The Problem of Inflation

MONEY MARKET REVIEW

extent of intervention through policy instruments is a challenging one in this case. Union Home Minister P Chidambaram, on an earlier occasion, expressed appre-EPW Research Foundation hension over whether the government

Given the lack of consensus within the government on the factors behind the current surge in inﬂation and the relevant tools to deal with it, an analysis of the trends in the food and non-food groups in the Wholesale Price Index and the Consumer Price Index for Industrial Workers for 2009-10 and 2010-11 could help bring clarity to the ongoing debate. Contrary to the view on food inﬂation as the major contributory factor, the analysis here reveals that the weighted contribution of non-food inﬂation to overall WPI and CPI inﬂation has increased in the current ﬁscal year. Moreover, the impact of food inﬂation on the overall inﬂation rates is easing. Non-food inﬂation, the rising prices of manufactured products and the global upswing in fuel and commodity prices warrant an increasingly important role for monetary policy.

1 Introduction

he Chief Statistician of India T C A Anant, in his convocation address delivered at the Indira Gandhi Institute of Development Research in Mumbai on 17 January dealt with an interesting issue – how could economic concepts be subject to different interpretations when applied to policymaking and at times result in confusion and controversy. He substantiated his observations with illustrative concepts of proﬁt and poverty. Another critical concept which ﬁts well into the above observation and which has been a matter of heated debate in the past several months is inﬂation. According to economic theory, inﬂation denotes an increase in the general price level, and not with reference to any particular sector or commodities. Alternately, it is the change in relative prices of goods and services. However, in practice, the variety of measures and concepts, and the numerous interpretations they are subject to, has sparked off a debate on the policy front in India. For instance, Reserve Bank of India (RBI) Governor D Subbarao in the same forum said that India is facing surging inﬂation, and faced a dilemma of supporting growth on the one hand and containing inﬂation on the other, he quipped that there was no template to deal with the problem of inﬂation. Thus the issue of timing and understood all the factors behind inﬂation and had the tools to control it. Kaushik Basu, the chief economic adviser, emphasised the important distinction between short-term and medium to long-term inﬂation. While the ﬁnance secretary observed that there was no scope for using either ﬁscal or monetary policy to address inﬂation in the current context, Chairman of the Economic Advisory Council C Rangarajan indicated that the latter should have price stability as its predominant objective and this is relevant even when inﬂationary pressures arise from food. In its second Financial Stability Report released on 30 December 2010, the RBI has identiﬁed inﬂation as one of the major risks:

Inﬂation, particularly food inﬂation, in India continues to rule at elevated levels reﬂecting in part the structural demand-supply mismatches resulting from, inter alia, rising incomes and changing consumption patterns. Non-food manufacturing inﬂation remains above trend. The recent upswing in food and commodity prices at the global level is also a concern for domestic inﬂation, going forward.

One of the central arguments running through the debate on the current inﬂation is regarding its nature – is it essentially that of food inﬂation alone, or is it generalised inﬂation? Further, what should be the role of monetary policy in containing the current inﬂationary pressure? An attempt is made here to throw some light on this particular issue based on an analysis of

Table 1: Inflation Trend and Build-up: Wholesale Price Index (% Increases)

(Base 2004-05=100)

Months All Commodities Food Index (Food Articles + Food Products) Non-Food Index (WPI - Food Index) Annual Inflation Inflation Build-up Annual Inflation Inflation Build-up Annual Inflation Inflation Build-up 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11

April 0.9 11.0 1.1 1.8 8.8 16.1 3.1 1.0 -1.6 9.2 0.5 2.2

May 1.2 10.6 0.7 0.4 9.4 15.8 1.3 1.1 -1.4 8.7 0.5

June -0.7 10.3 0.7 0.4 10.4 15.3 1.5 1.1 -4.2 8.5 0.4 0.2

July -0.6 10.0 1.1 0.9 11.1 14.3 2.5 1.6 -4.4 8.4 0.6 0.6

August 0.3 8.8 1.2 0.1 13.0 11.1 2.4 -0.5 -3.7 8.0 0.7 0.3

September 1.1 8.9 0.5 0.6 13.2 11.5 1.1 1.5 -2.9 8.0 0.2 0.2

October 1.5 9.1 0.5 0.6 12.7 10.6 1.4 0.5 -2.2 8.6 0.1 0.7

November 4.5 7.5 1.5 -0.1 17.2 6.1 4.1 -0.1 0.2 8.0 0.5 0.0

December 6.9 8.4 0.4 1.3 20.2 8.6 0.4 2.7 2.4 8.4 0.4 0.7

Team led by K Kanagasabapathy and supported

January 8.5 1.4 19.8 1.0 4.7 1.6

by V P Prasanth, Rema K Nair, Anita B Shetty,

February 9.7 0.0 20.2 -0.7 6.0 0.3

R Krishnaswamy, Pallavi Oak, Vishakha G Tilak

March 10.2 0.7 18.5 -0.8 7.4 1.4

and Sharan P Shetty.

Source: www.eaindustry.nic.in and as compiled by the EPWRF.

Economic & Political Weekly

january 22, 2011 vol XLVI No 4 73

MONEY MARKET REVIEW

the trends in the two major indices – the The trend in food inﬂation as reﬂected Wholesale Price Index (WPI) and the Con-in the annual increase in food index sumer Price Index for Industrial Workers reveals a consistent fall in the inﬂation (CPI-IW) during the current ﬁnancial year rate from 16.1% in April 2010 to 6.1% in vis-à-vis the corresponding period in the November, which got reversed to 8.6% last ﬁnancial year. in December, mainly due to the highest build-up since April (2.7 percentage

1.1 Inﬂation Trends: WPI points). Despite this, food inﬂation in The year-on-year inﬂation in wholesale December 2010 at 8.6% was signiﬁcantly prices since April 2010 has in fact been lower in comparison with 20.2% in showing a somewhat softening trend, December 2009. despite some ﬂuctuations during different Coming to non-food inﬂation, the inﬂamonths. Overall, the WPI inﬂation, which tionary pressure has consistently remained was ruling at double digits during April to at elevated levels of above 8% since April July, has been in single digits since 2010, in sharp contrast to signiﬁcant August. There was a reversal of trend in declines noticed during April to October December, the inﬂation rate increasing to 2009. This trend, however, has shown a 8.4% compared with 7.5% in the previous reversal since November 2009, and after month. This is due to a build-up of 1.3 per-touching a peak of 9.2% in April 2010, it centage points, the highest since April has not seen a let-up (Table 1, p 73). It is 2010, which is mainly due to the sharp signiﬁcant that in the non-food category, build-up of 2.7 percentage points in the the manufactured products index showed food index, as compared to a build-up of an annual increase of 5.3% in December only 0.7 percentage point in the non-food 2010 compared with a meagre 0.8% rise in index in December. It must nevertheless December 2009. be noted that the current inﬂation rate The source of inﬂationary pressure as remains at an elevated level of 8.4%, com-between food and non-food can also be pared with 6.9% in December 2009. gauged from the number of items showing

Table 2: Distribution of Commodities and Weighted Contribution: an increase in prices and Wholesale Price Index those showing a decline

2009-10 2010-11 Number Weight Weighted Number Weight Weighted among these two broad Contribution Contribution

commodity groups, and their

I: Non-Food Group

relative weighted contribu-

Showing Decline (-) 193 23.1 -11.8 127 12.9 -6.2

tion to inﬂation. The number

No Change 48 3.1 0 70 6.6 0

Showing Increase (+) 324 50.3 51.7 368 56.9 67.4 of items in the food group

Total Non-Food 112 76.5 39.9 565 76.5 61.2 which experienced a decline

II: Food Group			in prices jumped to 33 dur-
Showing Decline (-) No Change Showing Increase (+) Total Food	12 1.9 6 0.9 94 21.6 112 24.3	-0.8 0 62.4 61.6	33 6.4 7 0.9 72 17.0 112 24.3	-7.4 0 47.5 40.1	ing April-December 2010 compared to only 12 such items during the same period
Source: www.eaindustry.nic.in and as compiled by the EPWRF.			in	2009. Their weighted

Table 3: Inflation Trend and Build-up: Consumer Price Index (IW): Month-wise (% Increases)

(Base 2001=100)

Months CPI (IW) Food Index Non-Food Index Annual Inflation Inflation Build-up Annual Inflation Inflation Build-up Annual Inflation Inflation Build-up 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11 2009-10 2010-11

April 8.7 13.3 1.4 0.0 10.4 14.5 1.9 0.6 7.1 12.2 0.8 -0.5

May 8.6 13.9 0.7 1.2 11.7 13.6 1.9 1.1 5.8 14.2 -0.5 1.3

June 9.3 13.7 1.3 1.2 12.2 13.9 1.9 2.2 6.5 13.5 0.8 0.2

July 11.9 11.3 4.6 2.3 14.7 11.6 4.2 2.1 9.3 10.9 4.9 2.5

August 11.7 9.9 1.3 0.0 13.7 9.8 1.2 -0.5 9.8 10.0 1.3 0.5

contribution to the increase in the index was minus 7.4% in 2010, compared with only minus 0.8% in 2009. On the other hand, the number of items showing an increase in prices fell from 94 in 2009 to 72 in 2010, and their weighted contribution declined from 62.4% in 2009 to 47.5% in 2010. Overall, the weighted contribution of food inﬂation to WPI inﬂation declined from 61.6% to 40.1% between the two periods.

In comparison, the non-food items present a very different picture. The number of items showing a decline in prices fell from 193 to 127 and their weighted contribution to the increase in the index was minus 11.8% in 2009 compared to minus 6.2% in 2010. On the other hand, the number of items showing a price increase went up from 324 to 368 and their weighted contribution jumped from 51.7% to 67.4%. Overall, the weighted contribution of the nonfood index increased from 39.9% to 61.2% between the two periods (Table 2).

1.2 Inﬂation Trends: CPI-IW

An analysis of the trend in inﬂation and its build-up based on consumer prices yields similar conclusions. However, the CPI ruled at much higher levels last year relative to the WPI, mainly because of the larger weight assigned to food items. Furthermore, the type of products covered under the food and non-food groups in the two indices are also different, implying that food inﬂation based on the two indices is not strictly comparable. As a result, there was a sharp and consistent fall in CPI inﬂation during the current year from 13.3% in April to 8.3% in November. Similarly during the last year, in contrast to a declining WPI inﬂation, the CPI inﬂation was consistently accelerating.

What the CPI and WPI inﬂation rates have in common is the trend in non-food inﬂation. The non-food CPI inﬂation which was relatively subdued in 2009-10, consistently remains at elevated levels at doubledigit rates higher than 11% through out the current ﬁscal year.

September 11.6 9.8 0.6 0.6 13.5 9.7 1.1 1.0 9.8 10.0 0.1 0.1 Food inﬂation based on the CPI has con-

October 11.5 9.7 1.2 1.1 13.8 7.7 2.8 1.0 9.2 11.7 -0.4 1.2 sistently declined during the current year November 13.5 8.3 1.8 0.6 17.6 5.3 3.3 1.0 9.5 11.5 0.3 0.1

from 14.0% in April to 5.3% in November,

December 15.0 0.6 21.3 0.5 9.0 0.7

much lower than the level seen in the

January 16.2 1.8 19.2 -1.1 13.4 4.8

WPI. This is attributable to differences in

February 14.9 -1.2 17.3 -1.6 12.5 -0.7

commodity groups and their weight as

March 14.9 0.0 16.0 -1.1 13.8 1.1 Source: Labour Bureau, and as compiled by the EPWRF. between the two indices. What is surprising

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Economic & Political Weekly

MONEY MARKET REVIEW

% Annual Increase

14 10 6 2

0

-2 4/09 6/09 8/09 10/09 12/09 2/10 4/10 6/10

is that the intensity of food inﬂation, which is much talked about currently, is not all that visible in the movement of the CPI (Table 3, p 74).

The divergence between the WPI and the CPI inﬂation rates, which was quite large during 2009-10, has narrowed signiﬁcantly and both the inﬂation rates currently rule at around 8.5% (Graph A).

In sum, the conclusions from the above are: (i) the WPI inﬂation still remains at elevated levels compared to last year, though the rate of inﬂation has been showing a softening trend, except for the reversal in December; (ii) the inﬂation build-up came mainly from non-food during 2010-11 compared with food inﬂation during 2009-10; (iii) the weighted contribution to overall WPI inﬂation from non-food items has increased during the current year, comhave no effect.

The policy rate hikes are already overdue and the central bank is behind the curve by at least 25 basis points (bps). A hike in policy rates by at least 50 bps will be warranted

8/10 10/10 12/10

before or at the time of announcing the Third Quarter Review of Monetary Policy on 25 January 2011.

2 Money, Forex and Debt Markets

Money markets remained relatively volatile during December with growing uncertainty about the overall economic prospects on the back of ﬂuctuating industrial production data along with investor speculation over further monetary policy tightening by the central bank in January. Cash tightness in the banking system, which has persisted since the last several months, continued, with banks borrowing heavily from the central bank to bridge the deﬁcit during the entire month of December. The month also recorded the highest outﬂow of funds from the system which further worsened the liquidity scenario.

Table 4: Results of OMO Auctions (Amount in Rs crore)

Table 6: RBI’s Market Operations (in Rs crore)

Month/Year OMO LAF (Average Daily (Net Purchase(+)/Sale(-)) (Injection (+)/Absorption(-))

April-10 10 -54,009

May-10 0 -34,749

June-10 -2 43,123

July-10 -16 48,740

August-10 -11 1,207

September-10 8 14,364

October-10 -1 62,309

November-10 8,354 98,001

December-10 41,383 1,16,355

Source: RBI’s Weekly Statistical Supplement.

The massive cash drain was a result of bank credit to the extent of Rs 2,00,000 crore, followed by an accumulation of the central government’s cash balances with the RBI and net reserve bank credit to the government, together resulting in the depletion of Rs 1,00,000 crore from the system. As on 31 December 2010, the yearon-year deposit growth at 16.5% was way behind the faster growth of bank credit by 24.4%. However, to ease the liquidity crunch, the RBI initiated several measures during the beginning of the month in its mid-quarter policy review. It slashed the statutory liquidity ratio (SLR) by 1 percentage point to 24% and announced the purchase of securities worth Rs 48,000 crore

pared with last year; (iv) similar conclusions are derived from an analysis of CPI inﬂation rates and their build-up between the two years; and (v) despite some differences, the two inﬂation rates overall have	Date of Auction 09-Dec-10	Nomenclature of Loan (in %) 7.59 2016 7.99 2017 7.80 2020 8.20 2022	Type of Auction OMO OMO OMO OMO	Notified Amount 12,000	Competitive Bids Accepted Amount -5,977.50 3,936.07 206.51	Bid-Cover Ratio -2.15 2.58 16.53	Indicative YTM at Cut-Off Price (in %) -8.00 (Rs 99.96) 8.06 (Rs 98.30)
been converging during the current year.	15-Dec-10	7.02 2016	OMO	12,000	1,028.09	2.41	8.16 (Rs 100.29) 7.91 (Rs 96.00)
		7.99 2017	OMO		4,797.18	1.66	7.95 (Rs 100.21)
1.3 Policy Approach		8.13 2022	OMO		5,880.60	1.93	8.07 (Rs 100.46)
The above analysis shows that the empha	22-Dec-10	6.49 2015	OMO	12,000	934.92	5.67	7.81 (Rs 95.10)
sis upon food inﬂation is somewhat misplaced. No doubt food inﬂation must be	29-Dec-10	7.46 2017 7.80 2020 6.49 2015	OMO OMO OMO	12,000	2,279.40 4,843.01 -	1.89 1.91 -	7.83 (Rs 98.10) 7.91 (Rs 99.29) -
contained, but over the last year, the		7.02 2016	OMO		524.10	7.45	7.79 (Rs 96.55)
impact of food inﬂation on the overall		7.99 2017	OMO		3,124.50	1.87	7.78 (Rs 101.08)

inﬂation rates of both wholesale prices and 8.13 2022 OMO 5,436.84 1.99 7.99 (Rs 101.04)

consumer prices is easing. In contrast, nonfood inﬂation, particularly of industrial inputs such as ﬁbres, iron ore and fuel prices, is on an accelerating pace. The prices of manufactured products are also on the rise. The global trend of rising commodity and fuel prices will also have serious con

8.26 2027 OMO 2,416.68 1.10 8.32 (Rs 99.49)

Total 48,000 41,385

Source: RBI press releases. Table 5: Money Market Activity (Volume and Rates)

Instruments		December-10			November-10
	Daily Average Volume (Rs Crore)	Monthly Weighted Average Rate (%)	Range of Weighted Average Daily Rate (%)	Daily Average Volume (Rs Crore)	Monthly Weighted Average Rate (%)	Range of Weighted Average Daily Rate (%)
Call Money	7,657	6.74	5.65-6.97	8,663	6.97	6.16-7.38

sequences upon domestic inﬂation. In this context, the role of monetary policy becomes increasingly important in containing inﬂation. No longer can one argue that inﬂation is from the supply side, and	Notice Money 1,888 Term Money @ 150 CBLO 42,885 Market Repo 12,589 @: Range of rates during the month. Source: www.rbi.org.in. and www.ccilindia.com.	6.72 -6.20 6.28	4.00-9.22 6.00-10.00 4.79-6.31 3.00-6.36	1,875 103 31,600 9,635	6.81 -6.12 6.44	3.75-6.95 6.00-8.85 4.00-6.87 4.68-6.47
Economic & Political Weekly		january 22, 2011	vol XLVI No 4					75

MONEY MARKET REVIEW

CBLO Rates (December 2010)

8 stayed above Rs 1,00,000

Call Rates

crore during the entire month with some intermittent exceptions. As liquidity conditions

6

are expected to start easing,

4

Repo Rates–Outside the RBI

the market is almost certain 2 that the central bank will rein in inﬂation again by another round of policy rate hikes up

0

27/11 1/12 5/12 9/12 13/12 17/12 21/12 25/12 29/12 31/12

to 50 bps in its Third Quarter through its open market operations (OMO). Review of Monetary Policy (Table 4, p 75). Still, the system continued to be in deﬁcit The persistent liquidity crunch had an mode throughout the month as the buoy-impact on the entire range of money market ant tax collections from corporates for the rates across instruments, though some third quarter of 2010, which rose by 17.8% softening was noticed towards the end of over the previous year, weighed signiﬁcantly the month. The rates in general ruled on the liquidity of the system. To manage above the LAF corridor. In the forex market, the situation, the banks borrowed heavily the performance of the rupee against the from the RBI’s Liquidity Adjustment dollar was comparatively better compared Facility (LAF) repo window and the daily to the previous month. On the other hand,

Table 7: Foreign Exchange Market: Select Indicators the dollar depicted a diverse

Month Rs/$ Reference Appreciation (+)/ FII Flows BSE Sensex US Dollar

behaviour and recorded a dras-

Rate (Last Friday Depreciation (-) (Equity +Debt) (Month-end Index of the Month) of Rs/$ (in %) in $ Million Closing) tic fall particularly against the

Apr-10 44.44 2.03 2,783 17,559 81.99

Asian currencies in the second

May-10 46.54 -4.51 -1,505 16,945 86.58

fortnight of the month. The

Jun-10 46.54 0.00 2,424 17,701 86.28

yield rates in the government

Jul-10 46.46 0.17 5,285 17,868 81.65

securities market also continued

Aug-10 46.86 -0.85 3,163 17,971 83.25 Sep-10 45.54 2.90 7,100 20,069 78.72 to rise with a heightened expec

Oct-10 44.54 2.25 5,468 20,032 77.27 tation that the central bank will

Nov-10 45.74 -2.62 4,785 19,521 81.19 further increase its key policy Dec-10 44.81 2.08 710 20,509 79.03

rates. In the corporate bonds

Source: RBI (www.rbi.org.in), BSE (www.bseindia.com), SEBI (www.sebi.gov.in), www.futures.tradingcharts.com market, the activity remained

Table 8: Turnover in the Foreign Exchange Market* (in $ billion)

Month Merchant Interbank Spot Forward Total

Apr-10 233.6 -(9.8) 689.0 -(6.9) 489.7 -(4.5) 433.0 -(11.0) 922.6 -(7.6)

May-10 320.9 (37.3) 839.9 (21.9) 595.8 (21.7) 565.0 (30.5) 1,160.8 (25.8)

Jun-10 281.2 -(12.4) 803.4 -(4.3) 547.1 -(8.2) 537.6 -(4.9) 1,084.7 -(6.6)

Jul-10 253.4 -(9.9) 747.5 -(7.0) 492.4 -(10.0) 508.5 -(5.4) 1,000.9 -(7.7)

Aug-10 284.2 (12.2) 796.3 (6.5) 517.7 (5.1) 562.9 (10.7) 1,080.5 (8.0)

Sep-10 306.1 (7.7) 819.5 (2.9) 559.2 (8.0) 566.4 (0.6) 1,125.6 (4.2)

Oct-10 398.9 (30.3) 1,047.6 (27.8) 708.3 (26.7) 738.1 (30.3) 1,446.4 (28.5)

seen on developing a strong corporate bond market to fund infrastructure development, which will require an estimated $1 trillion during the Twelfth Plan period.

2.1 Money Market

The tightness in the liquidity situation continued to take a toll on the short-term money market instruments and rates. The weighted average rate in the call money market continued to rule above the 6% mark, but somewhat softened to 6.74% in December as against 6.97% of November. The fortnight ending 3 December saw the short-term rates closing lower at 5.97%, helped by the temporary leeway given to banks allowing for lower holdings under the SLR. However, in the second fortnight, the call rates again continued to rise as most banks preferred to cover their positions as early as possible to manage the outﬂow of the third instalment of advance tax payments by corporates, estimated at around Rs 50,000 crore. Thereafter, the inter-bank call money rates stayed above the RBI’s LAF corridor, but ended the month with 5.65% on 31 December, since banks largely took advantage of the RBI’s repo window to fulﬁl their liquidity needs.

The notice money rates displayed a more volatile behaviour – moving in a wide range of 4.00% and 9.22% during December 2010. Compared to overnight money market rates, the weighted average rate of collateralised borrowing and lending obligations (CBLO) witnessed a hardening trend. The market repo rates however softened. Overall, except CBLO all other short-term money market rates witnessed some softening trend during December

Nov-10 369.2 -(7.4) 926.2 -(11.6) 634.1 -(10.5) 661.3 -(10.4) 1,295.4 -(10.4) compared with the previous month.

*: Includes trading in FCY/ INR and FCY/FCY. Figures in brackets are percentage change over the previous month. Source: RBI’s Weekly Statistical Supplement, various issues.

Table 9: Details of Central Government Market Borrowing (Amount in Rs crore)

Date of Auction Nomenclature of Loan Notified Amount Bid Cover Ratio Devolvement on YTM at Cut-off Cutt-off Price (in %) Primary Dealers Price (in %) (In Rupees)

03-Dec-10 7.99 2017 R 4,000 2.14 nil 8.01 99.88

8.13 2022 R 4,000 1.68 nil 8.15 99.80

8.30 2040 R 3,000 2.32 nil 8.49 97.90

10-Dec-10 7.49 2017 R 3,000 2.06 nil 8.08 97.09

8.26 2027 R 3,000 2.41 nil 8.50 97.87

24-Dec-10 7.17 2015 R 2,000 2.29 nil 7.87 97.42

While the daily average volumes in the call money segment recorded a fall by 12% during December over November, the other four short-term money market instruments together showed a notable rise of 33% in their daily average volume, contributed mostly by the CBLO during the same period (Table 5, p 75 and Graph B).

Reversing the previous two fortnights’

8.08 2022 R 2,000 3.07 nil 8.04 100.26trend, the volume of outstanding certiﬁcates

8.30 2040 R 2,000 2.46 nil 8.44 98.45 of deposit (CDs) increased by Rs 130 crore Total for December 23,000 2.23 8.20

during a period of one fortnight and

Total for November 33,000 2.15 8.09

the total outstanding amount stood at

R: Re-issue. Source: RBI press releases. Rs 3,31,109 crore on 3 December. The rates

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of this instrument continued to rule high on the back of increase in the ﬁxed deposit rates by banks and tight liquidity. Since the past several months, the rates on commercial papers (CPs) have increased substantially and touched their high of 18% during end of October and November, reﬂecting increased demand for the instrument following a cash crunch in the banking system. However, the outstanding volumes of CPs fell by Rs 15,600 crore during a period of 15 days and stood at Rs 1,02,156 crore on 15 December 2010. As the rates continued to rule in the range of 8.00% to 16.00% during the ﬁrst half of December, the instrument became more expensive and hence the volume witnessed a considerable fall for three fortnights in a row from 15 October and 15 November 2010.

The liquidity deﬁcit, also reﬂected in the banks’ borrowing from the repo tender of the RBI, has been over Rs 1,00,000 crore on an average since November. However, during the initial days of December the injection of money by the RBI marginally declined on the expectation that the announcement of buyback of securities by the RBI in its monetary policy review, will help to ease the liquidity pressure. However, banks again continued to depend on the RBI’s LAF window to meet their quarter-end targets and borrowed an average amount of Rs 1,16,000 crore during the month with the RBI’s LAF repo window recording the highest ever infusion of Rs 1,71,480 crore on 22 December. The RBI purchased securities worth Rs 41,383 crore through its OMO window on top of Rs 8,374 crore in December (Table 6, p 75).

The interest rate futures segment of the National Stock Exchange (NSE) recorded a notable increase in its average daily volume (Rs 37 lakh) during December as against Rs 5 lakh during the previous month.

2.2 Forex Market

The rupee appreciated against the dollar by 2% during the review period. It strengthened in the ﬁrst week of December, taking cues from positive domestic and global sentiments. Robust gross domestic product (GDP) and foreign trade numbers, coupled with initial public offering (IPO)-related capital inﬂows also fuelled the sentiments. However, hurt by the reversal in foreign institutional investors (FII) ﬂows along with an increase in crude oil prices in the overseas market, the rupee recorded continuous depreciation during the second week of the month. From 20 December onwards the domestic currency managed to recover, and appreciated marginally against the greenback up to 23 December. However, this trend was not sustainable and the rupee fell by 21 paise on 24 December. The rupee bounced back in the last week of the month aided by improved portfolio investments into the equity

Table 10: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)

Descriptions December 2010 Previous Month Three Months Six Months

Last Week (31st) First Week (3rd) Total for the Month (November 2010) Ago (September 2010) Ago (June 2010) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

1 Treasury Bills 2,652.35 2,932.22 12,902.86 11,946.76 15,768.39 24,724.29

A 91-Day Bills 1,625.38 7.01 1,391.84 6.81 7,883.30 6.99 6,845.7 6.62 11,315.07 5.97 14,148.87 5.24

B 182-Day Bills 701.28 7.15 215.00 7.17 2,191.23 7.16 2,720.38 7.08 1,356.91 6.21 4,300.24

C 364-Day Bills 325.69 7.23 1,325.38 7.11 2,828.33 7.17 2,380.68 7.02 3,096.41 6.31 6,275.18 5.27

2 GOI Dated Securities 28,132.46 7.98 25,323.98 8.05 1,56,555.86 8.04 1,39,918.7 7.99 2,20,322.38 7.93 2,90,135.12 7.56

Year of (No of Maturity Securities) 2011 5 335.38 7.54 18.00 7.22 1,160.44 7.50 215.70 6.88 615.16 6.43 4,540.57 5.21

2012 4 287.13 7.52 170.00 7.31 1,773.13 7.41 1,578.42 7.21 3,056.57 6.93 7,330.38 6.08

2013 3 28.34 7.67 0.03 7.99 68.86 7.53 801.15 7.30 1,535.36 7.20 4,172.63 6.61

2014 8 66.06 7.78 45.00 7.62 347.45 7.68 521.29 7.45 855.00 7.54 2,693.66 6.98

2015 6 3,059.13 7.85 1,530.00 7.92 12,297.53 7.92 13,249.76 7.80 27,528.91 7.71 10,582.32 7.32

2016 4 160.09 7.84 6.00 7.91 735.62 7.93 415.34 7.84 1,332.10 7.91 8,914.66 7.63

2017 4 4,205.92 7.80 9,882.70 7.99 38,087.79 7.95 35,362.25 7.93 6,822.84 7.96 242.46 7.53

2018 3 1.79 8.26 90.00 7.95 124.97 8.00 53.08 8.10 138.17 8.09 161.13 8.20

2019 2 8.28 8.22 0.10 8.02 12.23 8.14 26.60 7.97 205.21 8.02 453.14 7.51

2020 5 1,692.04 7.93 4,901.80 8.03 20,517.54 8.03 23,235.90 8.02 1,06,674.04 7.95 1,54,498.78 7.54

2021 2 2.47 8.02 8.07 8.11 5.55 8.09 2.04 8.24 34.16 8.63

2022 5 15,801.56 8.02 6,552.87 8.10 69,298.49 8.07 55,481.01 8.04 63,454.84 8.04 88,556.25 7.89

2023 2 1.80 8.31 2.10 8.32 0.75 8.38 5.05 8.51 160.57 8.04

2024 460.57 8.16

2025 70.00 8.12

2026 0.09 8.55 147.13 8.17

2027 2 1,205.71 8.35 1,459.08 8.42 8,768.77 8.42 6,107.55 8.39 6,224.54 8.36 4,437.29 8.18

2028 1 5.60 8.51 10.94 8.30 5.74 8.52 3.42 8.18 37.00 8.07

2032 3 93.91 8.40 25.00 8.43 243.11 8.42 39.00 8.42 518.74 8.25 2,535.89 8.21

2034 1 0.25 8.29 16.99 8.37 2.27 8.28 60.00 8.26 106.75 8.12

2035 1 2.07 8.42 0.02 8.73 54.75 8.09

2036 1 92.62 8.47 2.00 8.40 110.62 8.47 50.00 8.40 39.84 7.21

2039 0.40 7.91

2040 1 1,089.98 8.45 635.80 8.47 2,969.09 8.47 2,817.21 8.47 1,240.39 8.38

3 State Govt Securities 734.73 8.35 304.92 8.36 2,264.49 8.36 2,448.71 8.33 2,679.40 8.20 3,172.84 7.34

Grand total (1 to 3) 31,519.54 28,561.12 1,71,723.21 1,54,314.17 2,38,770.17 3,18,032.25

(-) means no trading. YTM = Yield to maturity in per cent per annum. NDS = Negotiated Dealing System. OM = Order Matching Segment. (1) Yields are weighted yields, weighted by the amounts of each transaction. Source: Compiled by EPWRF; base data from RBI, CCIL.

Economic & Political Weekly

january 22, 2011 vol XLVI No 4

MONEY MARKET REVIEW

Graph C: Spot Quotations and Annualised Forward Premia for the US However, the premia continued Dollar in the Domestic Inter-Bank Market

8 60 to record a softening trend Monthly Averages

(Daily) Working Days

thereafter, except for some

7 50 intermittent days, and ended

at 6.69% on 31 December

40

5

against 6.78% on 30 Novem

30 ber. The other two tenures, 3

the two-month and three

20 month premia also ruled 1

10 higher, but recorded a steady 0

upward trend compared to the

0

market. Overall, the rupee moved in a wide range of Rs 44.81 to Rs 46.04 per dollar during December and closed the month at Rs 44.81 against the dollar on 31 December 2010 (Table 7, p 76).

The forward premia across the three maturities reﬂected a mixed trend during the entire month implying the uncertainty in the domestic forex market. The onemonth premia witnessed an upward trend from the beginning of the month and hardened to as much as 7.96% on 13 December, inﬂuenced by the continuous fall in the rupee during the second week leading to the expectation that the rupee will depreciate further in the near-term.

Table 11: Yield Spreads (Weighted Average) – Central Government Securities – December 2010 (basis points (bps)) tions decreased by 10.5%

Yield December 2010 Previous Three Six Months and 10.4%, respectively, Spread in bps Last Week First Week Entire Month Month Months Ago Ago

during the same period

1 Year-5 Year 31 70 42 92 128 211

(Table 8, p 76).

5 Year-10 Year 8 11 11 22 24 22

Following the sharp appre

10 Year-15 Year -----58

ciation of the dollar against

1 Year-10 Year 39 81 53 114 152 233 Source: As in Table 10. the rupee in November, the

Table 12: Predominantly Traded Government Securities (Amount in Rs crore)

one-month premia. Nevertheless, compared to 30 Nov ember, the threeand six-month premia hardened by 96 bps and 143 bps respectively on 31 December, with the renewed investor sentiments that the rupee could depreciate in the three to six months time horizon (Graph C).

The overall turnover in the forex market after recording signiﬁcant increases in the course of three months up to October, plunged by 10.4% during November, despite exceptional growth in exports. It is notable that imports witnessed a deceleration, which can be partly attributed to the depreciated rupee. The turnover in merchant and inter-bank segment showed a fall of 7.4% and 11.6%, respectively, while

spot and forward transacaggregate currency derivatives market turnover continued to fall and recorded a 21% reduction over the previous month, amounting to Rs 5,43,569 crore during December. The aggregate currency derivatives turnover on the Multi-Commodity Exchange (MCX-SX) fell by 17% followed by the NSE with 11% fall in volume. The MCX-SX trades only in futures. However, the United Stock Exchange (USE), still struggling to establish its position in this segment, shed more than half of its previous month’s turnover during December. The combined average daily turnover in the futures segment of all the three exchanges fell by 24% during December over the previous month. Among the traded currencies the rupeedollar futures continued to be predominant. The options trading contributed to only 2.5% of the total derivatives turnover.

2.3 Government Securities Market

In December, keeping in mind the liquidity tightness, the government reduced the total auctioned amount in primary issues. Three auctions of central government securities garnered an aggregate amount of only Rs 23,000 crore against Rs 33,000 crore in the previous month. The overall weighted average cut-off yield hardened in December to 8.20% from 8.09% of November. The higher bid cover ratio of 2.23 times for the month can be partly attributed to the liquidity easing measures. With reduced notiﬁed amounts, the RBI came out with those maturities and coupons, which

Descriptions December 2010 Previous Month Three Months Ago Six Months Ago

Last Week (31st) First Week (3rd) Total for the Month (November 2010) (September 2010) (June 2010) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

GOI Dated Securities

9.39 , 2011 295.28 7.54 18.00 7.22 945.28 7.52 160.68 6.90 330.00 6.46 1,541.03 4.81

7.40 , 2012 245.13 7.49 150.00 7.31 1,284.58 7.38 1,128.05 7.25 1,275.00 6.92 4,380.60 6.03

7.27 , 2013 28.00 7.67 68.00 7.53 787.90 7.30 1,525.00 7.20 3,928.25 6.61

7.32 , 2014 40.00 7.75 45.00 7.62 200.00 7.70 36.21 7.48 695.00 7.56 1,350.00 6.98

7.17 , 2015 3,004.00 7.85 1,355.00 7.91 11,967.00 7.92 12,948.95 7.81 27,120.23 7.70 6,244.97 7.26

7.02 , 2016 140.00 7.82 699.30 7.93 415.00 7.84 1,040.00 7.90 8,822.43 7.63

7.46 , 2017 120.92 7.85 307.00 7.99 1,705.02 7.93 1,900.88 7.92 5,602.36 7.98 60.70 7.29

7.49 , 2017 671.41 7.83 4,050.71 7.97 0.02 8.20 12.14 6.83

7.99 , 2017 3,412.50 7.80 9,567.93 7.99 32,317.80 7.95 33,411.35 7.92 1,220.48 7.87 27.20 7.60

7.80 , 2020 1,577.00 7.90 4,631.80 8.08 19,182.50 8.04 23,174.75 8.02 1,06,427.26 7.95 1,53,204.49 7.55

8.08, 2022 7,272.82 8.04 2,047.50 8.10 28,302.41 8.06 16,944.00 8.06 18,856.37 8.04 32.00 7.98

8.13 , 2022 8,477.00 8.00 4,505.27 8.10 40,721.14 8.07 38,393.55 8.04 43,655.74 8.03 220.00 8.03

8.20 , 2022 42.56 8.06 0.10 8.04 265.76 8.12 142.30 8.09 942.72 8.14 88,193.39 7.89

8.26 , 2027 975.75 8.35 1,431.58 8.42 8,442.12 8.42 6,072.60 8.39 6,199.05 8.36 4,073.34 8.17

8.28 , 2032 44.51 8.42 15.00 8.46 160.01 8.43 15.00 8.46 96.42 8.37 1,194.86 8.21

8.30, 2040 1,089.98 8.45 635.80 8.47 2,969.09 8.47 2,817.22 8.47 1,240.39 8.39 -

Total (All Securities) 28,132.46 7.98 25,323.98 8.05 1,56,555.86 8.04 1,39,918.70 7.99 2,20,322.38 7.93 2,90,135.12 7.56

(-) means no trading. YTM = Yield to maturity in percentage per annum. (1) Yields are weighted yields, weighted by the amounts of each transaction. Source: As in Table 10.

january 22, 2011 vol XLVI No 4

Economic & Political Weekly

MONEY MARKET REVIEW

one to ﬁve-year maturities,

Participating Amount Ratio Cut-off Price Average States Accepted (in %) Yield (%) ﬁve to ten-year maturities

07-Dec-10 4 2,975 3.15 8.44 8.42

and one to ten-year maturi

21-Dec-10 5 3,975 2.85 8.41 8.39

ties shrunk con siderably to

Total for December 9 6,950 2.98 8.42 8.4

42 bps, 11 bps and 53 bps in

Total for November 11 7,375 3.96 8.41 8.4 Source: RBI press releases. December from 92 bps, 22 bps and 114 bps in Novem-

Table 14: Auctions of Treasury Bills (Amount in Rs crore)

Date of Auction Bids Bid Cover Cut-off Weighted Cut-off Weighted ber, respectively (Table 10, Accepted Ratio Yield (%) Average Price (Rs) Average Yield (%) Price (Rs)

p 77, Tables 11, 12, p 78).

A: 91-Day Treasury Bills During December, nine 01-Dec-10 4,000 2.06 6.94 6.9 98.3 98.31

states raised funds aggregat

08-Dec-10 4,000 1.78 7.23 7.06 98.23 98.27

ing Rs 6,950 crore through

15-Dec-10 2,000 3.7 7.19 7.14 98.24 98.25

two trenches of state devel

22-Dec-10 2,000 3.75 7.19 7.14 98.24 98.25

opment loans. The ﬁrst issue

29-Dec-10 2,000 2.85 7.19 7.14 98.24 98.25 Total for December 14,000 2.57 7.13 7.05 98.25 98.27

hit the market on 7 Decem-

Total for November 14,000 2.85 6.82 6.78 98.33 98.34 ber when four states – Kar-

B: 182-Day Treasury Bills nataka, Madhya Pradesh, 08-Dec-10 2,000 4.71 7.3 7.27 96.49 96.5

Punjab and Tamil Nadu –

22-Dec-10 2,000 2.89 7.34 7.32 96.47 96.48

mopped up Rs 1,000 crore,

Total for December 4,000 3.8 7.32 7.3 96.48 96.49

Rs 1,200 crore, Rs 150 crore

Total for November 4,000 2.34 7.2 7.16 96.54 96.56

and Rs 625 crore, respec-

C: 364-Day Treasury Bills 01-Dec-10 1,000 5.08 7.27 7.25 93.24 93.26 tively. In this auction,

15-Dec-10 1,000 4.77 7.34 7.32 93.18 93.2 Madhya Pradesh and Tamil 29-Dec-10 1,000 2.97 7.49 7.42 93.05 93.11

Nadu raised Rs 200 crore

Total for December 3,000 4.27 7.37 7.33 93.16 93.19

and Rs 125 crore in excess of

Total for November 4,000 2.75 7.14 7.11 93.36 93.38

their notiﬁed amounts. The

Source: RBI's Press Releases.

response to all auctions was

Table 15: Details of Commercial Bond Issues during December 2010

good with a bid-cover ratio

Institutional Category No of Issues Volume in Range of Range of Rs Crore Coupon Rates Maturity in Years(y) of 3.15 times. Karnataka, in % and Months(m)

Kerala, Meghalaya, Punjab

FIs/Banks 6 3,409 8.75-9.25 3y-10y

and Uttar Pradesh garnered

NBFCs 2 450 9.05-9.40 2y-10y Central Undertakings 3 1,964 6.05-9.05 5y-20y Rs 3,975 crore in the sec-

Corporates 1 200 9.30 5y ond auction on 21 Decem-

Total for December 2010	12	6,023	6.05-8.98	3y-15y	ber, with a bid-cover ratio
Total for November 2010	8	7,010	6.05-8.98	3y-15y	2.85 times. Yield rates at all
Source: www.debtonnet.com

auctions remained almost could perhaps turn into new benchmarks. ﬂat compared to November (Table 13). In December, the securities that were auc-The traded amount of state loans in the tioned in the primary market remained secondary market fell marginally to Rs 2,264 liquid and contributed considerably to the crore with yield to maturity (YTM) of traded volume in the secondary market 8.36% in December from Rs 2,449 crore (Table 9, p 76). with YTM of 8.33% in November.

In the secondary market, interest in government securities was reﬂected in a 2.4 Treasury Bills higher volume of trade in December to the The volume of treasury bills (TBs) issued tune of Rs 1,56,556 crore as compared to in the primary market marginally fell Rs 1,39,919 crore in November. The most from Rs 22,000 crore in November to traded securities in December were 8.13% Rs 21,000 crore in December. The 91-day 2022, 7.99% 2017, 8.08% 2022, 7.80% 2020 TBs were sold for Rs 4,000 crore in the and 7.17% 2015 with traded amounts ﬁrst two auctions while the last three accounting for 85% of the total trade. Yield were for Rs 2,000 crore each. The 182-day rates ﬁrmed up for most of the securities, and 364-day TBs were auctioned twice but more so for the shorter term securities. during the month for Rs 2,000 crore and This is clearly seen from the yield curve at Rs 1,000 crore each, respectively. Both cutthe shorter end. So the yield spread for all off an weighted average yields steepened

Economic & Political Weekly EPW january 22, 2011 vol XLVI No 4

across maturities compared to November

(Table 14).

The traded amount in the secondary market for TBs at Rs 12,902 crore in December showed a marginal rise from Rs 11,947 crore in November, trades mostly concentrated in 91-day TBs.

2.5 Corporate Bonds Market

During December, 12 institutions raised Rs 6,023 crore in the corporate bonds market through the issuance of bonds. Compared to the previous month, the number of issues increased while the mobilised amount decreased by 14%. Among the issues, ﬁnancial institutions/banks raised the highest sum and contributed to 57% of the total garnered amount. Central undertakings continued their interest as in the previous month and accounted for 33% of the total mobilisation during the month. However, non-bank ﬁnancial companies and corporates favoured the non-convertible debentures route and their participation remained somewhat subdued during December.

Among the issues, the Indian Railway Finance Company raised the highest amount of Rs 1,314 crore offering ﬁve-year and 15-year tax free bonds with a coupon rate ranging from 6.05% to 6.72%. EXIM Bank tapped the bond market thrice during the month and raised an aggregate amount of Rs 1,024 crore offering 8.75%9.00% for a two to three-year paper.

Overall, the offered rates witnessed a distinct rise during the month. The LIC Housing Company offered the highest rate of 9.40% for two years NCDs in December which was 65 bps higher than its threeyear maturity paper issued in November. Similarly, the NCD issue of HDFC offered 9.25% for the three-year paper during December whereas the same instrument offered 8.98% for a 10-year maturity paper. All these issues carried AAA ratings by rating agencies (Table 15).

According to Prime Database, India Inc witnessed a fund-raising of around Rs 1,07,177 crore through bonds on private placement basis in the ﬁrst half of the current ﬁscal, a 23% jump over the same period a year ago.

The average daily turnover in the secondary market transactions of the corporate bond segment of NSE fell by 8% during December.