Current Economic Statistics and Review For the Week 
Ended July 09, 2005 (28^th Weekly Report of 2005)

  I

Highlights of  Current Economic Scene

BANKING HIGHLIGHTS

o Canara Bank, celebrating centenary year, is planning to set up branches in South Africa, North America and the Middle East as part of its overseas expansion plans. 

o The Andhra Pradesh Government and the Reserve Bank of India (RBI) has signed a Memorandum of Understanding (MoU) in a bid to review the fortunes of the ailing urban co-operative banks (UCBs) in the state. The MoU is aimed at overcoming the problem of dual control, and striking a convergence on the approach and remedial actions that are required to be taken for facilitating development of the UCBs. Andhra Pradesh is the first state to sign a MoU with the central bank for streamlining the functioning of the UCBs. Under the MoU, the RBI has constituted a Task Force for Co-operative Urban Banks (TAFCUB) for the State of Andhra Pradesh. TAFCUB will identify the potentially viable UCBS and draw up a time bound action plan for their revival by setting specific monitorable milestones. It will also identify the non-viable UCBs and chalk out a non-disruptive exit path for them. According to a preliminary survey, AP has about 49 UCBs out of a total of 127 banks, which are classified as grade III and IV calling for immediate attention.

INSURANCE

o After permitting Urban Co-operative Banks to conduct insurance business on a referral basis, the RBI has now extended this facility to Regional Rural Banks (RRBs) as well. According to a press release from RBI, RRBs will now be permitted to perform insurance business on a referral basis, without any risk. Under the referral arrangement, RRBs can provide physical infrastructure within some select branch premises to insurance companies for selling their products to the bank’s customers. In return the banks earn fees on the basis of the premia collected. 

INFORMATION TECHNOLOGY

o 3 i Infotech , the business process outsourcing arm of ICICI Bank, is scouting for acquisition in banking, financial services and insurance (BFSI) sector, both locally and overseas. The company intends to invest around Rs.100 – 150 crore in the current fiscal year. Recently the company has bagged a $3.5 million banking and finance business from Kazakhstan and e-commerce projects worth $7 million from US.

o According to a study report by Gartner, the domestic Indian IT services market has recorded the strongest growth at 26.7 per cent in 2004-05 for the Asia Pacific region to touch $2.1 billion. According to Gartner, some of the key drivers for the increased domestic spending in India are as follows:

1) The urgency to fulfill regulatory compliance requirements in the banking and financial services sector
2) Deployment of IT to improve business efficiency, for better competitive capabilities against global competition in domestic and international markets
3) Improving infrastructure availability and quality coupled with rapidly dropping costs
4) Large scale IT deployment by the central and state government and public sector enterprises to reduce the cost of governance, improve transparency and make the process more user friendly for the citizens.

FINANCIAL MARKETS

• Capital Markets
 Primary Market

o During the week, there were three public offers from IL&FS Investment Limited, Syndicate Bank, and Shri Ramrupia Ltd. All the three were through 100 per cent book building process. 

 Secondary Market

o In a volatile week marked with terror attacks in Ayodhya and London, the 30-share BSE sensex gyrated throughout the week by recording a fall of 57 points and 143 points, respectively. Over the week, it registered marginal gain of 1.31 points, while the NSE nifty recorded a loss of 14.70 points. Among the sectoral indices of BSE, the highest gain has been registered by BSE consumer durables, followed by BSE metals and BSE capital goods. While BSE sensex registered a gain of 0.018 per cent, the BSE mid-cap and BSE small cap recorded growth of 3.92 per cent and 3.17 per cent, respectively. 

o The average daily turnover at BSE and NSE was pegged lower at 2873.65 crore and Rs 5606.03 crore, respectively, as compared to previous weeks daily turnover of Rs 3116.62 crore and Rs 5986.35 crore. 

o Between July 1 and 8, FIIs have been net buyers of equities to the extent of Rs 2416 crore with purchases of Rs 7631.70 crore and sales of Rs 5215.20 crore. During this period, mutual funds have been net sellers of Rs 484.23 crore with sales of Rs 1552.94 crore and purchase of Rs 1068.71 crore.

• Derivatives 

o The F&O segment of NSE saw the daily turnover range lower between Rs 10,562 crore and Rs 19,059 crore during the week as compared to a range of Rs 16,440 crore to Rs 21,761 crore, in the previous week. 

• Government Securities Market
 Primary Market

o The government re-issued 7.27 per cent 2013 and 10.25 per cent 2021 for notified amounts of Rs 6,000 crore and Rs 4,000 crore, respectively. The cut-off yield was set at 7.06 per cent for the former paper and 7.57 per cent for the latter.

 Secondary Market

o Following the higher cut-off yields being set at the central loan flotation’s, higher inflation and the surge in international crude oil prices, the yields on gilt-edged securities firmed up. In addition, the speculation of a hike in reverse repo rate in the impending review of credit policy in July, impinged on the market sentiments. The weighted average YTM of 7.38 per cent 2015 has increased from 6.88 per cent on July 1 to 7.14 per cent on July 8. Due to the outflows on account of auctions, the call rates also remained firm. 

o With a view to strengthen its monetary operations, the RBI has constituted a new financial market department (FMD). The core functions would comprises of: 
i) )Monetray operations such as open market operations, LAF, standing liquidity facilities (SLF) and market stabilization scheme (MSS); ii) Regulation and development of money market instruments such as call/ notice/ term money, repo, collaterised borrowing and lending obligation (CBLO), commercial paper and certificate of deposits; and iii) monitoring of money, government securities and forex market. 

o The collateralized borrowing and lending obligation (CBLO) segment of money market recorded the highest volume on July 4 of Rs. 12,456 crore and the highest number of trades of 287. 

• Bond Market

o Nabard is tapping the market to moblise Rs 200 crore through non-convertible debenture by offering 5.9 per cent for a paper with three years maturity. The issue is rated AAA by Crisil. 

• Foreign Exchange Market

o Over the week, the rupee has depreciated against the dollar by 12 paise due to the huge demand for dollars from oil companies, induced by higher international crude oil prices. Robust dollar movements against the other major currencies such as euro and yen also contributed to the higher demand. 

o The six-month forward premia eased from 1.52 per cent on July 1 to 1.50 per cent on July 8. 

• Commodities Futures derivatives.

o The NCDEXAGRI index rose from 1234.85 points on July 2 to 1251.96 on July 9. 

o The highest daily turnover on MCX of Rs 4,211 crore was touched on July 7, of which the crude oil turnover accounted for Rs 2189 crore. The open interest in crude oil contracts have been 21,79,500 barrels, which reflects the utility to the hedgers of petroleum and petrochemicals sector.

INFLATION

o Inflation rate, based on wholesale price index has risen fractionally to 4.14 per cent during the week ended June 25, 2005 from 4.10 per cent registered during the previous week. The annual point-to-point inflation rate was at 6.95 per cent in the corresponding week last year.

o The WPI has risen to 193.9 during the week in review from the last weeks’ level of 192.9 (Base: 1993-94=100). The index of primary articles’ group has risen considerably (by 0.5 per cent) to 191.4 from the previous week’s level of 190.4, mainly due to a considerable surge in the prices of food articles by 0.7 per cent. The index of fuel, power, light and lubricants group has surged significantly (by 2.1 per cent) to 302.5 from the previous week’s level of 296.3. The heavy-weighted manufactured products’ group constituting 63.7 per cent of total weight, has declined fractionally to stand at 170.6 from 170.7. 

o The latest final index of WPI for the week ended April 30, 2005 has been remained unaltered; as a result both, the absolute index and the implied inflation rate remained at the same level of 192.1 and 5.67 per cent, respectively, as revealed by the provisional figures. 

o The weekly indices in the last two months of May and June 2005 have been more or less rising. The similar rising trend is evident during the corresponding weeks last year. The rate of inflation in the week in review has shown only a negligible increase, due to a high base effect. 

LABOUR

o The interim Pension Fund Regulatory and Development Authority (PFRDA) is likely to set a Rs.100 crore minimum capital norm for pension fund managers. According to the chairman of interim PFRDA, the capital base and capital adequacy ratio would be the major determinants in appointing pension fund managers. The regulator may also appoint more than one Central Record-keeping Agency (CRA) to ensure smooth functioning of the new pension scheme. The CRA would be appointed for the purpose of transfer of public funds from banks and post offices to a centralised agency. The move to have more than one CRA, as it is in the most of the developed countries, is to infuse competition in the market. Further, the PFRDA may also decide to have a totally safe option, in which the pension funds, if the subscriber chooses to, will invest only in government securities. At present, there are 75,000 central government employees under the new pension scheme, where the contribution by the employees would be defined, but the returns would depend on the type of scheme like income, balanced or equity. Apart from these, 45,000 employees from 15 states are also proposed to be covered under the new pension scheme.

SOCIAL INFRASTRUCTURE

• Higher education

o According to the report by the Central Advisory Board of Education (CABE), the real expenditure of the government per student for higher education declined during the post-independence period. The highest decline in the expenditure on higher education per student was during 1990s, i.e. from Rs. 7,676 in 1990-91 to Rs.5,500 in 2002-03. The budget allocation has been severely affected with the introduction of new economic reforms of 1990. The decline in per student expenditure means decline in real resource allocation for libraries, laboratories, scholarships and faculty development programmes affecting quality of higher education. The board also emphasises the need to increase the allocation for education from the current 4 per cent to 6 per cent of GNP, in line with the recommendation of Kothari Commission in 1966 and the national Policy on Education, 1968. The total (Union and state government) expenditure on technical education like engineering, technology and management institutes forms only a small portion of the total government expenditure of about 0.4 per cent. This is quite low as compared to investment between 1 to 2.5 per cent of GNP, by the developed countries. 

PUBLIC FINANCE

o Transporters earning less than Rs 1 lakh a year from their subcontracting work will no longer have to have tax deducted at source on their earnings. The Finance minister has introduced a declaration form, which will save the hassle for such sub contractor to file refunds for their TDS. The move is expected to benefit nearly 50 per cent of the transporters in the country.

o The Finance minister is confident of collecting over 5 per cent of the GDP from direct taxes. He has asked tax officials to improve their collection strategies, which should include monitoring the top 100 corporate taxpayers under each commissionerate. In 2005-06, the direct tax to GDP ratio is expected to cross 5 per cent. The minister also pointed out that for the first time direct tax revenue would exceed non-direct tax revenue. This is being viewed as an important turning point for the country as in many developed nations direct taxes will play an increasing role and contribute largely to exchequer.

o The government is planning to grant a 10-year tax holiday to pharmaceutical companies involved in research and development in the country. The details of the policy, such as the criteria for companies to qualify for such tax benefits are being worked out. Once finalised, the proposal will be sent to the finance ministry for approval. The pharmaceutical industry now enjoys a tax exemption of 150 per cent of the amount invested in research and development, which was initially granted for five years and then extended by another two years.

o The Central Board of Direct Taxes (CBDT) will focus on companies that are in the minimum alternate tax (MAT) ambit to increase advance tax collection. The CBDT has planned to “persuade” the MAT paying companies to pay the tax in advance instead of doing so at the time of filing annual returns. Tax authorities will also examine the quarterly financial statements of large and medium companies each time advance taxes are collected. In the restructured method of advanced tax collection, tax deducted at source and the procedure for scrutiny assessment have been changed. Normally, financial statements are assessed by tax authorities during the final assessment of income at the end of financial year. Advance tax on MAT has remained a debatable issue, as companies cannot estimate the book profit (on which MAT is paid) in advance, they normally do not pay it in advance even though they are required to do so. 

o The CBDT is set to clear all doubts relating to the Fringe Benefit Tax (FBT), through a set of frequently asked questions. Apart from these clarifications, businesses can also look forward for some fringe relief. Tax issues such as what would be treated, as sales promotion and gift for the purpose of FBT would be clarified. Such issues have become significant as FBT on sales promotion is calculated on 20 per cent of the expense, while on gifts it is computed on 50 per cent. Specific sectors like hotels and tour operators are expected to get relief in form of FBT on specific expenses being allowed to be computed on ‘net expenditure basis’. Experts have asked CBDT to allow businesses a deduction of an amount equal to the transport allowance for all employees to avoid differential tax treatment in case a company directly spends the money instead of giving an allowance.

o Ramesh Chandra, Member Secretary, of the Empowered Committee on value added tax has said that the compensation claimed by states for revenue loss due to the new tax system would be within the Rs 5,000 crore earmarked by the union budget. It was earlier expected that the demand for compensation could cross Rs 10,000 crore. As per the data provided by the states collection figures in June were impressive. Many states have registered impressive growth in tax collection.

EXTERNAL SECTOR

o Services exports have posted an astounding growth of 105 per cent from $24.9 billion in 2003-04 to $51.3 billion in 2004-05. According to a study carried out by Federation of Indian Chambers of Commerce and Industry (Ficci), the improved performance of service sector has fuelled growth in overall external trade. Overall exports of goods and services went up from $89.7 billion in 2003-04 to $132.2 billion in 2004-05, an increase of 47.4 per cent.

o Exports of agriculture and allied products went up by over 11 per cent, from $5.4 billion in 2003-04 to $6 billion in 2004-05. However, in rupee terms the growth was around 9 per cent.

o The ministry of mines has rejected a proposal from the industry ministry to raise the foreign direct investment (FDI) limit for the mining of diamonds and precious stones from 74 per cent to 100 per cent. However, the proposal to allow 100 per cent FDI for cola mining by cement and steel companies is expected to pass.

o The decision by the government to allow FDI in private FM radio is expected to see foreign investment of Rs 200 crore into the sector in the next 18 months.

o Center is likely to fix the FDI limit in pension sector at 26 per cent, in the first phase. However, the announcement is unlikely to be made immediately after the new pension scheme is introduced.

o The government has allowed 26 per cent FDI in print media, with immediate effect. This included FDI by NRIs, IPOs and FIIs.

CREDIT RATING

o Icra has assigned an A1+ rating to the Rs. 1000 crore (enchanced from Rs 300 crore) certificate of deposit programme of Karnataka Bank Limited (KBL). The rating takes into account the comfort lent by the excess SLR and other non SLR investments in available for sale category to KBL’s liquidity position and KBL’s strategy to reduce its short term asset liability mismatches. 

o In an another exercise, the agency has retained the MAA and A1+ ratings assigned to Rs. 100 crore debenture and Rs. 200 crore short term debt programmes, respectively of Nirmal Piramal India Ltd. (NPIL). The agency has also reaffirmed the LAA rating assigned to the Rs. 383.7 million redeemable preference share programme of NPIL. The ratings take into account NPIL’s progress on exports business through contract manufacturing and the proposed infusion of equity capital. The reaffirmed ratings reflect NPIL’s dominant position in the domestic formulations industry with strong established brands, besides its high profitability, and strong cash accruals,

o Fitch has assigned F1 (ind) (SO) and AAA (ind) (SO) ratings to the Pass Through Certificates issued under the construction equipment securitisation programme of SREI Infrastructure Finance Limited. The agency has also assigned an F1 (ind) rating to the short-term debt programme of Essar Shipping Limited (ESL) for an amount of Rs.100 crore. The rating factors ESL’s established position in the energy transportation business and dry bulk and petroleum products handling, relatively modern shipping assets as well as its geographically diversified customer base.
 

Theme of the week:

Does Competition Among Banks Favour 
Bank Customers in Setting Reasonable Interest Rates?

The core aspect of monetary policy today is the interest rate policy, according to which bank deposit rates and lending rates are allowed to be by and large freely determined by the commercial bank boards based on their commercial judgement. But, the policy has to subserve the broader macro-economic goals of offering reasonable incentives for savers, and at the same time, charging realistic rates of interest on bank loans. No doubt, in a liberalised environment, there could be divergent viewpoints on what are reasonable and realistic rates. But, it could be established, on the basis of some definitive yardsticks, that the banks’ approaches in these respects now call for some fresh cautioning. As early as in October 1996, the Reserve Bank of India (RBI) had warned that “a number of banks are charging lending rates far higher than PLR on a significant portion of bank credit to borrowers…..” Some guidelines were issued for avoiding this situation. Again, in April 2003, the RBI was constrained to state that “as per the latest available information, spreads above PLR of some banks are substantial”. The banks were then advised to “review the present maximum spreads over PLR and reduce them wherever they are unreasonably high so that credit may be available to the borrowers at reasonable rates of interest”. Some stylized facts in this respect suggest that this theme of improper practices on the part of banks deserves to be revisited by the RBI now.

First, the banks have reduced the rates of interest offered on term deposits to unusually low levels. The maximum rates of interest offered on fresh term deposits of long maturities of over three years by public sector banks have been 5.50 to 6.00 per cent and it has remained so now for 3 to 4 years. In fact, with the maturing of past deposits contracted at higher rates of interest, the weighted average interest cost for banks on term deposits has slumped to a little below 6.0 per cent at the end of March 2004 from about 10.2 per cent in March 2000 or over 11.2 per cent in the mid-1990s. With zero cost on current account balances (12 per cent of aggregate deposits) and only 4.0 per cent interest (now 3.5 per cent) on saving account balances (26 per cent of deposits), the effective interest cost for banks on aggregate deposits has dipped to as low as 4.6 per cent (Table 1).

On the other hand, the effective rate of interest on bank lendings (of credit limit of over Rs 2 lakh) has declined only fractionally from 14.9 per cent in March 2000 to 13.3 per cent in March 2004. As a result, the spread between the average loan rate and the cost of deposits has begun to increase in recent years; it has risen from 7.0 per cent in March 2001/2002 to 8.3 per cent in March 2004 (Table 1).

That the banks adopt asymmetrical approach to effecting interest rate changes as between depositors and borrowers, is widely known, but that it has reached a serious proportion is evident from the latest RBI data on interest range-wise distribution of bank deposits and bank credit. In the case of bank credit, if 14 per cent is treated as the cut-off point taking into account the benchmark prime lending rate (PLR) and the chosen spread over it, over 64 per cent of bank credit had fetched 14 per cent or more of interest for the banks in March 2000. By March 2004, this proportion had fallen to 44 per cent - a reduction of one-third. Contrariwise, in the case of bank deposits, banks have reduced their rates of interest rather more steeply. In March 2000, only 6.9 per cent of bank deposits carried interest rates of less than 6 per cent, but by March 2004, this proportion had jumped to 46.3 per cent. Or interest rates of less than 8 per cent had captured 16.8 per cent of bank deposits earlier, but now they cover 64 per cent of deposits.

In fact, as fresh term deposits generally carry interest rates of less than 7 per cent for longest possible maturities (amongst private sector banks), by 2005, almost all fixed deposits of scheduled commercial banks as a whole would fall within this interest rate bracket. In the case of bank credit, on the other hand, reductions on demand and term loan rates haves been fractional, as shown in Table 2. These lending rates reported by the RBI pertain to advances of above Rs 2 lakh, but with better latitude given to banks to charge rates of interest on smaller accounts in recent years, and also with considerably lower proportions of such small-size loans served by banks now, it is unlikely that average earnings of banks on their aggregate loans including small loans would have eroded any further. It is also significant that all major sectors – agriculture, industry and services - carry, on their bank loans, weighted average rates of interest of 13 per cent or over (Table 3).

Broadly, there are some interesting lessons to be learnt from the banks’ behaviour in regard to their deposit and lending rates in the post-reform period. First, given the freedom, the banks have drastically reduced their deposit rates to unattractive levels close to the inflation rate of 5.50 to 6.0 per cent. At the same time, reductions effected by them in loan rates have been meagre such that the real rates of interest on bank loans remain stubbornly high (7 to 9 per cent). Secondly, the assumption that, in a liberalised environment, competition amongst banks would establish some reasonableness in banks’ behaviour in setting rates of interest on deposits and loans, is not borne out of the reality. Thirdly, the competition has of course spawned one of the most unhealthy 

tendencies amongst banks, which is that they have shown no compunction in resorting to sub - PLR lendings for big size corporates, though PLR is said to cover just the cost of funds, operating expenses, a margin for provisioning and some normal profit. A few months ago Governor Reddy was quite surprised at as much as 60 per cent of bank loans being disbursed at sub-PLR rates because of competitive pressures. With the weighted averages of lending rates remaining high, this implies that the banking system cross-subsidises the big-size corporates against the interest of other borrowers. Given the option, the banks seek to exploit both the depositors as well as the borrowers. Much the larger part of the reason for the downward adjustments in the structure of interest rates in India since the second half of the 1990s have been due to strong central banking actions and signals of moral suasion. This brings us to the final lesson which is that if the signs of rising loan rates as well as growing spread between loan rates and deposit rates have to be curbed so as to stimulate the growth in real sectors (agriculture and industry) as distinguished from the services sectors, some definitive policy signals from the Reserve Bank of India are called for. Apart from the dispensation of moral suasion, prescription of a definitive spread over the PLR is desirable. At present, banks are only asked to declare their spread and not adhere to any specific prescriptions. 

It is true that public sector banks are facing increased wage bills and also the cost of technology upgradation. As against these, increased loan portfolios now seen, away from investment portfolios, may improve profitability. The recent increases in bank credit have been largely for the ‘services’ sectors, whereas the need of the hour is to expand the credit base in real sectors. In such a situation, banks cannot justify such a high real interest burden of 7 to 9 per cent or continue to extract such a high spread of over 8 per cent.

*These statistics and the accompanying review are a product arising from the work undertaken under the joint ICICI research centre.org-EPWRF Data Base Project.

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