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Need for Calibrated Policy in Interest Rates and Credit

The indirect measures taken by the central bank to control inflation have led to a situation where banks are pushing up rates on both deposits and loans, more on the latter than on the former, ending in a widening of the spread. This is of a piece with banks' recent behaviour in ignoring the credit requirements of a number of productive sectors. What is called for is a calibrated intervention by the monetary authority with a combination of regulations and measures of moral suasion on both the cost of credit as well as its distribution in favour of the productive sectors.

Money market

Need for Calibrated Policy in Interest Rates and Credit

The indirect measures taken by the central bank to control inflation have led to a situation where banks are pushing up rates on both deposits and loans, more on the latter than on the former, ending in a widening of the spread. This is of a piece with banks’ recent behaviour in ignoring the credit requirements of a number of productive sectors. What is called for is a calibrated intervention by the monetary authority with a combination of regulations and measures of moral suasion on both the cost of credit as well as its distribution in favour of the productive sectors.

EPW RESEARCH FOUNDATION

I Interest Rates and Credit: Imperatives of Regulations

T
he scheduled commercial banks, the large ones in particular, are now vying with each other in pushing up interest rates on their deposits and loans. The banks are obviously taking advantage of the clues offered by the Reserve Bank of India (RBI), which has taken a series of monetary measures to fight inflation on the ground that to an extent the current inflationary pressures are attributable to monetary conditions. The RBI’s response is based on the conventional monetary policy stance which uses indirect instruments of monetary control with a bias towards erratic, short-term policies. Instead, what is required is a pro-development stable policy which focuses on credit and its distribution amongst sectors and classes at reasonable rates of interest. Earlier, for about six to seven years from 1998 to 2005, RBI used its various weapons, more significantly its weapon of moral suasion, to bring down the levels of interest rates from the high levels which had truly become unsustainable for the productive sectors after the mid-1990s. By the year 2005, the rates had settled at moderate and realistic levels, which have helped the process of economic recovery in the recent period.

But, now there appears to be a sudden reversal of this stable interest rate policy, and this has come about because the banks have begun to taste an environment of free-for-all without there being any moral restraint. What the State Bank of India (SBI) has done of late is a blatant case of showing utter disregard for the developmental needs at a time when the economy is poised for a sustained expansion. The largest bank in the country, which enjoys many advantages in terms of low cost funds, has hiked its benchmark prime lending rate (BPLR) by 75 basis points from 11.50 per cent to 12.25 per cent with effect from February 20. Its deposit rates have also been raised but by a smaller amount. Many other banks have also effected similar upward revisions in their deposit and lending rates. The sharp jump in the benchmark prime lending rates for major public sector banks from a range of 10.25-11.25 per cent in March 2006 to 11.50-12.25 per cent in January 2007 and by another 25-75 basis points in February 2007 (Table 1), may in fact understate the increases in lending rates because of a chaotic situation obtaining in regard to the spread between the minimum and maximum rates charged by banks over BPLR. The increase has been much sharper for private sector banks from 11-13.50 per cent to 11.75-15.50 per cent over the same period.

An objective assessment of the current cost of and return on funds for banks does not justify such high increases in their prime lending rates. As shown in Table 2, their average cost of funds works out to 4 per cent while the return on funds is at

7.2 per cent, thus retaining the rising spread at 3.2 per cent, which is arguably high for any banking system. When the margin is worked out only as between the average interest rates on bank credit and those on bank deposits, the increase in the margin has been much higher in the recent period.

To an extent, somewhat high spreads may be justified on the ground of certain social responsibilities that the banks have to bear, but the recent increases in interest rates would further widen the spread, which would be at the cost of the myriad productive sector borrowers and does not have any justifiable basis.

The banks’ behaviour in many other respects leaves much to be desired. Their reluctance to expand the rural network and to reduce their exposure to agriculture, small-scale industries and generally to small

Table 1: Movement in Key Policy Rates and Inflation

(Per cent per annum)

Effective since Reverse Repo Repo Rate Cash Reserve Prime Lending WPI
R a te Ratio Rate^ Inflation @
(1) (2) (3) (4) (5) (6)
31-Mar-04 4.50 6.00 4.50 10.25-11.00 4.60
18-Sep-04 2-Oct-04 4.50 4.50 6.00 6.00 4.75 5.00 10.25-10.75 10.25-10.75 7.90 7.10
27-Oct-04 4.75 6.00 5.00 10.25-10.75 7.40
29-Apr-0526-Oct-05 5.00 5.25 6.00 6.25 5.00 5.00 10.25-10.75 10.25-10.75 6.00 4.50
24-Jan-06 5.50 6.50 5.00 10.25-10.75 4.20
9-Jun-06 5.75 6.75 5.00 10.75-11.25 4.90
25-Jul-06 6.00 7.00 5.00 10.75-11.25 4.70
31-Oct-06 6.00 7.25 5.00 11.00-11.50 5.30
23-Dec-06 6.00 7.25 5.25 11.00-11.50 5.50
6-Jan-07 6.00 7.25 5.50 11.50-12.00 6.10
17-Feb-07 6.00 7.25 5.75 11.75-14.75 6.73
3-Mar-07 6.00 7.25 6.00 11.75-14.75*

Notes: * Estimated range of rate; @ As on the date of change in policy rates; ^ Prime Lending Rate related to five major banks.

Source: RBI publications.

Economic and Political Weekly February 24, 2007

Graph A: Trends in WeightedGraph B: Spot Quotations forlending rates which also generally operateAverages of Call Rates, Repo Rates,the US Dollar in the Domestic

against the productive sectors and which

CBLO Rates and Call MoneyInter-Bank Market Borrowing – January 2007 50.0 deserve to be prevented. 17

25.5

l il i (Daily Working Days January 2007) Monthly Averages (Jan 2001 to Dec 2006)
The implied distortions in the above

16.5 16

scenario do not get corrected by the ap

15.5

plication of conventional indirect instru

15

14.5

20.5 14

January 2007

Weighted Average (Per Cent)

(Rupees Thousand Crore)Rupees per US dollar

pp

48.0

ments of monetary control. What is called

13.5 13

for is a calibrated intervention on the part

12.5 12 15.5

of the monetary authority with a combi

11.5 11

10.5

nation of regulations and measures of moral

46.0

suasion on both the fronts: cost of credit as

10.5 9

8.5

well as distribution of bank credit in favour

8

7.5 7

of the desired sectors. The banks on their

5.5

44.0

own, without appropriate policy interven

5.5 5

tions, will not achieve the desired results.

4.5 4 0.5

Call Money Volume (Rs Cr)
Repo Rates – Outside the RBI

l -i 42.0

II

ll

CBLO Rates

Call Rates

borrowers has been widely documented. current situation calls for, first, redistribu-They are also insensitive to the adverse tion of bank credit in favour of vast segrepercussions arising from high interest ments of the informal sector; second, as costs for the medium and small borrowers the economy is on a high growth trajecwhile they, in a nonchalant manner, render tory, continued expansion of bank credit large proportions of bank credit to cash-rich for all productive sectors has to be ensured; corporates at below prime lending rates. third, if bank credit expansion has been

When such is the behaviour of the excessive and creating a situation of heatbanking industry, the monetary authority ing up, it has been essentially because of has no option but to adopt a calibrated huge increases in bank credit for various intervention policy so that the objectives less productive sectors like commodity of inflation control are attained through markets, the capital market and real estate direct credit and interest rate regulations as well as the retail consumer segments; rather than indirect instruments of monetary these deserve to be contained. Finally, control which are of a blunt nature. The there is the unreasonable increases in

Table 2: Cost of Funds and Returns on Funds: Bank Group-wise

Bank Group Public Sector Banks New Private Sector Banks Foreign Banks Scheduled Commercial Banks
2004-05 2005-06 2004-05 2005-06 2004-05 2005-06 2004-05 2005-06

1 Cost of deposits 4.4 4.3 3.4 3.6 3.0 2.8 4.2 4.1 2 Cost of borrowings 1.3 2.2 1.4 3.1 3.5 4.3 1.7 2.8 3 Cost of funds 4.2 4.2 3.0 3.5 3.1 3.2 4.0 4.0 4 Return on advances 6.9 7.1 7.3 7.0 7.3 7.6 7.1 7.2 5 Return on investments 7.9 8.2 5.3 5.5 6.9 7.3 7.6 7.6 6 Return on funds 6.9 7.1 7.3 7.0 7.3 7.6 7.1 7.2 7 Spread (6-3) 2.8 2.9 4.3 3.5 4.2 4.4 3.1 3.2

Source: RBI (2006): Report on Trend and Progress of Banking in India 2005-06.

Money, Gilt-Edged and Forex Markets

The outlook for the money and gilt-edged securities market improved significantly from the pangs experienced in December in the wake of the effect of the first phase of CRR hike of 25 basis points on December 23 along with advance tax outflows. The RBI governor characterised this CRR hike as rebalancing of portfolios but yet, in January the short-term rates continued to remain firm and secondary market turnover for gilt-edged securities remained subdued, due to the second leg of CRR hike of 25 basis points on January 6, emerging inflationary concerns with the inflation rate touching a peak of 6.12 per cent despite the easing of global crude oil prices amidst a robustly growing economy and concerns emerging from amendments to the Banking Regulation Act 1949 wherein the statutory reserve requirements limits have been made flexible. With the inflow of interest outgo on the special deposit scheme and reduction in centre’s balance with RBI, the liquidity situation

Table 3: Money Market Operations (RBI’s Daily Data)

Average January 2007 Average December 2006 Items for Four for Five Weeks 26$ 19 (RF) 12 5 (RF) Weeks 29 22(RF) 15 8(RF)

No of working days 22 5 6 6 5 29 5 6 6 66 Call Money Weighted average of call rates:

per cent (weekly range) per annum 6.64-12.96 7.48-7.93 7.77-8.12 7.68-8.35 6.64-12.96 6.00-16.78 10.73-16.78 7.94-8.61 6.23-8.00 6.10-6.13 6.00-6.25 Daily averages (Rupees crore) (7.77) (7.46) (8.61) (6.13) Total call market borrowings 10117 9633 9756 10740 10286 12211 12114 12361 12837 11115 13587

(372) (463) (675) (514) Notice Money Weighted average of notice money rates:

per cent (weekly range) per annum 6.89-13.78 7.18-7.95 7.41-8.59 6.99-8.14 6.89-13.78 5.95-16.89 9.51-16.89 7.00-8.71 5.99-8.14 6.01-6.23 5.95-6.28 Daily averages (Rupees crore) Total notice market borrowings 2623 2758 2041 2581 3235 3027 4062 2250 3304 2842 2581 (12066) (14388) (14138) (16635) Turnover in term money market 270 91 497 154 318 316 503 238 218 360 360 (borrowings) $$ (135) (75)

* Data for reporting Fridays are given within brackets and they are also included in the weekly range/daily averages. $$ No of reporting/traded days is fewer than given above. $ Thursday data.

Economic and Political Weekly February 24, 2007

Graph C: Annualised Forward Premia in Graph D: Yield Curves for Datedand RBI endeavouring to arrest the sharpPercentage for the US Dollar in theSecurities – Weighted Average for

movements. With effect from January 2,

Domestic Inter-Bank Market and WeightedWeeks of January 2007 Averages of Call Rates for January 2007

1st Week 2nd Week 3rd Week 4th Week
2007, BSE became the single unified report

9

6.5

14.0

ing platform for all corporate deals done

6.0

in the country in respect of debt that is listed

8.5

anywhere, that which is in a demat form

12.0

1-month -3-month i 6-month Weighted Averages of Call Rates (Right Axis)

Yield (per cent per annum)

and over Rs 1 lakh in value as prescribed

Per cent per annum

8

by SEBI. Incidentally, S&P raised India’s

10.0

sovereign local currency credit ratings to

3.5

3.0

8.0

7.5

investment grade BBB-/A-3, with a stable

outlook, citing strong economic prospects

6.0

and an improving fiscal situation.

7

1.0

4.0

0.5

0.0

-0.5

2.0

Working Days

eased, and as a result, the second phase of CRR hike had a marginal effect on the overall sentiments, though the short-term rates firmed up. Further, the government cancelled the auction of one out of the three securities to be auctioned during the month, thereby sustaining liquidity, which was buttressed by colossal injections through the repo window of RBI’s LAF. Moreover, the unwinding of MSS borrowings continued sporadically in all the three treasury bills auctioned during the month. However, the higher yield set at the first dated securities auction generated expectations of a tighter monetary policy stance in the ensuing third quarterly review. However, as the US Federal Reserve continued to hold rates steady and the RBI setting somewhat expected yield rates in the second dated securities auction of the month, the market sentiments eased. Following the cabinet’s approval of the ordinance giving more flexibility to the RBI on SLR requirements of the banks, the market sentiments turned cautious as it implied reduced banks’ inclination for dated securities which pushed yields higher on January 12 when the yield on 10-year benchmark security rose by 33 basis points. Thereafter, as the possibility of the president approving the ordinance gathered momentum, the pressure on yields rose but the actual rise was contained as the market perceived that the RBI would retain SLR limits for the present. Given surge in inflation rate, the government undertook a number of measures such as reduction in import duty and ban on futures trading in urad and tur, which turned the market sentiments positive. As the RBI chose to set higher yields at the penultimate TB auctions of the month, the market began anticipating a rate hike in the review, but in January the RBI hiked only the repo rate by 25 basis points from 7.25 per cent to

7.50 per cent leaving all other rates

6.5

Call Money Market

2 3 4 5 6 7 8 9 1011121314151617181921232729

Years to Maturity

The weighted averages of call rates eased unchanged, which buoyed market sentiments.1 significantly as compared to the levels In the forex market, the rupee oscillated attained in December but yet remained with inflows pushing the unit to appreciate above the repo-reverse repo corridor

Table 4: Weighted Averages of Daily Call/Notice Rates in Per Cent Per Annum: Simple Statistical Characteristics

Month/Week Simple Standard Coefficient Simple Standard Coefficient Mean* Deviation of Variation Mean* Deviation of Variation (Percentages)$ (Percentages)$

Call Money Notice Money** December 2006

All five weeks 7.94 2.57 32.39 7.80 2.58 33.06 29 12.78 2.38 18.60 12.59 2.68 21.32 22 (RF)* 8.21 0.22 2.66 7.81 0.70 8.97

  • 15 7.25 0.76 10.46 7.17 0.82 11.39 8 (RF)* 6.12 0.01 0.20 6.13 0.09 1.46
  • 1 6.15 0.08 1.33 6.09 0.12 1.92
  • January 2007All four weeks 8.30 1.47 17.73 8.13 1.66 20.47

  • 25 7.79 0.19 2.41 7.67 0.34 4.43 19 (RF)* 8.01 0.14 1.70 7.87 0.41 5.21
  • 12 8.11 0.27 3.30 7.62 0.41 5.37 5 (RF)* 9.38 3.04 32.47 9.50 3.30 34.72
  • ** Separate reportings began on March 15, 2005.

    * Including data for reporting Fridays (RF). $ Based on original unrounded figures. Source: RBI.

    Table 5: Comparison of Call, Overnight CBLO and Repo Rates

    Week-Ending Weighted Average Rates Daily Average Volumes (in Per Cent) (Rs crore) Call Overnight CBLO Repo Call Overnight CBLO Repo

    1-Dec-06 6.16 5.97 6.13 16350 17279 9450 8-Dec-06 6.13 5.96 6.06 13956 16222 8645 15-Dec-06 7.46 7.09 7.14 16141 18796 7837 22-Dec-06 8.27 7.37 7.43 13882 16374 6027 29-Dec-06 13.31 9.51 10.67 16206 11116 5117

    5-Jan-07 8.68 6.43 7.25 13520 15052 6794 12-Jan-07 8.24 7.27 7.40 13321 16371 5976 19-Jan-07 8.01 7.23 7.31 11797 16230 6944 25-Jan-07 7.84 7.25 7.31 12390 14755 5981

    Source: The Clearing Corporation of India (CCIL).

    Table 6: Details of Central Government Market Borrowing

    (Amount in Rs crore)

    Date of Nomenclature Notified Competitive Competitive Indicative Devolve-Auction of Loan Amount Bids Bids YTM at ment on Received Accepted Cut-off Primary Price Dealers

    Number Amount Number Amount (in Per Cent) (Rs Crore)

    12-Jan-07 8.33 per cent 4000 115 5705 105 3980 8.23 per cent Nil 2036 (Rs 101.00) 25-Jan-07 7.94 per cent 5000 248 12032 114 4989 8.20 per cent Nil 2021 (Rs 97.81)

    Source: RBI Press Releases.

    Economic and Political Weekly February 24, 2007

    throughout the month. The month began with the overnight rate falling from a peak of 12.96 per cent on January 2 to 7.41 per cent on January 3 and further to 6.64 per cent on January 4. On the first reporting Friday, January 5, the rate rose to 7.64 per cent and further to 7.68 per cent on January 6, wherein the last phase of earlier CRR hike of 25 basis points came into effect. Thereafter, the overnight rate ruled firm due to increased borrowings, given the higher level of CRR requirements. Until January 12, the rate ruled in a range of 8.13 per cent-8.35 per cent. Following the cancellation of one of the dated security auctions, the rate eased to 7.9 per cent on January 12. The overnight rate ruled firm in a range of 7.93-8.12 per cent despite the RBI continuing to inject liquidity through the repo window. On the second reporting Friday, January 19, the rate eased to 7.77 per cent as the banks had already covered their positions. Thereafter, the call rates rose to 7.93 per cent on January 20 and then began easing continuously to 7.48 per cent on January 25. However, the rate rose to 7.74 per cent on January 29 due to holiday-shortened fortnight and closed at

    7.76 per cent on January 31 (Graph A). Also, volatility as well as volume eased significantly in January both for call money rates as well as notice money rates (Tables 3 and 4).

    The collateralised market is now the predominant segment in the money market, with a share of around 65 per cent in total volume in 2006-07 so far. Between the two collateralised instruments of CBLO and institutions are the major lenders in the market repo, CBLO rates were lower than CBLO market with nationalised banks those on market repos (Table 5 and being the major borrowers. In the market Graph A). Mutual funds and financial repo segment, mutual funds are the major

    Table 8: Auctions of 182-Day Treasury Bills

    (Amount in rupees crore)

    Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Auction Amount Devolved Price Yield Outstanding No Face Value No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (Per Cent) of Issue

    2006 Jan 10 500.00 28 2206.99 8 500.00 0.00 96.99 6.22 13137.23

    (0) (0.00) (0) (0.00) [97.01] [6.16] Jan 25 500.00 19 628.00 All bids 13137.23

    (0) (0.00) rejected

    2007 Jan 10 1500.00 50 3408.40 16 1500.00 0.00 96.56 7.14 21052.83

    (1) (400.00) (1) (400.00) [96.57] [7.12]Jan 24 1500.00 22 635.00 21 560.00 0.00 96.28 7.75 20112.83

    (0) (0.00) (0) (0.00) [96.38] [7.53]

    Figures in the square brackets represent weighted average price and the respective yield. Figures in brackets represent numbers and amounts of non-competitive bids which are not included in the total.

    Table 9: Auctions of 364-Day Treasury Bills

    (Amount in rupees crore)

    Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Auction Amount Devolved Price Yield Outstanding No Face Value No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (Per Cent) of Issue

    2006 Jan 4 1000.00 51 2836.00 25 1000.00 0.00 94.24 6.13 47859

  • (1) (4.08) (1) (4.08) [94.25] [6.10] Jan 18 1000.00 47 2601.00 20 1000.00 0.00 94.09 6.30 46859
  • (1) (2.05) (1) (2.05) [94.13] [6.24] Feb 1 1000.00 48 2486.00 17 1000.00 0.00 93.70 6.72 46109
  • (1) (250.00) (1) (250.00) [93.72] [6.70]

    2007 Jan 3 2000.00 77 4225.00 26 2000.00 0.00 93.31 7.19 48348

  • (1) (5.10) (1) (5.10) [93.33] [7.17]Jan 17 2000.00 41 2315.00 19 1155.00 0.00 93.24 7.27 48903
  • (2) (402.20) (2) (402.20) [93.26] [7.25]Jan 24 2000.00 38 3890.00 1 1000.00 0.00 92.87 7.70 48903
  • (1) (250.00) (1) (250.00) [92.87]

    Figures in the square brackets represent weighted average price and the respective yield. Figures in brackets represent numbers and amounts of non-competitive bids which are not included in the total.

    Table 7: Auctions of 91-Day Treasury Bills

    (Amount in rupees crore)

    Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Outstanding Auction Amount Devolved Price Yield Rate on the Date of Issue No Face Value No Face Value on PDs (Rupees) Rate

    (Amount) (Amount) (Amount) (Per Cent) Total With RBI Outside RBI

    (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

    2006 January 4 500.00 56 1993.05 19 500.00 0.00 98.54 5.94 18219.73 0.00 18219.73

  • (0) (0.00) (0) (0.00) [98.54] [5.93] January 10 500.00 43 1283.25 24 500.00 0.00 98.48 6.17 16727.21 0.00 16727.21
  • (1) (7.48) (1) (7.48) [98.50] [6.90] January 18 500.00 38 1534.16 16 500.00 0.00 98.48 6.19 15237.36 0.00 15237.36
  • (1) (10.16) (1) (10.16) [98.49] [6.13] January 25 500.00 36 918.21 23 500.00 0.00 98.36 6.69 13890.44 0.00 13890.44
  • (1) (153.08) (1) (153.08) [98.39] [6.55] February 1 500.00 47 2481.16 8 500.00 0.00 98.39 6.56 12245.48 0.00 12245.48
  • (3) (206.54) (3) (206.54) [98.39] [6.55]

    2007 January 3 2000.00 52 2971.91 36 2000.00 0.00 98.25 7.14 28507.16 0.00 28507.16

  • (0) (0.00) (0) (0.00) [98.27] [7.06]January 10 2000.00 48 2855.22 36 2000.00 0.00 98.25 7.14 29637.16 0.00 29637.16
  • (1) (2000.00) (1) (2000.00) [98.27] [7.06]January 17 2000.00 39 1920.15 16 931.15 0.00 98.25 7.14 29787.81 0.00 29787.81
  • (1) (500.00) (1) (500.00) [98.25] [7.14]January 24 2000.00 32 900.41 22 520.41 0.00 98.19 7.39 29757.22 0.00 29757.22
  • (1) (100.00) (1) (100.00) [98.23] [7.23]January 31 2000.00 41 1514.57 17 699.57 0.00 98.15 7.56 27854.39 0.00 27854.39
  • (0) (0.00) (0) (0.00) [98.17] [7.48]

    Figures in parentheses in cols 3 to 6 represent numbers and amounts of non-competitive bids which are not included in the total. Figures in the square brackets under cols 8 and 9 represent weighted average price and respective yield.

    Economic and Political Weekly February 24, 2007 providers of funds, while foreign banks, private sector banks and primary dealers are the major borrowers.

    Forex Market

    Robust domestic industrial growth and good third-quarter corporate earnings, amidst a buoyant macroeconomic scene induced continued inflows in the domestic stock exchanges, thereby exerting pressure on the rupee-dollar exchange rate to appreciate. Alongside the easing of international crude oil prices, this continued pressure for appreciation attracted intervention by the public sector banks at the behest of RBI, in view of its avowed objective of protecting export competitiveness, thus restraining the extent of upvaluation to just 6 paise over the previous month.

    The month began with the rupee-dollar exchange rate depreciating from Rs 44.20 on January 2 to Rs 44.42 on January 4 as the improvement in domestic liquidity limited the dollar sales while dollar purchases by domestic oil companies generated demand-supply mismatches. Weakness in the domestic equity markets, increased demand from importers and strengthening of dollar following robust economic US, pushed the rupee still lower to Rs 44.61 on January 12. As the corporate results displayed optimistic performance, particularly IT companies, notwithstanding the rupee appreciation, along with robust IIP growth, the rupee appreciated to Rs 44.31 on January 15 and further to Rs 44.25 on January 18 irrespective of the dollar strengthening against other major currencies as the expectations of increased FII inflows gathered momentum. Also, the funds mobilised through various sources were brought into the country, thereby increasing the inflow of foreign currency assets. However, further appreciation was arrested by interventions of the public sector banks and demand for dollars given the easy global crude oil prices; as a result, the rupee fell to Rs 44.34 on January 19, but on suspected RBI intervention it rose again to Rs 44.21 on January 22. With increasing month-end demand for dollars and limited RBI’s intervention, the rupee ranged between Rs 44.21 and 44.24 until January 25. But, the rupee depreciated to Rs 44.27 on January 29. But, following the Standard & Poor’s, upgrading of India’s rating to “investment grade”, the rupee surged to Rs 44.17 on January 31 (Graph B).

    It is interesting that the rupee on an annual basis as on January 31 remained depreciated against the major currencies except the yen. With the appreciation of the rupee, NEER and REER (Base year 2004-05) increased from 96.44 to 99.57 and from 99.91 to 105.95 as between July 2006 and January 19, 2007, respectively. Thus, the spread between the two indices has widened somewhat reflecting the impact of a widened inflation differential as between India and the competitor countries.

    As the domestic liquidity improved, the forward premia across maturities eased from the levels seen in the second-half of December, but yet remained firm as the spot rate remained volatile and the demand for dollars was robust; also with the implementation of the second phase of CRR, there was pressure on liquidity. The six-month forward premia however tracked the spot rupee movements. The premia surged from 3.17 per cent on January 2 to

    3.69 per cent on January 4 and further to

    3.69 per cent on January 8 in response to the second leg of CRR hike. Despite rupee depreciation, the market perceived the rupee’s weakness to be temporary; as a result, the premia fell to 3.03 per cent on January 10, but with firmness in dollar, the premia rose to 3.71 per cent on January 17. As spot rupee turned volatile, the premia dipped to 3.53 per cent on January 18 and touched a high of 3.98 per cent on January 25 ahead of a holidayshortened week, but following the ratings upgrade by S&P, the premia rose to 3.51 per cent on January 31. Unlike the sixmonth premia, the one-month forward premia eased over the month from 6.38 per cent to 3.4 per cent reflecting market expectation of higher depreciation at the long-end of the curve (Graph C).

    III Primary Market

    Dated Securities

    In January, the government mobilised Rs 9,000 crore as against Rs 14,000 crore visualised in the indicative calendar of issuances. The scheduled auction of a security with a term of 10-14 years for a notified amount of Rs 5,000 crore which was to be held during January 5-12 was cancelled. Thus, the government issued one security each at the two scheduled auctions in January (Table 6).

    On January 12, the government reissued

    8.33 per cent 2036 for a notified amount of Rs 4,000 crore through a price-based auction using the multiple price method. For underwriting the issue, the RBI offered

    1.88 paise per Rs 100 as against 1.50 paise offered for the same paper reissued in December. Also, the yield set at the auction at 8.24 per cent was higher compared to that set at the auction held in December at 7.63 per cent.

    In the second instance on January 25, the government reissued 7.94 per cent 2021 for a notified amount of Rs 5,000 crore,

    Table 10: Operations of RBI’s Liquidity Adjustment Facility**

    (Amount in rupees crore)

    Range of Repo (Injection)* Reverse Repo (Absorption)* Net Injection Net For the Week Repo/RR Bids Received Bids Accepted Bids Received Bids Accepted (+)/ Outstanding (Dec 2006-Period Number Amount Number Amount Number Amount Number Amount Daily Averages Absorption (-) Amount Jan 2007) Days of Bids of Liquidity at the

    Accepted Week End@

    (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

    27 Nov - 01 Dec 06 1-3 0 0 0 0 117 78420 117 78420 15684 -78420 24530 04 Dec- 08 Dec 06 1-3 0 0 0 0 160 140100 160 140100 28020 -140100 18095 11 Dec- 15 Dec 06 1-3 69 20605 69 20605 52 30840 52 30840 6168 -10235 -3090 18 Dec- 22 Dec 06 1-4 172 62575 172 62575 31 3320 31 3320 664 59255 -20280 26 Dec- 29 Dec 06 1-4 256 126395 256 126395 11 2835 11 2835 709 123560 -31685

    02 Jan - 05 Jan 07 1-3 66 26660 66 26660 105 42150 105 42150 10538 -15490 5185 08 Jan - 12 Jan 07 1-3 197 92775 197 92775 26 1390 26 1390 278 91385 -20725 15 Jan - 19 Jan 07 1-3 155 66660 155 66660 27 855 27 855 171 65805 -11810 22 Jan - 25 Jan 07 1-3 115 48595 115 48595 19 840 19 840 210 47755 -11445 29 Jan - 02 Feb 07 2-3 80 29980 80 29980 21 4225 21 4225 1408 25755 -7450

    Notes: * with effect from January 31, 2007 the Repo Rate is 7.50 per cent and Reverse Repo Rate 6.00 per cent. ** Includes Second LAF Auctions under Repo and Reverse Repo. @ Net of Repo and Reverse Repo Outstandings.

    Economic and Political Weekly February 24, 2007

    Appendix Table: Secondary Market Operations in Government Paper: RBI’s SGL Data

    (Amount in rupees crore)

    Descriptions Week-ending January 2007: Yield to Maturity on Actual Trading Total for the Month
    25 19 12 5 of January 2007
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury Bills A 91-Day Bills B 182-Day Bills C 364-Day Bills 2 GOI Dated Securities 202.26 166.20 91.50 7.10 7.13 7.23 801.47 563.00 562.52 7.10 7.03 7.26 622.74 543.79 658.62 7.08 7.05 7.09 1096.62 309.23 1459.14 6.67 6.98 7.18 2723.09 1582.22 2771.78 6.92 7.04 7.18
    A Regular (Per Cent: Year) 11.03 , 2007 0.11 7.87 9.69 - - - - - - - - - 0.11 7.87 9.69
    11.50 , 2007 - - - - - - 20.00 7.30 11.17 - - - 20.00 7.30 11.17
    11.83 , 2007 - - - - - - 1.00 6.83 11.62 - - - 1.00 6.83 11.62
    11.90 , 2007 105.53 7.07 11.72 16.99 7.13 11.71 46.46 6.99 11.69 102.52 7.19 11.69 271.50 7.11 11.70
    11.40 , 2008 - - - 3.22 7.66 10.80 - - - - - - 3.22 7.66 10.80
    12.00 , 2008 - - - 50.00 7.30 11.36 50.00 7.16 11.33 - - - 100.00 7.23 11.35
    6.65 , 2009 50.00 7.62 6.78 - - - - - - - - - 50.00 7.62 6.78
    7.00 , 2009 0.10 7.95 7.14 - - - - - - - - - 0.10 7.95 7.14
    7.07 , 2009 OMC SB 75.00 8.19 7.23 187.00 8.11 7.22 225.00 8.04 7.21 150.00 7.97 7.20 637.00 8.06 7.21
    7.33 , 2009 OIL MKT BONDS 65.00 8.12 7.44 185.00 8.11 7.44 100.00 7.96 7.42 55.00 8.00 7.43 405.00 8.06 7.44
    11.99 , 2009 100.00 7.49 11.00 45.00 7.48 10.99 - - - - - - 145.00 7.49 11.00
    7.50 , 2010 0.30 8.02 7.61 - - - - - - - - - 0.30 8.02 7.61
    7.55 , 2010 15.24 7.65 7.57 35.19 7.63 7.57 150.10 7.42 7.52 40.10 7.32 7.50 240.63 7.45 7.53
    11.50 , 2010 25.00 7.67 10.34 - - - - - - - - - 25.00 7.67 10.34
    12.25 , 2010 - - - 1.00 7.86 10.84 - - - 5.00 7.50 10.71 6.00 7.56 10.73
    12.29 , 2010 - - - - - - 50.00 7.43 10.87 25.00 7.48 10.88 75.00 7.45 10.88
    7.13 , 2011 FRB - - - - - - - - - 70.00 7.53 7.24 70.00 7.53 7.24
    8.00 , 2011 - - - 0.02 7.72 7.92 - - - - - - 0.02 7.72 7.92
    9.39 , 2011 275.00 7.78 8.86 320.00 7.74 8.85 1437.00 7.53 8.78 270.00 7.48 8.76 2302.00 7.58 8.80
    10.70 , 2011 - - - 0.20 7.83 8.67 - - - - - - 0.20 7.83 8.67
    12.29 , 2011 - - - - - - 25.00 7.45 10.53 - - - 25.00 7.45 10.53
    12.32 , 2011 - - - 50.00 7.66 10.63 50.00 7.45 10.55 - - - 100.00 7.55 10.59
    6.72 , 2012 - - - 10.00 6.78 6.74 - - - - - - 10.00 6.78 6.74
    7.40 , 2012 5.15 7.72 7.50 5.00 7.70 7.50 47.34 7.39 7.40 145.33 7.46 7.42 202.82 7.46 7.42
    7.44 , 2012 OMC SB - - - - - - 10.00 7.93 7.60 - - - 10.00 7.93 7.60
    7.46 , 2012 - - - - - - - - - 0.34 7.60 7.54 0.34 7.60 7.54
    9.40 , 2012 - - - - - - 10.00 7.49 8.65 - - - 10.00 7.49 8.65
    7.27 , 2013 0.20 8.11 7.59 134.99 7.70 7.43 50.00 7.43 7.33 - - - 185.19 7.63 7.41
    7.37 , 2014 60.00 7.80 7.55 220.10 7.73 7.52 303.73 7.45 7.40 85.00 7.51 7.43 668.83 7.58 7.46
    10.00 , 2014 - - - - - - 37.00 7.56 8.80 4.00 7.75 8.89 41.00 7.58 8.81
    10.50 , 2014 - - - - - - - - - 0.06 7.72 9.05 0.06 7.72 9.05
    11.83 , 2014 - - - 5.70 7.62 9.50 16.25 7.56 9.48 15.00 7.50 9.44 36.95 7.55 9.47
    7.38 , 2015 - - - - - - 0.41 7.44 7.41 - - - 0.41 7.44 7.41
    7.59 , 2015 OMC SB - - - 5.00 8.15 7.85 42.70 7.99 7.78 74.84 8.00 7.78 122.54 8.00 7.78
    7.61 , 2015 OIL MKT BONDS - - - - - - 30.00 8.00 7.79 100.00 8.00 7.79 130.00 8.00 7.79
    7.59 , 2016 1452.09 7.87 7.73 311.75 7.77 7.68 1866.21 7.53 7.56 1324.45 8.82 7.70 4954.50 7.99 7.66
    10.71 , 2016 - - - - - - 10.00 7.60 8.90 - - - 10.00 7.60 8.90
    7.46 , 2017 1.00 7.95 7.73 - - - 1.52 7.53 7.50 1.48 7.58 7.53 4.00 7.66 7.57
    7.49 , 2017 - - - 30.00 7.72 7.61 0.50 7.50 7.50 - - - 30.50 7.71 7.61
    8.07 , 2017 399.26 7.90 7.98 403.14 7.80 7.92 1432.17 7.54 7.78 1331.75 7.54 7.78 3566.32 7.61 7.82
    6.25 , 2018 5.03 8.16 7.24 31.50 7.91 7.10 6.45 7.59 6.93 14.75 7.58 6.93 57.73 7.81 7.05
    12.60 , 2018 ON TAP 0.10 7.84 9.25 - - - - - - - - - 0.10 7.84 9.25
    5.64 , 2019 - - - 1.00 7.88 6.81 1.40 7.61 6.66 11.67 7.61 6.66 14.07 7.63 6.67
    6.05 , 2019 3.04 7.71 6.96 3.70 7.70 6.96 10.13 7.54 6.86 25.05 7.59 6.90 41.92 7.60 6.90
    9.39 , 2019 - - - 5.00 7.70 8.84 - - - - - - 5.00 7.70 8.84
    10.03 , 2019 - - - 1.00 7.98 8.64 0.05 7.65 8.43 0.76 7.65 8.42 1.81 7.83 8.54
    6.35 , 2020 - - - 5.00 7.91 7.26 6.50 7.60 7.07 22.50 7.62 7.08 34.00 7.66 7.11
    10.70 , 2020 - - - 9.81 7.68 8.57 5.00 7.60 8.52 7.50 7.69 8.58 22.31 7.67 8.56
    10.73 , 2020 - - - - - - - - - 3.50 7.66 8.58 3.50 7.66 8.58
    11.60 , 2020 0.03 8.34 9.17 - - - - - - - - - 0.03 8.34 9.17
    7.75 , 2021 OMC SB 3.50 8.24 8.08 54.27 8.22 8.08 1.22 7.99 7.91 169.50 8.01 7.93 228.49 8.06 7.96
    7.94 , 2021 276.00 8.15 8.09 54.00 7.88 7.90 5.00 7.59 7.70 5.00 7.63 7.74 340.00 8.09 8.05
    8.13 , 2021 OMC SB 49.41 8.23 8.20 126.36 8.22 8.19 377.50 8.03 8.06 888.50 8.01 8.05 1441.77 8.04 8.07
    10.25 , 2021 - - - 5.00 7.72 8.42 10.00 7.73 8.43 10.00 7.67 8.39 25.00 7.71 8.41
    5.87 , 2022 - - - - - - 0.50 7.64 6.99 0.50 7.65 6.99 1.00 7.65 6.99
    8.15 , 2022 FCI SB 78.45 8.26 8.23 165.66 8.22 8.20 111.64 8.01 8.05 299.76 8.00 8.05 655.51 8.09 8.11
    8.35 , 2022 - - - 1.00 7.98 8.09 - - - 0.12 7.77 7.94 1.12 7.96 8.08
    6.17 , 2023 10.00 8.23 7.56 47.76 7.93 7.34 5.00 7.69 7.18 - - - 62.76 7.96 7.37
    8.01 , 2023 OMC SB - - - - - - 35.00 8.01 8.01 70.00 8.01 8.01 105.00 8.01 8.01
    8.03 , 2024 FCI SB - - - - - - 68.00 7.98 7.99 - - - 68.00 7.98 7.99
    10.18 , 2026 - - - 0.03 7.78 8.21 0.02 7.75 8.19 - - - 0.05 7.77 8.20
    6.01 , 2028 2.00 8.18 7.68 - - - 4.37 7.66 7.26 3.70 7.69 7.28 10.07 7.78 7.35
    6.13 , 2028 - - - 5.50 7.84 7.44 0.50 7.62 7.26 3.40 7.71 7.34 9.40 7.78 7.39
    7.95 , 2032 - - - - - - - - - 1.02 7.68 7.72 1.02 7.68 7.72
    7.50 , 2034 4.00 8.20 8.12 10.00 8.04 7.98 80.30 7.67 7.65 95.55 7.66 7.64 189.85 7.70 7.67
    7.40 , 2035 - - - - - - 10.20 7.65 7.63 0.40 7.66 7.63 10.60 7.66 7.63
    8.33 , 2036 179.75 8.22 8.23 604.84 8.10 8.12 648.91 7.90 7.94 205.16 7.68 7.74 1638.66 7.98 8.01
    Sub-total 3240.29 7.89 8.15 3150.71 7.90 8.08 7400.06 7.62 8.02 5638.20 7.98 7.91 19429.26 7.82 8.02
    B RBI’s OMO: Sales - - - 1.00 - - 228.00 - - 322.00 - - 551.00 - -
    Purchase - - - - - - - - - - - - 0.00 - -
    Sub-total - - - 1.00 - - 228.00 - - 322.00 - - 551.00
    (A+B) 3 Market Repo 4 State Govt Securities 3240.29 30570.38 106.88 7.89 7.91 8.15 3151.71 42582.13 8.68 97.09 7.90 7.86 8.08 8.05 7628.06 37010.27 231.59 7.62 7.58 8.02 5960.20 34992.28 8.68 293.44 7.98 7.69 7.91 19980.26 145155.06 8.09 729.00 7.82 7.71 8.02 8.36
    Grand total (1 to 4) 34377.51 47757.92 46695.07 44110.91 172941.41

    (-) means no trading YTM = Yield to maturity in percentage per annum CY = Current yield in per cent per annum SGL = (RBI’s) Subsidiary General Ledger OMO = Open Market Operations OMC SB = O:1 marketing companies special bonds. Notes: (1) Yields are weighted yields, weighted by the amounts of each transaction. (2) Current yield has not been worked out for treasury bills. (3) For Floating Rate Bonds (FRB’s) current yields

    are based on the latest half-year yield determined in the auction.

    Economic and Political Weekly February 24, 2007 also through a price-based auction using multiple price method. The RBI offered underwriting commission to primary dealers much above that offered earlier during the month on the 29-year paper at

    7.90 paise per Rs 100. The cut-off yield was set at 8.20 per cent, which was interestingly higher than that offered for the scrip in May 2006 (7.94 per cent) but lower than that set in June 2006 (8.46 per cent).

    On January 18, four state governments auctioned 10-year state development loans for an aggregate amount of Rs 1,214.59 crore through a yield-based auction using multiple price auction method. An exception was made in the case of Tamil Nadu, which had an option to retain additional subscription of a maximum of Rs 125 crore over and above the notified amount of Rs 500 crore. The yields offered were higher at a range of 7.96-7.99 per cent as against 7.81-7.99 per cent in December.

    Treasury Bills

    The usually observed term structure of yield rates among the three different maturities of treasury bills was disturbed in December wherein the monthly average yield on 182-day bills (7.27 per cent) exceeded that on 364-day (7.09 per cent). This was further reinforced in January with the average yield on 182-day TBs surging to 7.45 per cent while that on 364day ruling at 7.39 per cent and 91-day at

    7.28 per cent. The notified amounts of some of the auctions of all the three treasury bills were not fully subscribed during the month reflecting tight liquidity conditions. The yield on 91-day treasury bills ruled steady at 7.14 per cent for the three consecutive auctions held between January 3 and 17 and thereafter it jumped to

    7.39 per cent on January 24 and further to 7.56 per cent on January 31. Similarly, the yield on 182-day bills galloped from

    7.14 per cent on January 10 to 7.75 per cent on January 24. Likewise, the yield on 364-day TBs surged from 7.19 per cent on January 5 to 7.27 per cent on January 19 and further to 7.70 per cent on January 31 (Tables 7 to 9).

    Corporate Bonds Market

    The primary market for corporate debt issues turned subdued as borrowers refrained from tapping the market given the liquidity and interest rate concerns. Further, the two issuers, IDBI and REC, which had entered the market in December 2006, failed to get fully subscribed. In case of REC’s Rs 500 crore bond issue, the corporation could manage to mobilise just Rs 300 crore. According to market experts, the REC issue for 10 years was very finely priced at 8.85 per cent and hence failed to attract investors’ interest. Another major factor affecting the bond market sentiments was the attractiveness of overseas borrowings as against domestic borrowings. Overseas borrowings in the form of ECBs, FCCBs, ADR and GDR touched their peak mobilisations. As a result, the number of potential borrowers in the domestic market adopted a wait and watch policy.

    Thus, the mobilisation from the market fell from Rs 9,602 crore in November 2006 to Rs 3,565 crore in December 2006 and further to Rs 2,155 crore, of which a central PSU mobilised Rs 1,250 crore, accounting for about 60 per cent. There were six issues, of which two each were those of NBCFs and state undertakings and one each of a bank and a central undertaking. Interestingly, Punjab State Industrial Development Corporation mobilised a meagre amount of Rs 30 crore through an issue of unrated paper in spite of the importance attached to ratings.

    IV Secondary Market

    Despite the improvement in liquidity as reflected through the easing of call rates, the secondary market for gilt-edged securities remained subdued with weekly turnover rising, in the beginning of the month as the liquidity improved, from Rs 7,046 crore in week ending December 29 to Rs 17,686 crore in week ending January 5 and further to Rs 23,352 crore in week ending January 12. But as inflation began surging and ruling above 6 per cent and as buoyant macroeconomic indicators induced expectations of a rate hike in the impending review of the credit policy, the market sentiments turned cautious and the turnover dwindled to Rs 10,474 crore in week ending January 26 and further to Rs 9,682 crore in week ending February 2.

    Given the higher cut-off yield set at the first securities auction, amendment to the Banking Regulation Act and surging inflation rate, the yields firmed up across maturities but more at the longer end rather than the short-end reflecting inflationary concerns; this resulted in a yield curve with a steep upward slope. The spread between 9.39 per cent 2011 and 8.07 per cent widened from 6 basis points in the week ending January 5 to 12 basis points in week ending January 25. Similarly, the spread between 8.33 per cent 2036 and abovementioned 10-year security widened from 14 basis points to 32 basis points. The slope of the yield curve confirms with the RBI’s upgradation of the GDP forecast (Graph D) (see also Appendix Table).

    RBI Reverse Repos, OMOs and MSS

    The RBI sought to modulate liquidity through the LAF repo window by injecting a massive Rs 2,64,670 crore, exceeding Rs 2,09,575 crore in December 2006, despite improved inflows in the form of interest payments on special deposit schemes, increased government expenditure, cancellation of a dated security auction and partial unwinding of MSS borrowings. However, the week-by-week subscriptions declined from a peak of Rs 92,775 crore in week ending January 12 following the implementation of the second phase of CRR hike and a dated security auction to Rs 48,595 crore in the week ending January 25. The reverse repo subscriptions were just Rs 49,460 crore as against Rs 2,55,515 crore in December, indicating the pressure on liquidity (Table 10). Yet, despite being a holidayshortened week, the reverse repo bids tendered and accepted increased from Rs 840 crore in week ending January 25 to Rs 4,225 crore in week ending February 2.

    In sync with the subdued secondary market for gilt-edged securities, the repo transactions outside RBI fell fro Rs 2,25,036 crore in December to Rs 145,155 crore.

    Commercial Bonds

    Unlike the subdued primary corporate debt market, the secondary market for them remained buoyant with the daily average turnover increasing from Rs 40 crore to Rs 79 crore.

    EPW

    Note

    [Piyusha Hukeri has prepared the initial draft, while the required tabular data have been compiled by V P Prasanth.]

    1 Subsequently, on February 12, 2007, CRR was raised by 0.50 percentage point to 6 per cent in two stages following, amongst other things, a sudden jump in inflation rate to 6.73 per cent in week ended February 3, 2007.

    Economic and Political Weekly February 24, 2007

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