank Credit to the Government

30.7

18.2

Bank Credit to the Commercial Sector

15.8

20.6

Net Foreign Assets of the Banking Sector

-5.2

7.4

Reserve Money

17.0

19.1

Reserve Money adjusted for CRR changes

13.0

18.2

Scheduled Commercial Banks

 

 

Non-food Credit

17.1

21.2

Aggregate Deposits

17.2

15.8

Note: 1. Data are provisional.
2. Data pertain to March 31, except for SCBs, which pertain to March 25 for 2010-11 and March 26 for 2009-10.

IV.11 Money supply growth is largely influenced by the trend in aggregate deposits, as these account for over 85 per cent of the money stock. During the first three quarters of 2010-11, term deposits appeared relatively unattractive as a store of value, in view of the modest rise in deposit rates relative to high inflationary expectations. During the last quarter of the year, however, as deposit rates were raised sharply, deposit mobilisation gathered momentum, which also helped in the pick-up in money supply growth. As a result of a sharper increase in deposit interest rates during the quarter as also the deceleration in industrial activity and the underperformance of equity market, a shift from low interest bearing demand deposits to more lucrative time deposits became evident (Chart IV.3).

Strong currency demand aided tight liquidity and decline in money multiplier

IV.12 Stronger growth in demand for currency during 2010-11 contributed to both tightness in liquidity and subdued growth in broad money. The growth in currency demand, which generally remains below money supply growth, witnessed a spurt in 2010-11 partly reflecting stronger GDP growth and persistent high inflation. During the year 2010-11, the real elasticity of demand for currency remained close to unity, indicating the predominant role that inflation played in generating high currency demand (Chart IV.4). The rise in currency demand, coupled with deceleration in the growth of aggregate deposits resulted in a higher currency-deposit ratio, and hence, a decline in the money multiplier. Consequently, even with high base money growth, due mainly to injection of primary liquidity through repo and OMOs, the money supply growth remained lower than the indicative trajectory (Chart IV.5).

3

Income velocity of money recovers from the post-crisis dip

IV.13 There was a sharp fall in the velocity of money (M3) during 2008-09 and 2009-10 reflecting post-global crisis uncertainties in the financial system. With consolidation of growth and normal financial conditions, the income velocity of money reverted to its long-term path, involving a pick-up in 2010-11 (Chart IV.6).

Credit growth remains above trajectory but has started moderating

IV.14 Credit growth remained above the indicative trajectory, but with some moderation seen in the recent period. After witnessing an acceleration in non-food credit growth over the indicative trajectory of 20 per cent, there had been some moderation since the beginning of Q4 of 2010-11. In response to higher interest rates, the non-food credit growth decelerated and deposit growth accelerated. Consequently, the incremental credit-deposit ratio moderated (Chart IV.7).

4

4

IV.15 The moderation in credit growth on a yo- y basis was especially evident in the case of public sector banks, even though the credit conditions generally remained supportive of economic activity (Table IV.5).

IV.16 The sectoral deployment of credit continued to remain broad-based, with high growth in flow of credit to services and personal loans (Table IV.6). Disaggregated analysis suggests that credit to the industrial sector continued to be led by credit to infrastructure, metal and metal products, textiles, engineering, food processing and gems and jewellery. The high growth in credit to infrastructure is especially noteworthy as it is on a high base. The bank credit to NBFCs also witnessed a sharp rise.

6

8

IV.17 Banks continued to be the major source of finance for the commercial sector. During 2010-11, funding from non-bank sources registered a marginal decline as compared to the previous year (Table IV.7). In the case of foreign sources of funding, external commercial borrowings /FCCBs have registered robust rise, partly reflecting the soft interest rate regime prevalent in most of the advanced economies. The decline in foreign direct investment (FDI) was substantially offset by the rise in ECBs/ FCCBs.

Monetary policy to factor risks to growth from high inflation

IV.18 The Reserve Bank’s anti-inflationary policy has been calibrated with a view to containing inflationary expectations, while being non-disruptive to the overall growth process. The deficit liquidity conditions helped in strengthening the monetary transmission further in Q4 of 2010-11 as reflected in higher deposit and lending rates, which helped in easing the structural stress on liquidity. The growth momentum has continued so far. However, inflation remains elevated, despite the 350 bps effective increase in policy rates. Risk to growth from sustained high inflation could condition the stance of the monetary policy in near-term. Since high inflation itself could disrupt growth, it is important for the monetary policy to ensure a low inflation environment as a pre-condition for sustained high growth.

Table IV.5 : Credit Flow from Scheduled Commercial Banks

(Amount in ` crore)

Bank Groups

Outstanding as on Mar 25, 2011

Year-on-Year Variation as on

Mar 26, 2010

Mar 25, 2011

Amount

Per cent

Amount

Per cent

1

2

3

4

5

6

1. Public Sector Banks

29,19,923

3,95,427

19.6

5,05,785

21.0

2. Foreign Banks

1,97,893

-2474

-1.5

31,032

18.6

3. Private Banks

7,28,029

61,212

11.7

1,43,325

24.5

4. All Scheduled Commercial Banks*

39,38,659

4,69,240

16.9

6,93,870

21.4

Note : 1. Data as on Mar 25, 2011 are provisional.
2. * Including Regional Rural Banks.


Table IV.6 : Sectoral Deployment of Credit

(Per cent)

Sector

Q-o-Q Variation

Y-o-Y variation

Mar.26, 2010 over Dec. 18, 2009

Mar.25, 2011 over Dec. 17, 2010

Mar. 26, 2010 over Mar. 27, 2009

Mar. 25, 2011 over Mar. 26, 2010

1

2

3

4

5

Non-food credit

10.4

8.1

 16.8

20.6

Agriculture and allied activities

19.5

9.3

22.9

10.6

Industry

11.3

8.0

24.4

23.6

of which, Infrastructure

11.8

8.3

40.7

38.6

Basic metal & metal products

8.5

8.7

26.5

28.8

Textiles,

9.0

11.1

18.2

19.2

Engineering

9.6

4.8

12.2

26.3

Food processing

18.0

15.0

22.1

29.3

Gems & Jewellery

5.9

8.6

11.3

24.2

Services

9.8

8.9

12.5

23.9

of which, tourism, hotels, restaurants

16.4

2.9

 42.5

42.9

Professional services

2.6

7.1

-1.9

38.9

Commercial real estate

5.2

6.1

-0.3

21.4

NBFCs

10.2

22.9

14.8

54.8

Personal Loans

3.4

6.8

4.1

17.0

of which, consumer durables

5.2

12.4

1.3

22.4

Housing

2.5

4.1

7.7

15.0

Vehicle Loans

7.6

5.4

2.9

24.3

Note : Based on data collected from select SCBs that account for 95 per cent of the total non-food credit extended by all SCBs. These data are being disseminated every month from November 2010.


Table IV.7 : Flow of Financial Resources to the Commercial Sector

(` crore)

Item

April-March

2008-09

2009-10

2010-11

1

2

3

4

A.

Adjusted Non-food Bank Credit (NFC)

4,21,921

4,78,614

7,06,949

 

i) Non-Food Credit

4,11,824

4,66,960

6,78,078

 

of which petroleum and fertilizer credit

31,159

10,014

-24,236

 

ii) Non-SLR Investment by SCBs

10,097

11,654

28,871

B.

Flow from Non-banks (B1+B2)

4,51,399

6,04,303

5,09,432

 

B1. Domestic Sources

2,58,132

3,80,733

3,08,619

 

1. Public issues by non-financial entities

14,205

31,956

28,520

 

2. Gross private placements by non-financial entities

77,856

1,41,964

63,874 #

 

3. Net issuance of CPs subscribed to by non-banks

4,936

41,667

33,546 *

 

4. Net credit by housing finance companies

25,876

28,485

35,325 +

 

5. Total gross accommodation by the four RBI regulated AIFIs - NABARD, NHB, SIDBI & EXIM Bank

31,408

33,783

40,007

 

6. Systemically important non-deposit taking NBFCs (net of bank credit)

42,277

60,663

71,267 +

 

7. LIC’s gross investment in corporate debt, infrastructure and social sector

61,574

42,215

36,080

 

B2. Foreign Sources

1,93,267

2,23,570

2,00,813

 

1. External Commercial Borrowings / FCCBs

30,948

15,674

59,545

 

2. ADR/GDR Issues excluding banks and financial institutions

4,788

15,124

9,441

 

3. Short-term credit from abroad

-13,288

34,878

38,854 #

 

4. FDI to India

1,70,819

1,57,894

92,973 +

C.

Total Flow of Resources (A+B)

8,73,320

10,82,917

12,16,381

Memo Item :

 

 

 

Net resource mobilisation by Mutual Funds through Debt (non-Gilt) Schemes

-32,168

96,578

-36,707

* : Up to March 15, 2011      + : Up to February 2011     # : April-December 2010
Note :
FDI data for April-February include equity capital for April-February and reinvested earnings, other capital and
equity capital for unincorporated bodies for April-December.


Top