MONTHLY ECONOMIC REVIEW

April 2006

IX
Money and Banking

Monetary Projections for 2006-07

In its latest annual monetary policy statement for 2006-07, the Reserve Bank of India (RBI) has made an indicative projection of 15.0 per cent in M₃ growth for 2006-07 as against a comparable 26-fortnight growth of 18.3 per cent during 2005-06 (For 27 fortnights, it was 22 per cent after the effects of merger/conversion, etc).  This projection is apparently consistent with an anticipated real GDP growth of 7.5-8.0 per cent and inflation rate of 5.0-5.5 per cent.  For two consecutive years, M₃ growth has been above the trend growth and hence the RBI has preferred to maintain a policy stance of moderating monetary growth.  Experience, however, suggests that such a monetarist approach to policy formulation has less operational relevance except in the case of extreme situations.

Actual M₃ Growth in 2005-06

The performance of the monetary sector during 2005-06 is interesting in the above respect (Table 9.1). The RBI had placed a working estimate of 14.5 per cent against the backdrop of a possible GDP growth of 7.0 per cent and point-to-point inflation of 5.0-5.5 per cent.   The monetary growth, on a 26-fortngiht basis, has turned out to be of the order of 18.3 per cent as against 12.3 per cent during 2004-05.  As March 31, 2006 has fallen on a reporting Friday, the year has ended with 27 fortnights and an M₃ growth of 22.0 per cent.  All components of M₃ have registered significant accelerations in growth during 2005-06.  The sharpest increase has occurred in demand deposits because of the sustained increases in retail credit and also the buoyancy in the capital market activities.  Probably the same factors are responsible for rapid increases in currency with the public. 

It appears that term deposits with the banking system are increasingly becoming sensitive to interest rate changes.  Bank deposit rates, which had steadily fallen up to early 2005, began to look up.  The increase in average bank deposit rates from about 5.2 per cent to 6.0 per cent by January 2006 has begun to attract better term deposit accruals thus offering a stiff competition to postal deposits.  Postal deposits had grown by 24.2 per cent during 2004-05 while banks’ time deposits had grown by 12.2 per cent.  In the next year 2005-06, their roles got reversed: 18.5 per cent growth in time deposits and 15.2 per cent in postal deposits.

Bank credit to the commercial sector as an expansionary factor

            Amongst the expansionary factors that stand out are bank credit to the commercial sector which has happened for the second year in succession, that is, during 2004-05 (26.0 per cent) and 2005-06 (27.5 per cent) (Table 9.2). Net foreign exchange assets, a major contributory factor for monetary expansion during the past few years, slowed down during 2005-06.

Further expansion during 2006-07 so far

The new fiscal year has begun with a further rapid rise in some components of M_3.  The slightly reduced pace of M₃ growth at 2.4 per cent during the first month of the new fiscal year as against 3.8 per cent in the corresponding month of the previous year.  There is incidentally some non-comparability of the data because in the current year, the variations are over March 31 while in the previous year it was over March 17.  Even so, interestingly currency with the public as well as demand deposits has grown at the same or at higher rate than in the previous year (Table 9.3). Time deposits with banks have grown at a very moderate rate of 1.2 per cent as against 3.8 per cent in the previous year.  It is also significant that the inflow of foreign currency assets has been resumed this year.

Scheduled commercial bank operations

Table 9.4 presents the growth of banking variables during the past few years.  Undoubtedly, the commercial bank operations, particularly deposits and credit, have shown an

unprecedented growth during 2005-06.  An expansion of near 20 per cent in aggregate deposits followed by a 35 per cent bulge in non-food credit (on top of a 29.2 per cent rise in 2004-05) are truly noteworthy.  The possible causes of demand and time deposit accruals have been explained earlier.

The requirements of funds to meet the non-food credit expansion beyond bank deposit growth, have been met by disinvesting government securities and other approved securities.  The sources on non-food credit expansion, particularly retail credit, have been presented in a subsequent paragraph. 

Re-emergence of possible window-dressing

A comparison of monetary and banking data for the year-end periods of the past few years suggests the reemergence of the phenomenon of window-dressing by banks towards the end of March 2006.  The bulge of Rs. 83,895 crore in aggregate deposits or of Rs. 53,921 crore in non-food credit during March 17 to March 31,2006 cannot be explained by year-end  government transactions and interest crediting alone. Comparative figures last year were Rs. 46,680 crore and Rs. 49,610 crore for March 18 to April 1, 2005. No doubt, there is the unusual spurt in banking variables also in the first fortnight of the new year: Rs.25,431 crore and Rs. 3,555 crore in deposits and credit against (-) Rs. 9,986 crore and (-) Rs. 21,226 crore, respectively, last year.

            Interestingly, the window-dressing nature of the year-end bulge is seen more in bank credit variations than in deposits accruals.  As a part of the process of unwinding, credit expansion has been negative during the first two fortnights of the current year.  On the other hand, aggregate deposit growth has continued to expand probably because of the underlying long term trends in saving propensities of the community (Table 9.5).

Rising Real Estate Loans

Commercial banks’ exposure to the real estate sector has almost doubled in the first 10 months of 2005-06 over the March 31, 2005. The total outstanding loans to real estate have risen by 84.4 per cent to Rs 24,527 crore as on January 20, 2006 from Rs 13,302 crore as on March 31, 2005 according to RBI’s report on macroeconomic and monetary developments in 2005-06. The sharp rise in loans to real estate has resulted in RBI announcing guidelines on exposure to real estate last month. The guidelines practically ban banks from lending to real estate developers for purchase of land. Banks are allowed to lend only after developers obtain all necessary approvals from the state and local authorities, which can happen only after the land is acquired. Credit to real estate has increased sharply, although it still constitutes only a small part – less than 2 per cent of outstanding non-food credit and around 4 per cent of incremental non-food credit. The incremental growth in personal loans was 27.0 per cent, largely a contribution of housing loans, credit card loans and educational loans. Housing loans outstanding as on January 20, 2006 have increased by 29.1 per cent (Rs 37,431 crore) to Rs 1,66,159 crore from Rs 1,28,728 crore as on March 31, 2005. Loans outstanding on credit cards have been up by 53.3 per cent or Rs 3,072 crore to Rs 8,832 crore during the period. Similarly, education loans outstanding have risen by Rs 3,884 crore to Rs 9,003 crore. The incremental growth in non-food gross bank credit up to January 20, 2006 has been 25.7 per cent.

The outstanding non-food credit has increased by Rs 2,56,580 crore to Rs 12,56,368 crore. Industrial sector has availed Rs 66,480 crore of loans from the banking system in the first 10 months of 2005-06 against Rs 35,485 crore a year earlier. The increase in industrial credit in consonance with sustained growth in domestic industrial production has been mainly on account of infrastructure, textiles, iron and steel, chemicals, vehicles, gems and jewellery, food processing and construction. The infrastructure sector alone has accounted for more than a third of incremental credit to the industry, while textiles and iron and steel industries absorbed another one-fourth.

Policy Developments

The RBI has liberalised rules governing coporate guarantees and disinvestment. It has also eased the regulatory regime for overseas investment by proprietary concerns. Under the new regime, Indian corporates can offer all forms of guarantees subject to overseas investment cap of 200 per cent of net worth. At present, only promoter companies are allowed to offer guarantees on behalf of their wholly-owned subsidiaries and joint ventures. All other guarantees require a prior RBI approval.

RBI has permitted transfer/trading in power bonds maturing on October 1, 2010 and April 1, 2011, issued by various states to central public sector undertakings in terms of Tripartite Agreement among 27 state governments, ministry of power, government of India and the RBI, under One Time Settlement Scheme for dues of State Electricity Bonds.

Yielding to one of the key demands of the banking community, the RBI has hiked the interest rate ceiling on FCNR (B) deposits by 25 basis points. In the April-December period, the outstanding FCNR (B) deposits have stood at $11.6 billion. The move follows a meeting of senior bankers with RBI governor in which they asked for a cut in the cash reserve ratio, unwinding of market stabilization securities and deregulation of expatriate deposits to ease a liquidity squeeze in the banking system. The decision is expected to further bolster banks’ deposit mobilization programme and will impart some liquidity into the system.

Following the introduction of norms for issuance of perpetual debt instruments by RBI in January 2006, a large number of banks are increasingly tapping the hybrid capital route to raise the fresh capital. The banking industry plans to raise close to Rs 3,000 crore through issuance of perpetual debt instruments in a couple of months. Among the state-run banks, UCO Bank was the first bank to raise Rs 200 crore through hybrid upper Tier II bonds carrying a coupon of 8.75 per cent.

Banks have started levying annual charges on automated teller machines (ATM) cum debit cards ranging from Rs 50 to Rs 500. Bankers are saying this is a small price customers have to pay for all the convenience they enjoy. The banking sector will generate revenue of over Rs 400 crore from this charge annually. State Bank of India (SBI) the country’s largest bank and the largest issuer of debit cards with a card base of 20 million is the latest to join the list levying this charge, is charging Rs 50 per card per annum implying earnings of Rs 100 crore under this head. While private sector banks such as ICICI Bank, HDFC Bank charge debit cardholders an annual fee of Rs 100, customers of multinational banks such as Standard Chartered and HSBC will be shelling out nearly Rs 150-200 annually. ICICI Bank links the annual fee on its debit card to the average balance maintained by its account holders. For instance, the bank does not charge its corporate salary customers or high-networth individuals for debit cards.

Merger

Saraswat Co-operative Bank has completed the merger of Maratha Mandir Co-operative Bank (MMCB) with itself. This is a major merger in the co-operative banking sector in the recent past. MMCB has deposits worth Rs 180 crore and loan assets worth Rs 110 crore, with a branch network of 11 branches and one extension counter. Saraswat Bank has absorbed MMCB’s 242 employees.

Highlights

Over 200,000 employees of the country’s largest bank, State Bank of India (SBI) had begun an indefinite strike, demanding revision in their pension package. The strike affected India ’s payment system, as well the money market and foreign exchange market as SBI accounts for over 20 per cent of the banking industry.  Around 100 million customers of SBI were inconvenienced by the strike. The strike also affected the government’s revenue collection and payment of salaries to employees of companies having salary accounts with the bank. The week-long strike called by over 2 lakh SBI employees was finally called off on April 16, 2006 after Finance Minister P Chidambaram personally intervened in the negotiations between the bank management and the unions. The government has finally agreed to hike the salary cut off point to Rs 21,040 for calculating the pension formula against the existing Rs 8,500 which is related to the pay scale of SBI employees fixed in 1992. The revised scale would be applicable to the existing pensioners as well. As a result the minimum pension would now be Rs 10,520 instead of Rs 4,250.

Nabard’s refinance for commercial banks has increased to Rs 4,289 crore in 2005-06 from previous year’s Rs 2,469 crore. The bank hopes that the demand for refinance from commercial banks would increase further.

*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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