DOMESTIC

Upward revision of real GDP growth to 7.5-8.0 % for FY 2005-06.Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, was 4.0 % at end-March 2006.Year-on-year M3 growth was 16.2 % (Rs.3, 77,238 crore) in 2005-06.Year-on-year increase in aggregate deposits during 2005-06 (March 31, 2006 over April 1, 2005) was 16.9 % (Rs.3, 02,534 crore) as against an increase of 12.8 % (Rs.1, 92,269 crore), net of conversion, in the previous year. Year-on-year increase in non-food bank credit during 2005-06 (over April 1, 2005) was 30.8 % (Rs.3, 42,493 crore) on top of 27.5 % (Rs.2, 21,602 crore). The uncollateralised overnight call market experienced persistent tightness during the last quarter of the year.

The total liquidity as reflected in outstanding under the Liquidity Adjustment Facility (LAF), the Market Stabilisation Scheme (MSS) and surplus cash balances of the Central Government taken together declined from an average of Rs.1, 14,192 crore in March 2005 to Rs.74, 334 crore in March 2006.Investment by SCBs in Government and other approved securities declined by Rs.11, 576 crore in 2005-06 in contrast to an increase of Rs.49, 373 crore. During 2005-06, the Central Government's net market borrowings at Rs.95, 370 crore were 86.5 % of the budgeted amount of Rs.1, 10,291 crore and gross market borrowings of Rs.1, 58,000 crore were 88.5 % of the budgeted amount of Rs.1, 78,487 crore.

•  What does this mean?

Economy has grown since the last year on the back of low inflation and cheap/easy credit. This has resulted in banks shifting their investment in government and other approved securities to loans and other assets. A perceptible change is observed.

EXTERNAL

Merchandise exports increased by 24.7 % during 2005-06 as compared with 26.4 % in the previous year. Imports showed an increase of 31.5 % as compared with 36.4 % in the previous year. The increase in oil imports was higher at 46.8 % as compared with 45.2 % in the previous year, non-oil imports showed an increase of 25.6 % as compared with 33.3 % in the previous year. Foreign exchange reserves increased by US $ 10.1 billion from US $ 141.5 billion at end-March 2005 to US $ 151.6 billion by end-March 2006. Rupee depreciated by 1.9 % against the US dollar but appreciated by 4.4 % against the euro, by 5.5 % against the pound sterling and by 7.5 % against Japanese yen.

•  What does this mean?

The growth story has continued even on the external front with rise in both exports and imports.

GENERAL COMMENTS /ASSESSMENT:

In the face of the oil shock, risks loom large in the form of lagged second order effects of oil price increases, geopolitical tensions, the probability of disorderly and rapid adjustment of current account imbalances and the risks emanating from the housing market, particularly when the cycle turns down. There are indications of improvement in the fiscal situation and the return to the path of correction set by the Fiscal Responsibility and Budget Management Rules. Elevated asset prices, global imbalances and tightening of monetary policy globally also are a cause for concern. In the domestic economy, non-food credit growth, deposit growth and money supply growth were higher than the projections. Asset prices have registered a substantial increase. Ensuring credit quality and increasing the pace of investment in infrastructure is important.

•  What does this mean?

Credit would very soon be a "bad word" in the books of RBI.Quality of bank credit (purpose and type of borrower) would soon come under the scanner. Lagged impact of oil shocks could hamper growth.

POLICY STANCE

The expansion in M3 is projected at around 15.0 % for 2006-07 even though the policy preference would be for maintaining a lower order of money supply growth in 2006-07.The growth in aggregate deposits is projected at around Rs.3, 30,000 crore in 2006-07. Year-on-year adjusted non-food credit is expected to increase by around 20 %, a calibrated deceleration from a growth of above 30 % ruling currently. The Reserve Bank will continue to ensure that appropriate liquidity is maintained in the system so that all legitimate requirements of credit are met, consistent with the objective of price and financial stability to focus on credit quality and financial market conditions to support export and investment demand in the economy.

•  What does this mean?

Expectations of a calibrated deceleration in credit growth actually saved the day for bond traders. However, a review of the same in July could tilt scales the other way round.

MONETARY MEASURES

Bank Rate, Reverse Repo Rate and Repo Rate, Cash reserve ratio (CRR) kept unchanged

•  Why?

It is only a temporary relief. Bank Rate, Reverse Repo Rate and Repo Rate could well be moving northwards in the next policy or even before that…!!!

NRE deposit for one to three years' maturity raised by 25 basis points to 100 basis points above LIBOR/SWAP rates for US dollar. Export credit in foreign currency raised by 25 basis points to LIBOR plus 100 basis points from LIBOR plus 75 basis points.

•  Why?

To discourage portfolio outflows from the NRE accounts & to discourage speculations in forex markets.

FIXED INCOME MARKET DEVELOPMENTS:

A screen-based negotiated quote-driven system for dealings in call/notice and term money market (NDS-CALL) to be launched shortly with participation by market constituents on a voluntary basis.' When issued' (WI) market in Government securities being introduced shortly. Primary dealers permitted to diversify their activities as considered appropriate, in addition to their core business of Government securities, subject to limits.
Ways and means advances (WMA) limits for the Central government is fixed on a quarterly basis as against half-yearly as hitherto. For consolidation of Central Government securities, identified illiquid securities to be bought from the secondary market by the Reserve Bank and once a critical amount of securities is acquired, they would be bought back by the Government to extinguish the stock.
Mutual Funds, which are NDS members, permitted to access the NDS-OM module with immediate effect. Other MFs would be permitted access by opening temporary current/SGL accounts with the Reserve Bank. Large pension/provident funds like CBOT/Seamens'/Coal Miners' funds permitted to access the NDS-OM module by opening temporary current/SGL accounts with the Reserve Bank. The smaller funds would be allowed access through the CSGL route.
State Governments to be encouraged to progressively increase the share of market borrowings under the auction route. States, at their discretion and initiative, is encouraged to develop an advance indicative open market borrowing calendar.
Facility of non-competitive bidding (currently limited to Central Government dated securities) be extended to the primary auction of State Development Loans. Purchase and resale of State Development Loans by the Reserve Bank introduced under the overnight LAF repo operations. Working Group to be constituted to examine the relevant recommendations of the High Level Expert Committee on Corporate Bonds and Securitisation

•  What does this imply?

This is done to encourage participation of different entities in the domestic money & fixed income markets with the objective of pepping up the turnover in gilts & other approved securities.

RISK MANAGEMENT

General provisioning requirement raised on standard advances, i.e., personal loans, loans and advances qualifying as capital market exposures, residential housing loans beyond Rs.20 lakh and commercial real estate loans from the present level of 0.40 % to 1.0 %. Risk weight on exposures to commercial real estate raised from 125 % to 150 %. Bank's total exposure to venture capital funds will form a part of its capital market exposure and banks should assign a higher risk weight of 150 % to these exposures.

•  What does this imply?

This is done to discourage loans and advances towards real estate & capital markets as that could lead to an asset bubble.