Secular Trends in the Behaviour of Monetary Variables*

India can justifiably claim to possess a fairly well-developed financial system and in it the pivotal role of monetary and banking sectors; in fact the latter role has been dominating which speaks for many an aspect of the country’s development or the lack of it in some respects.

As the economy got evolved through different stages in the six decades of post-Independence era, there have been divergent debates on the role of the monetary and banking sectors. For instance, in the 1950s and 1960s, there was concerted thinking on the subject of monetisation. With increasing commercialization of agriculture, it was thought that the widespread system of barter would be progressively replaced by the phenomenon of monetisation. It did happen and there had been many field studies which brought out this changing phenomenon.

The process of monetisation itself was a complex phenomenon. The reflection of it in monetary and banking data was not found to be straightforward. Along with the replacement of barter transactions by currency, there was also the commercialization of the rural economy and the gradual modernization of the economy in general which facilitated the growth of the banking system and the transfer of transaction balances in favour of bank deposits in a variety of forms: current, saving and term deposits.

 Currency-Money Supply Ratio

 As shown in Table 1, the share of currency with the public in broad money (M₃) remained much above 50% throughout the first 15 years of planning – 1950s and the first half of 1960s.  If narrow money (M₁) is considered as the genuine transaction balance, currency component in it had constituted more than two-thirds during that period. But, it is significant that despite the progressive commercialization of the rural economy and modernisation of the economy as a whole, the importance of currency in transaction balances has hardly come down. It was around 60% in early 1970s and it has remained at around 50% even after four decades (see also Chart A). The persistence of this relative importance of currency in transaction balances is an interesting feature of the Indian economy to which we shall revert after awhile.   

No doubt, the process of financial development and economic modernization was reflected in the steady growth in the proportion of aggregate bank deposits in M₃ (Table 1 and Chart B). This proportion, which was around 40% in the early 1950s, gradually increased to over 50% in mid-1960s, to 70% in mid-1970s, to 80% in mid-1980s and to over 85% now. Aggregate deposits play twin roles; on the one hand, they constitute transaction balances, but on the other, the increases in their stock represent savings of the community. One of the outstanding aspects of the Indian economy has been the steady increase in the household financial savings, and in this feature, bank deposits played a major role. As per the recent Report of the High-Level Committee On Estimation of Saving and Investment (2009), household financial savings have risen steadily from 1.9% of GDP at current prices in the 1950s to 8.7% in the 1990s and finally to 11.3% in 2006-07; in fact, the latest RBI’s updated data suggest that the ratio has stood at 11.2% in 2007-08 (RBI’s Annual Report 2007-08, p.71). As per these RBI data, of the gross financial assets, as much as 56.5% represent bank deposits.

 Currency to GDP and M₃ to GDP Ratios

The process of financial sector development is also reflected, in very broad terms, by the ratios of currency, narrow money (M₁) and broad money (M₃) to GDP. As shown in Table 2, the currency with the public had consistently fallen from around 14% of GDP in the early 1950s to the lowest level of 8% in 1975-76, the year of the Emergency when there was a drastic curb on holdings of unaccounted money (Chart C). Looking at the behaviour of currency to GDP ratio more closely, we find that the falling trend in it had almost stopped in the mid-1960s. By then many structural changes had occurred in the Indian economy. Certainly, the process of monetisation replacing barter had spent itself out, which may have entailed the use of relatively more currency. But by then the banking system had got strengthened and hence the banking habits. These banking habits were promoted by the changes in the composition of national income. Agriculture which contributed more than about 57% of GDP suddenly began to lose its importance after the Green Revolution in the 1960s and 1970s. By the end of 1980s, its share in GDP had dipped to 31.3%; in fact, now in 2007-08 it stands at as low as 18%.

The gainer in the development process has been the various kinds of services sectors, which has contributed to the growth of urbanization. All of these in turn would have contributed to the advancement of banking habits and the expansion of bank deposits.  But the progress of banking and expansion of bank deposits have been greatly facilitated by the measure of bank nationalization in July 1969. Even as these changes have occurred in the system, it was accompanied by a major feature particularly in the urban economy, which was the phenomenon of informalisation; such informalisation has been also in the unorganized manufacturing. The informal sectors obviously use relatively more of currency for transaction purposes. Added to all these, there are clear indications that the incidence of unaccounted dealings had grown and become rampant in India, which obviously calls for deployment of more currency. 

The behaviour of currency to GDP ratio has become an amalgam of all of the above forces operating in the economy. It is interesting that the phenomenon of falling trend in this ratio had almost stopped in the mid-1960s. More significantly, the ratio had remained almost unchanged for about 34 years from 1967-68 to 2000-01, and thereafter it tended to increase.  While more systematic econometric works may establish very authentic hypotheses on this divergent behaviour of currency to GDP ratio, it is possible to pinpoint certain institutional and other causes which may have contributed to this phenomenon.

First, it was during the first 15 years after Independence that the banking system was put on a firmer footing thus facilitating increasing confidence in its operations. Therefore, the people reposed faith in them and opted for more of bank deposits as percentage of GDP. As shown in Table 3, the proportion of aggregate bank deposits to GDP steadily increased during the first 15 years after Independence (see also Chart D).

Second, in the next three decades or so, the phenomenon of bank deposits increasing in relation to GDP continued as a result of the diversification of the economy and the institutionalization of household savings, but there was the pressing need for more currency holdings as a result of informalisation of the economy and also rising tendency to settle transactions out the official channels. These conflicting demands made the currency to GDP ratio remain at around 9 to 10% for 34 years as mentioned above. Finally, after the start of the current century, there have occurred increases in the share of services sectors in total GDP, with small enterprises occupying the commercial activity scene. Besides there has been a tendency for greater inequality and also the phenomenon of large unaccounted money – all of which have entailed relatively more of currency in circulation.

Income Velocity of Money 

The inverse of currency to GDP, M₁ to GDP and M₃ to GDP ratios are their income velocities – income velocity of currency and income velocity of money (Chart E and Table 4). As shown therein, a unit of currency turned over 7 to 8 times the GDP in the 1950s but thereafter the multiple steadily increased to 10 to 11 in the 1970s and even to 12 in the 1980s. Of course there was the interregnum of the Emergency period when the currency velocity had touched the highest level in history at 12.4/12.6. The phenomenon of the currency velocity sticking above 10 remained until 2001-02 after which it has gradually receded to as low as 8.3. That is, despite the phenomenal growth in the economy, a unit rupee turned GDP amount just over about 8 times going back to the early 1950s. The obverse of it is that the currency proportion in GDP has remained now as it was in the early 1950s.

On the other hand, velocities of M₁ and M₃ have behaved rather divergently. While the velocity of M₁ has stubbornly remained high for five decades at 6 to 7, that is, until the end of the last century, income velocity of M₃ has experienced almost a persistent and steady decline from a multiple of 4/5 in the early 1950s to 1.2 in 2008-09. This is the surest sign of increasing monetisation of the Indian economy.

(This note has been prepared by Miss Shruti Pandey under the guidance of R. Krishnaswamy)

• This note has been prepared by Sonali prabhu

The Centre’s wheat procurement from non-conventional states like Uttar Pradesh, Gujarat and Bihar has not yet picked up substantially during this season. The government agencies by 22 April 2009 have procured 16.81 lakh tonnes in non-conventional states as compared with 121.95 lakh tonnes from the conventional states of Punjab and Haryana. Procurement from Gujarat during the same period has declined by 29% to 37,680 tonnes against previous year, while from Bihar, it stood at zero. The maximum procurement has been reported from Punjab and Haryana, touching to 121.95 lakh tonnes, wheat purchase in Haryana intensified at 50.73 lakh tonnes due to UP farmers, who sold major chunk of wheat in the state. Of the total 144.96 lakh tonnes of wheat arrival, the government has so far purchased 138.97 lakh tonnes of wheat.

Imports of vegetable oil is expected to rise by 20% to 7.5 million tonnes in 2008-09 season ending October this year on the back of zero import duty on cooking oil. Imports of vegetable oil which include both edible and non edible oil have increased by 59% to nearly 36 lakh tonnes during November 2008 to March 2009 of the current oil year. It is projected that imports of oil are likely to slow down in the coming months due to additional stock of 1 million tonnes of edible oil. The total oil imports during the oil year (November – October) 2007-08 have been 6.3 million tonnes, of which 5.6 million tonnes were in the form of edible oil. Imports of palm oil were sourced from Indonesia and Malaysia, while soyabean oil was sourced from Argentina and Brazil.

The central government would be allowing the private traders to import duty free refined sugar to cool domestic prices that have reached a three-year high amid a decline in sugar output domestically and internationally. Country’s sugar output is expected to be around 15 million tonnes in the year ending 31 September 2009. The central government on 17 April 2009 has asked mills to sell an additional 600,000 tonnes of sugar locally in April- June quarter to boost supplies. 

Sugar industry is trapped under regulatory measures announced by the central government. As per the order issued by the government on 16 April 2009, mills have to sell half of the unsold stock under the monthly free sale quota by 11 April and remaining part before 30 April 2009. Mills are facing the threat of unsold stocks under the open market quota converted into levy sugar and sold through PDS system, where these are fetching lower prices. Dispatches of sugar are affected badly due to unavailability of trucks.  

As per the notification released by Directorate General of Foreign Trade (DGFT), the government has reimposed export restriction on sugar with effect from 01 January 2009 for export under open general list. Since sugar production in 2008-09 sugar season would be substantially lower than that of last two years, this attempt would improve the availability of the sweetener in the domestic market and price would slowly come down. Since January 2009, the directorate has not been issuing any release orders for exports of sugar and hence exports have not been carried out.

Cotton Corporation of India (CCI) has reduced the sale price of the Sankar-6 variety of cotton by around Rs 400 per candy. Currently, it is selling this variety at Rs 23,100 per candy from Rs 23,500 a week back. They have reduced prices of cotton as the demand from domestic mills has gone down and further, cotton merchants have also cut its prices. Out of the total 88-lakh bales cotton procured, the CCI had sold 61 lakh bales by the first week of April. Cotton mills have lower stocks, which are expected to last up to four months; as a result, they have slowed down purchases, forcing the CCI to reduce prices. 

Cashew kernel exports from the country have declined by 5.4% to 108,131 tonnes for the year ended March 2009 as compared to the period a year ago. In value terms exports have gone up by 29% to Rs 2,950 crore as compared to the last year; the highest ever performance by the commodity. The rise in the value was mainly due to a 36% rise in the unit value realisation at Rs 272.8 per kg, as a result of the appreciation of dollar against Indian rupee in the international market. The cashewnut processing industry, which is mainly dependent on the import of raw cashew nut to meet requirements, has imported 605,654 tonnes of raw nuts during the year. In value terms, the imports have gone up by 50.6% to Rs 2,631.78 crore compared to the last financial year. The unit value of imported nuts has increased by 50.7% to Rs 43.45 per kg compared to the last year. The export of cashew nut shell liquid, which is a major raw material in various industrial applications, has declined by 10.7% to 6,976 tonnes. In value terms, exports have risen by 40.1% to Rs 16.7 crore compared to last year.

Officials of Automotive Tyre Manufacturers’ Association (ATMA) have reiterated that imports of natural rubber is likely to double in the current fiscal due to the growing concerns on availability and price. It is expected that the huge difference in the prices of global and domestic rubber is likely to take the imports to 1, 50,000 tonnes in the current fiscal as against 80,000 tonnes of 2008-09.

Seafood importing countries led by Japan and the European Union (EU) have tightened quality checks on shrimp imports from India. Japan has increased the frequency of quality checks of the Indian consignments nearly by 30%. These cecks would undergo thorough quarantine stations.

Industry

Infrastructure

Inflation

The annual rate of inflation, calculated on point-to-point basis, stood at 0.26 percent (Provisional) for the week under reference as compared to 7.95 percent during the corresponding week of the previous year.  

Capital Markets

Primary Market

Adani Power has re-filed its draft red herring prospectus (DRHP) for IPO, after dropping plans last year, scaling down the size of offering. The company had filed DRHP in May 2008 but did not proceed with the IPO due to unfavourable market conditions. According to the revised DRHP, the percentage of equity share holding of the promoter and promoter group would decrease to 73.50% from 86.97% after the issue.

Secondary Market

Bulls are on the rampage with the market surging for the seventh week in a row on the back of sustained buying by foreign funds amid signs of improvement in the Indian economy, possibility of further reduction in interest rates with inflation at near zero and on easing credit crunch. Domestic indices ignored the weak global markets. The RBI, as part of its Annual Credit Policy, cut its key short-term rates by 25 basis points each on 21 April 2009, to prop up growth amid global economic slowdown. The repo rate, was cut to 4.75%, and the reverse repo rate, was reduced to 3.25%, effective immediately. The bank rate, used by banks to price long-term loans, remained at 6%. Banks' cash reserve ratio (CRR) was also left unchanged at 5%. Inflation based on the wholesale price index (WPI) rose 0.26% in the year through 11 April 2009, higher than previous week's 0.18%. BSE Sensex rose 306 points or 2.78% to 11,329 during the week. It was the biggest closing level for the BSE Sensex in more than six months. Demand for mid and small cap counters has helped BSE mid-cap and BSE small-cap indices to close with gains of 3.67% and 2.95% respectively. The NSE Nifty increased 96 points or 2.84% to 3,481 in the week. Sustained buying by FIIs to the tune of Rs 583.3 crore in the first four days of the week also helped to build on the gains from previous week. Foreign institutional investors (FIIs) inflow in April 2009 totaled Rs 4,860.40 crore, while the outflow in calendar year 2009 totaled Rs 1,811.20 crore (till 23 April 2009).

All the sectoral indices of BSE recorded positive returns over the week except Consumer Durable index. Among the gainers Metal recorded 5.5% growth followed by TECk and Realty with 5.4% and 4.2%, respectively.

Derivatives

Primary Market

RBI auctioned 91-day TBs and 364-day TBs on 22 April 2009 for the notified amount of Rs 8,000 crore and Rs 1,000 crore, respectively. The cut-off yield for the 91-day TBs and 364-day TBs was set at 3.36% and 3.76%, respectively.

On 23 April 2009, RBI purchased 7.38% 2015, 8.07% 2017, 8.24% 2018, 8.35% 2022 and 7.95% 2032 securities through open market operation (OMO) for the notified amount of Rs 6,000 crore. The cut-off yield for these securities was set at 6.74%, 6.45%, 6.46%, 6.83% and 7.28%, respectively. 

RBI re-issued 6.05% 2019 and 7.50% 2034 for the notified amount of Rs 8,000 crore and Rs 4,000 crore, respectively. The cut-off yield for the 10-year paper maturing in 2019 was set at 6.13% and for the 25-year paper maturing in 2034 was set at 7.23%.

Secondary Market

Inter-bank call rates moved in the range of 2.17-3.48% during the week. Bond prices rallied on the back of liquidity overhang in the financial markets and low credit off-take. The rally came as the RBI signalled its intention for lower interest rates in the lean season Credit Policy announcement, through a 25 basis points reduction each in the reverse repurchase and repurchase rates taking them down to 3.25% and 4.75% respectively. As a result, the reverse repo rates dropped below the savings bank rate of 3.5%.

During the week under review, 3 FIs/banks, 1 NBFC and 1 central undertaking tapped the bond market to mobilize an amount of Rs 4,111 crore, respectively.

In order to enable over-the-counter (OTC) settlements in corporate bonds on a real time basis, the RBI decided to allow the clearing houses of the exchanges to have a transitory pooling account facility with the central bank on April 21. The move comes close on the heels of a recent announcement by the Securities and Exchange Board of India (SEBI) Chairman C B Bhave to route OTC corporate bond transactions through clearing entities to mitigate risks in such deals while bringing in more transparency in OTC settlements. Under the proposed transitory pooling mechanism, settlements of corporate bonds can be done through the real time gross settlement (RTGS) system with the corresponding central clearing house. The buyer of corporate bonds will transfer the funds through his bank to the transitory account, while the clearing house will be able to transfer the securities to the buyer's account from the seller's account and release the funds to the latter's account. According to the central bank, this settlement mechanism will be done on a trade-by-trade basis or delivery versus payment-I (DvP-I) basis that was earlier recommended by the R H Patil Committee at RBI.

Forward premia remained largely steady. As result, one, three six and 12-month premia ended the week at 3.63% (3.5%), 3.27% (3.16%), 2.77% (2.69%) and 2.17% (2.13%) respectively. Cash-to-spot ended the week at a low of 2.32% (2.51%), in view of the low call rates and high liquidity. Despite the slight widening of premia, the rupee faced little downside risk, traders said. This was apparent from the Non-Deliverable Forward market ((NDF) rate that ended the week at Rs 49.92 (Rs 49.97) or lower than the domestic spot rate.

Commodity market regulator Forward Markets Commission (FMC) has said it does not intend to suspend futures trading in sugar in the near future, even though traders' association are demanding a ban on sugar futures to arrest price rise. On 22 April in the Committee of Secretaries (CoS) decided that the FMC will monitor the price movement of sugar in the futures market and take steps if and when necessary. According to B C Khatua futures trading is not responsible for the rise in sugar prices in the spot market. The demand for suspension of sugar futures arose following an unprecedented rise in prices of sweetener in the physical market in the last couple of weeks. Mumbai-based Bombay Sugar Merchants Association had sought ban on sugar futures. It had attributed the latest price spurt to unbridled speculation in the futures market.

Public Finance

Banking

HDFC Bank has announced reduction in its deposit rates by 25-35 basis points across all tenors, with effective from April 22, 2009. The bank’s domestic term deposit rate for one year tenure has been revised to 7%. However, the highest interest rate of 8% offered by the bank on deposit for the tenure of two years and 16 days remains unchanged.

On a standalone basis Mahindra & Mahindra Financial Services has posted profit after tax (PAT) at Rs 108 crore during the quarter ended 31 March 2009, an increase of 43.3% from Rs 75 crore  during the same period a year ago.

Private sector lender Yes Bank’s net profit increased by 24% in the fourth quarter ended March 31, 2009 at Rs 80 crore as against Rs 64.50 crore over the corresponding period a year ago.

State Bank of Mysore has reported an increase in its net profit to Rs 337 crore from Rs 318 crore during the financial year ended March 31, 2009.

ACC, the largest cement manufacturer in India has reported increase of 23% in its net profit to Rs 399 crore for the first quarter ended March 31, 2009, against Rs 324 crore in the corresponding quarter last year. The company is going ahead with its planned organic expansion programme of increasing the capacity to 30.58 million tonnes by 2010 from the current 22.63 million tonnes. The company has planned capital expenditure of Rs 1,600 crore in the year 2009 followed by Rs 1,300 crore in 2010.

Engineering equipment supplier BGR Energy has bagged a contract worth Rs 15 crore from Maithon Power at Jharkhand for engineering related works.

Piramal Healthcare is planning to hire 300-400 people this year across the country, taking its total employee base to 7,400. Last year the company had employed 1,500 people in the country for its mass marketing division.

External Sector

Information Technology

HCL Technologies net profit had declined by 36.3% to Rs 218 crore during the third quarter ended March 31, 2009 compared to the same quarter last year. The company has been suffering heavy forex losses during the past couple of quarters due to its long-term hedging policies (Rs 97.4 crore in the first quarter, Rs 120 crore in the second quarter and Rs 201 crore in the third quarter ended March 31, 2009).

India’s largest IT Company TCS has declared a 7% increase in its net profit for the fourth quarter ended March 31, 2009 at Rs 1,333 crore, in line with market expectations. Consolidated net profit for the full year ended March 31, 2009 rose by 4.6% to Rs 5,256 crore against Rs 5,026 crore in 2007-08. The company closed 28 large deals during 2008-09, and acquired 163 new customers. TCS has announced a bonus issue in the ratio of 1:1, subject to regulatory approvals. This is in addition to a total dividend of Rs 14 per share. The company acknowledged that it is facing pressure from its clients to rework prices.

Telecom 

Value added services (VAS) providers have been witnessing huge volume of messaging. According to analysts, political messaging has become 25% of the total traffic during the last 2-3 months. VAS providers are charging less, in the range of 5-10 paise for each SMS for bulk of the messages. The various political parties in the country are using this new option as the cost of sending message is comparatively less than campaign from TV channels. 

ZTE Chinese telecom equipment provider, which has provided infrastructure to Indian firms like Reliance Communication, Tata Teleservices, Aircel and Loop Telecom, has found a novel way to do business in India. ZTE has tied up with China Development Bank for financing mobile operators for network rollout in India. This is a strategy not only to compete with existing, well-established players like Ericsson, Nokia-Siemens but also to increase its market share in one of the fastest growing telecom sector in India.