The following are excerpts from Reserve Bank India Governor Duvvuri Subbarao’s statement for the year 2008-09:
Assessment of Macroeconomic and Monetary Developments during the First Half of 2008-09
Domestic Developments
During the first quarter of 2008-09, real GDP growth was 7.9 per cent as against 9.2 per cent a year ago. The end-August 2008 release of national income aggregates by the Central Statistical Organisation placed the growth of real GDP originating in agriculture, industry and services at 3.0 per cent, 5.2 per cent and 10.2 per cent, respectively, during April-June 2008 as against 4.4 per cent, 9.6 per cent and 10.6 per cent a year ago.
There are some distinctive features in macroeconomic developments during the second quarter of 2008-09 (July-September) in relation to the preceding quarter. According to the India Meteorological Department, cumulative south-west monsoon season rainfall for the country as a whole was two per cent below the long period average.
Of the 36 meteorological sub-divisions, rainfall was excess/normal in as many as 32 sub-divisions as against 30 sub-divisions in the 2007 season. The deficient rainfall regions were Vidarbha, Kerala, West Madhya Pradesh, Nagaland, Manipur, Mizoram and Tripura.
As on October 15, 2008 live storage in 81 major reservoirs was 73 per cent of the designated capacity which is seven per cent higher than the last 10 years' average but 10 per cent lower than the level a year ago.
By October 10, 2008 the area sown under kharif rice and major oilseeds increased by 2.9 per cent and 3.6 per cent, respectively, over the previous year's sown area but acreage under coarse cereals, pulses, cotton, sugarcane and jute was lower by 6.4 per cent, 15.5 per cent, 1.3 per cent, 16.6 per cent and 10.8 per cent, respectively, than in the corresponding period a year ago. First advance estimates released by the Ministry of Agriculture place kharif foodgrains production at 115.3 million tonnes, below the target of 121.5 million tonnes and also lower than the production of 121.0 million tonnes recorded last year.
According to these initial estimates, rice production is estimated at 83.3 million tonnes which is above the preceding year's output of 82.8 million tonnes. Production of nine major oilseeds during the kharif season was placed at 17.9 million tonnes which is lower than the target of 20.0 million tonnes for the current year and also below the output of 19.8 million tonnes in 2007-08. Production of sugarcane and cotton is expected to decline in 2008-09 in relation to targets as well as output levels a year ago.
The index of industrial production (IIP) rose by 4.9 per cent during April-August 2008 as compared with 10.0 per cent in the corresponding period last year. Manufacturing output growth, electricity generation and mining activity slowed to 5.2 per cent, 2.3 per cent and 4.1 per cent, respectively, from 10.6 per cent, 8.3 per cent and 4.9 per cent in the corresponding period last year. Manufacturing activity was led by chemicals and chemical products, beverages, tobacco and related products, machinery and equipments including transport equipment and parts, which together accounted for 89 per cent of the growth of industrial production during April-August 2008, despite constituting only 30 per cent of the index in terms of weight.
On the other hand, production of food products, jute textiles, wood and wood products, rubber, plastic, petroleum and coal products declined and had a moderating effect on overall manufacturing sector growth. The use-based classification indicates some moderation in investment demand with the growth of capital goods production slowing to 9.2 per cent from 20.1 per cent a year ago.
Production of consumer non-durables rose by 8.6 per cent on top of 10.0 per cent in the corresponding period last year; consumer durables recorded a turnaround, growing by 5.6 per cent as against a decline of 2.3 per cent a year ago. Production of basic and intermediate goods rose by 3.8 per cent (9.9 per cent a year ago) and 0.7 per cent (9.9 per cent), respectively.
The six infrastructure industries, which together comprise 27 per cent of the IIP, posted a growth of 3.4 per cent during April-August 2008 as against 7.1 per cent a year ago. Except for coal, other infrastructure sectors recorded deceleration in growth while the production of crude petroleum declined.
For the private non-financial corporate sector, sales increased by 30.0 per cent during April-June 2008, higher than 19.2 per cent in the corresponding quarter a year ago. There was deceleration in income from non-core activities, largely attributable to subdued conditions in the capital market.
Growth in expenditure at 34.5 per cent outpaced sales growth. On a year-on-year basis, raw material expenses rose by 35.9 per cent and staff cost increased by 23.2 per cent. Due to mark-to-market losses on foreign currency borrowings resulting from exchange rate depreciation during the quarter, a sizeable number of companies reported erosion in financial performance.
Despite an increase in interest outgo, the interest burden (interest to gross profits ratio) at 16.7 per cent remained distinctly lower when compared with 50.0 per cent in the 1990s and 43.7 per cent in the first half of the current decade.
Reflecting the pick-up in expenditures, net profits growth decelerated to 8.2 per cent in the first quarter of 2008-09 as compared with double-digit growth rates recorded in the previous quarters and 33.9 per cent a year ago. At the sectoral level, manufacturing companies recorded higher sales growth when compared with information technology and non-IT service companies.
Early results for the second quarter of 2008-09 for a truncated sample of companies indicate continuing moderation in profitability growth, especially for manufacturing companies. Sales growth was driven by a combination of increased volumes and higher prices but was not able to fully mitigate rising input cost and staff cost pressures.
Financing costs have increased due to rising interest payments as well as the impact of losses on foreign liabilities. Income from non-core activities were lower reflecting subdued treasury incomes. Consequently, corporates' earnings growth appears to have weakened further in the second quarter of 2008-09.
The 43rd round of the Reserve Bank's quarterly Industrial Outlook Survey conducted during July-August 2008 and covering private manufacturing companies indicates a moderation in business sentiment.
The assessment for July-September 2008 reflects a lower level of optimism than in the previous round of the survey, with the business expectations index for July-September 2008 down by 2.4 per cent from the previous quarter. There was moderation in all major parameters such as the overall business situation, the overall financial situation, production, order books, cost of raw materials and profit margins.
Demand conditions appear to have weakened as reflected in the assessment of production, order books and export demand. Higher input costs are expected to compress profit margins significantly during the second and third quarters of 2008-09. For October-December 2008, working capital finance requirements are expected to remain high; there are, however, concerns about the availability of finance.
Capacity utilisation is expected to remain generally stable and production capacity is expected to be adequate to meet demand. An increasing number of respondent firms expect price pressures to rise on the back of higher raw material costs and expect to pass on higher prices to end-consumers to protect profit margins. The business expectations index for October-December 2008 was 2.6 per cent lower than in the preceding quarter.
Other business confidence surveys continue to reflect uncertainty on the outlook, as also noted in the First Quarter Review of July 2008. Business confidence has generally ebbed relative to its level in previous survey rounds on increases in the cost of finance and raw materials and some concerns on moderation in overall economic conditions and export demand.
According to one survey, there was a decline of 19 per cent in the indicator for the overall economic conditions over the next six months in relation to its level polled in the previous quarter. Another survey reported a 28.1 per cent decline in the composite business optimism index for October-December 2008 across sales volumes, new orders and net profits, reflecting subdued demand conditions.
Seasonally adjusted purchasing managers' indices indicate that manufacturing sector activity has lost some momentum due to deterioration in both local and export market conditions and increased inflationary pressures. Forward looking indicators point towards someslowdown and margin pressures.
Lead indicators of activity in the services sector suggest that the pace of expansion has picked up in the communication sector with an increase of 33.8 per cent in switching capacity in April-July 2008 as against a decline of 53.1 per cent a year ago.
There was a robust growth of 32.4 per cent in telephone connections (fixed plus cellular) with the addition of 34.4 million connections as compared with 26.0 million connections provided in the corresponding period last year. Railway revenue earnings from freight traffic increased by 9.4 per cent, higher than the growth of 6.1 per cent in the corresponding period last year due to higher traffic for carriage of petroleum, oil and lubricants (POL), container services and cement.
Growth in cargo handled at major ports increased by 8.3 per cent as compared with 14.9 per cent a year ago. In the civil aviation sector, handling of import cargo and export cargo increased by 6.6 per cent and 8.1 per cent, respectively, as against 23.4 per cent and 3.6 per cent in the corresponding period of 2007-08. Growth in passengers handled at domestic and international terminals declined/decelerated to (-) 2.2 per cent and 7.9 per cent, respectively, from 27.3 per cent and 11.8 per cent a year ago.
According to the CSO's end-August 2008 release, real private final consumption expenditure (PFCE) increased by 8.0 per cent during April-June 2008, which was marginally higher than the growth of 7.6 per cent recorded in the corresponding period a year ago. Real gross fixed capital formation (GFCF) rose by 9.0 per cent, lower than the growth of 13.3 per cent recorded in April-June 2007. The share of PFCE in GDP at 59.8 per cent during the first quarter of 2008-09 remained stable whereas the share of GFCF increased to 32.3 per cent of GDP from 32.0 per cent a year ago.
Credit extended by scheduled commercial banks (SCBs) increased by 29.4 per cent (Rs.5,91,935 crore) on a year-on-year basis up to October 10, 2008 as compared with an increase of 23.1 per cent (Rs.3,77,628 crore) a year ago. On a financial year basis, bank credit increased by 10.4 per cent (Rs.2,45,491 crore) up to October 10, 2008 as compared with the increase of 4.4 per cent (Rs.84,280 crore) in the corresponding period last year. Food credit increased by Rs.4,496 crore as against a decline of Rs.9,501 crore in the previous year.
Non-food credit recorded an increase of 10.4 per cent (Rs.2,40,995 crore) as compared with an increase of 5.0 per cent (Rs.93,781 crore) in the corresponding period of the previous year.
On a year-on-year basis, non-food credit growth was higher at 29.3 per cent up to October 10, 2008 than 23.3 per cent a year ago. Provisional information on the sectoral deployment of bank credit available up to August 2008 indicates that on a year-on-year basis, credit to the services sector recorded the highest growth (35.3 per cent), followed by industry (30.6 per cent), agriculture (18.5 per cent) and personal loans (17.4 per cent). Growth in housing and real estate loans decelerated to 13.9 per cent (16.6 per cent) and 46.3 per cent (52.9 per cent), respectively.
Within the industrial sector, there was a sizeable credit pick-up in respect of infrastructure (35.8 per cent as against 32.0 per cent a year ago), petroleum (91.8 per cent as against 32.9 per cent), basic metals and metal products (32.2 per cent over 20.6 per cent), cement and cement products (62.8 per cent over 18.1 per cent a year ago), chemicals (27.1 per cent as against 15.3 per cent) and construction (48.3 per cent as against 42.9 per cent).
There was moderation in credit growth to food processing (25.6 per cent over 29.0 per cent), textiles (23.1 per cent as against 28.7 per cent) and vehicle, vehicle parts and transport equipments (27.5 per cent as against 34.2 per cent). Credit to industry constituted 44.6 per cent of the total expansion in non-food bank credit up to August 2008, followed by services (30.3 per cent), personal loans (16.7 per cent) and agriculture (8.4 per cent).
The share of infrastructure, petroleum, construction, cement and mining and quarrying in total credit to industry increased to 22.5 per cent, 6.7 per cent, 3.3 per cent, 1.6 per cent and 1.4 per cent, respectively from 21.6 per cent, 4.6 per cent, 2.9 per cent, 1.3 per cent and 1.0 per cent. On the contrary, the share of credit to textiles, chemicals, engineering, food processing, gems and jewellery and fertiliser declined to 10.4 per cent, 7.5 per cent, 6.1 per cent, 5.4 per cent, 2.9 per cent and 1.2 per cent respectively, from 11.0 per cent, 7.7 per cent, 6.4 per cent, 5.6 per cent, 3.3 per cent and 1.3 per cent.
Priority sector advances grew by 20.8 per cent with a moderation in their share in outstanding gross bank credit to 33.1 per cent in August 2008 from 34.7 per cent a year ago. While there has been a sharp increase in credit off-take by petroleum and fertliser companies in 2008-09, the annual growth rate of non-food credit, even excluding credit to petroleum and fertiliser sectors, has been significantly higher at 25.6 per cent in August 2008 as compared with 24.5 per cent a year ago.
Commercial banks' investments in shares, bonds/debentures and commercial papers (CPs) increased by 17.5 per cent (Rs.13,600 crore) on a year-on-year basis up to October 10, 2008 as against a decline of 5.4 per cent (Rs.4,458 crore) a year ago. On a financial year basis, such investments by banks fell by 4.6 per cent (Rs.4,386 crore) during 2008-09 so far (up to October 10), as against a decline of 7.2 per cent (Rs.6,025 crore) in the corresponding period of 2007-08.
The year-on-year growth in total resource flow from SCBs to the commercial sector was 28.9 per cent up to October 10, 2008 over and above the growth of 21.9 per cent a year ago. During the current financial year, banks' investments in instruments issued by all-India financial institutions and mutual funds declined by Rs.11,411 crore as against an increase of Rs.51,656 crore in the corresponding period of the previous year.
Additional resources raised by corporates in the form of external commercial borrowings (ECBs) was lower at Rs.6,494 crore (US $ 1.6 billion) during April-June 2008 as compared with Rs.28,822 crore (US $ 7.0 billion) during the corresponding period last year. An amount of Rs.4,652 crore (US $ 1.1 billion) was mobilised through issuance of American Depository Receipts/Global Depository Receipts (ADRs/GDRs) during April-September 2008 as compared with Rs.11,284 crore (US $ 2.8 billion) raised during the corresponding period last year.
Aggregate deposits of SCBs increased by 21.6 per cent (Rs.6,15,263 crore) on a year-on-year basis up to October 10, 2008 as compared with 24.7 per cent (Rs.5,65,124 crore) a year ago. On a financial year basis, aggregate deposits rose by 8.5 per cent (Rs.2,72,420 crore) as compared with an increase of 9.3 per cent (Rs.2,42,163 crore) in the corresponding period of the previous year.
The share of savings deposits in total deposits has been declining and there appears to be some migration from small savings instruments to term deposits with banks where the rates of return are relatively more attractive. The incremental annual credit-deposit ratio increased to 96.2 per cent on October 10, 2008 from 66.8 per cent a year ago.
SCBs' incremental investment in Government and other approved securities during 2008-09 up to October 10, 2008 was Rs.9,201 crore as against Rs.1,56,236 crore in the corresponding period last year. The ratio of such investments to aggregate deposits on an incremental basis was 3.4 per cent which was much lower than 64.5 per cent in the corresponding period last year.
Adjusting for collateral securities under the liquidity adjustment facility (LAF) operations, however, statutory liquidity ratio (SLR) investments increased by Rs.80,176 crore during 2008-09 so far as against the increase of Rs.90,806 crore in the corresponding period last year. Inclusive of LAF collateral securities on an outstanding basis, SCBs' holdings of SLR securities amounted to Rs.10,72,416 crore or 28.2 per cent of net demand and time liabilities (NDTL) on October 10, 2008 implying an excess of Rs.1,20,870 crore or 3.2 per cent of NDTL over the prescribed SLR of 25 per cent of NDTL.
Money supply (M3) increased by 20.3 per cent on a year-on-year basis up to October 10, 2008, lower than 21.9 per cent a year ago but above the indicative projection of 17.0 per cent set out in the Annual Policy Statement of April 2008. On a financial year basis, M3 increased by 7.7 per cent (Rs.3,07,403 crore) up to October 10, 2008 as compared with the increase of 8.1 per cent (Rs.2,68,694 crore) in the corresponding period of the previous year.
Reserve money increased by 17.6 per cent on a year-on-year basis as on October 17, 2008 as compared with 24.4 per cent a year ago. On a financial year basis, reserve money declined by 2.9 per cent (Rs.27,296 crore) up to October 17, 2008 as compared with the increase of 8.1 per cent (Rs.57,189 crore) in the corresponding period of the previous year.
Among the components of reserve money, currency in circulation registered a higher growth of 7.3 per cent (Rs.43,095 crore) as compared with 4.5 per cent (Rs.22,702 crore). Bankers' deposits with the Reserve Bank declined by 20.3 per cent (Rs.66,793 crore) against an increase of 18.7 per cent (Rs.36,984 crore) in the corresponding period last year. Among the sources of reserve money, the Reserve Bank's net credit to the Central Government increased by Rs.15,534 crore as against a decline of Rs.1,43,116 crore in the corresponding period last year.
Adjusted for transactions under the LAF, however, the Reserve Bank's credit to the Central Government showed an increase of Rs.57,244 crore, mainly on account of securities received under special market operations (SMO) and reduction in cash balances of the Government of India with the Reserve Bank. The Reserve Bank's net foreign exchange assets (NFEA) increased by Rs.93,402 crore as compared with an increase of Rs.1,71,080 crore during the corresponding period of the previous year.
Adjusted for revaluation of foreign currency assets, however, NFEA declined by Rs.34,556 crore as compared with an increase of Rs.2,17,201 crore during the corresponding period of the previous year. The ratio of NFEA to currency increased marginally from 209.2 per cent on March 31, 2008 to 209.7 per cent by October 17, 2008.
During the second quarter of 2008-09, liquidity conditions were generally tight and, except in the first week of July, there were continuous injections of liquidity under the LAF. In addition, an amount of Rs.26,000 crore (net) was mopped up through the issuances of 91-day, 182-day and 364-day Treasury Bills during July-September, 2008.
Net injections under the LAF increased from an average of Rs.8,622 crore in June 2008 to Rs.22,560 crore in August 2008. During September 2008, liquidity injections under the LAF ranged between Rs.1,025-90,075 crore, reaching a level of Rs.90,075 crore on September 29, 2008 with adverse developments in international financial markets coinciding with advance tax outflows and the half-yearly bank closing. To ease liquidity pressures, the Reserve Bank unwound the market stabilisation scheme (MSS) to the tune of Rs.3,105 crore during June 30-August 21, 2008.
The Reserve Bank also cut the cash reserve ratio (CRR) by 250 basis points in October 2008 and expanded liquidity support to the market through additional facilities referred to later. During October 2008, liquidity injections under the LAF rose to Rs.91,500 crore on October 10, 2008, but there was a turnaround in liquidity conditions in the subsequent period and the Reserve Bank absorbed Rs.27,745 crore under the LAF on October 22, 2008. Banks' dependence on export credit refinance (ECR) rose from a daily average of Rs.2,208 crore in June 2008 to Rs.3,110 crore in August 2008 and further to Rs.6,752 crore on September 29, 2008 before declining to Rs.91 crore on October 22, 2008.
The Central Government's cash balances declined from Rs.37,194 crore on June 30, 2008 to Rs.2,967 crore on August 2, 2008 and it took recourse to ways and means advances during August 4-6 and September 2-14, 2008 with a peak level of Rs.10,903 crore on September 5, 2008. In the subsequent period, the Central Government's cash balances increased to Rs.29,753 crore on October 20, 2008.
On a net basis, average daily LAF absorption, which stood at Rs.9,881 crore in the first quarter of 2008-09 changed to a net injection of Rs.30,912 crore during the second quarter and Rs.53,259 crore in October 2008 (up to October 22).
The balances under the MSS increased marginally from Rs.1,76,422 crore in June 30, 2008 to Rs.1,77,817 crore on September 25, 2008 before declining to Rs.1,71,317 crore on October 22, 2008. Cash balances of the Central Government with the Reserve Bank fell from an average of Rs.30,587 crore in the first quarter of 2008-09 to Rs.17,821 crore in the second quarter and Rs.36,599 crore in October 2008 (up to October 22).
The total overhang of liquidity as reflected in the balances under the LAF, the MSS and the Central Government's cash balances taken together declined from a daily average of Rs.1,93,726 crore in June 2008 to Rs.1,53,863 crore in September 2008 and further to Rs.1,22,182 crore on October 5, 2008. The total overhang of liquidity increased to Rs.2,17,415 crore on October 20, 2008.
Overall Assessment
Aggregate supply conditions in the Indian economy have shown resilience in the second quarter of 2008-09 in the face of a deteriorating global macroeconomic and financial environment. There are, however, growing indications that the underlying economic cycle is turning in tune with global economic developments and that domestic economic activity is straddling a point of inflexion.
While the 2008 south-west monsoon season has been near normal as anticipated, large temporal variations have resulted in some production losses on account of floods in June in some north-eastern, eastern and northern States and deficient rainfall in July over the north-east, central India and Kerala. At the all-India level, the area sown under various crops is close to the normal cropping coverage but lower by about 2.6 per cent in relation to the high level a year ago.
Acreage under key crops such as rice and oilseeds has increased on a year-on-year basis but there are downside risks for the prospects of crops such as sugarcane, coarse cereals, pulses and jute. First advance estimates of the production of foodgrains in 2008-09 from the Ministry of Agriculture suggest that some improvement in these key crops could occur as these early indications firm up into a clearer picture on the final level of output for the year and the overall outlook on agriculture.
Industrial activity in the second quarter of 2008-09 has shown mixed developments with indications of a moderation in pace diffusing across the sector. While the pick-up in industrial production in July 2008 surprised consensus expectations, occurring as it did after an uneven trough during November 2007-June 2008, base effects weighed heavily on the growth rates observed in August and could continue to cast a shadow in some of the months ahead, especially in October-December 2008.
Slackening of momentum is essentially located in the basic and intermediate goods sectors, weighed down by the decline in production of fertilisers, steel, aluminum products, yarns and fibre, organic pigments and the like. The rebound in capital goods production in July after a sag in the preceding two months was not sustained in August, indicative of considerable uncertainty in the evolving investment climate.
On the other hand, the sustained turnaround in consumer goods output, particularly durables, indicates that the strength of consumption demand is inducing supply responses, aided by the return of pricing power in an environment of high inflation. Manufacturing activity is being driven by industries such as chemicals, machinery and transport equipment and beverages and tobacco products.
In fact, excluding items such as wood and products, leather and paper products, textiles, rubber, plastic, petroleum and coal products which have recorded a decline/negligible growth in production and together have a weight of only 26 per cent in the IIP, the growth of industrial output would be 6.5 per cent, somewhat above the observed headline growth of 4.9 per cent in April-August, 2008. Surveys of corporate finances are indicating a worsening outlook with erosion of profitability due to rising expenditures relative to sales, particularly in respect of raw materials and other inputs, staff costs and exchange losses.
Various surveys suggest that overall business confidence is flagging. Service sector activity appears to be moderating in several sub-sectors except in communication and freight movement in terms of lead indicators. Construction activity may pick up in the coming months on the back of some improvement in cement and steel production.
Widening gaps in the physical infrastructure, markedly in power but elsewhere too except in coal production, could impose a binding constraint on growth. Capacity addition in the power sector has remained far short of tenth Plan targets, worsening the persisting large shortage in the country.
Electricity output appears to have been sharply affected by the downslide in hydro power generation, with the energy content of reservoirs posting a shortfall of 27 per cent of the full reservoir level (FRL) at the all-India level up to mid-October 2008.
While thermal power generation has provided support, delays in commissioning/commercial operations, high moisture content in coal due to the monsoon as well as the loss of 3.8 billion units of generation during April-August due to shortages of coal reported by utilities across the country are debilitating factors. Shortages of fuel have also resulted in a loss of 1.2 billion units in the first five months of 2008-09 under nuclear power generation.
Aggregate demand conditions continue to be mainly investment-driven, although some slackening which set in during the first quarter of 2008-09 appears to have become broad based. So far, however, investment intentions remain strong as indicated by the memoranda/letters of intent/direct industrial licences.
Private consumption, the mainstay of aggregate domestic demand in India, appears to be firming up steadily since the third quarter of 2007-08 and is expected to benefit from fiscal stimuli on account of enhanced expenditures of subsidies, the farm loan waiver and salaries consequent upon the Sixth Pay Commission award that could come into play during the second half of the year.
Reflecting the aggregate demand pressures, key monetary and banking aggregates - money supply, deposit and non-food credit growth - have been expanding during the year so far at rates that are significantly elevated relative to indicative trajectories given in the Annual Policy Statement of April 2008. Money supply has continued to rise at the expansionary rates of 2003-08, propelled by the sustained pace of credit growth.
In the July 2008 Review, concerns relating to the significantly overdrawn state of the banking system due to elevated credit growth were expressed in this context. Supervisory review processes have been initiated with selected banks with a view to putting in place appropriate adjustments in their operations.
The unabated bank credit growth relative to the sources of funds and the whittling down of excess SLR investments warrants serious policy surveillance in the context of overall financial stability and the efficiency of financial intermediation.
The developments in monetary conditions resulted in a tightening of liquidity conditions in domestic financial markets through the second quarter of 2008-09. The strains on market liquidity were aggravated by sizeable fluctuations in the Central Government's cash balances, advance tax payments in mid-September, higher than anticipated credit growth as well as the heightening of volatility in domestic equity and foreign exchange markets in the wake of the sudden deterioration in international financial markets.
In the money market, overnight interest rates generally ruled above the upper bound of the corridor albeit in a narrow range with a peak in the second week of October 2008 as the international financial turbulence intensified. While the measures announced by the Reserve Bank in September-October 2008 alleviated these pressures, considerable uncertainty surrounds the evolution of liquidity conditions in the months ahead, given the fragile international environment. In response to the measures announced by the Reserve Bank, interest rates have moderated across the overnight market segments.
In the Government securities market, high demand for SLR securities depressed yields across the spectrum from mid-July with intermittent spurts on liquidity concerns. Yield curve inversion became persistent through the quarter, with the yield on the benchmark 10-year security ruling consistently below those on lower maturity securities in reflection of the uncertain macroeconomic outlook and to some extent, the softening of international crude prices.
In the foreign exchange market, activity picked up mainly on rising import demand induced by volatile international crude prices, portfolio outflows and uncertainties surrounding the global outlook. There was considerable volatility in the spot segment with the exchange rate slipping to multi-year lows as the extraordinary developments in international financial markets unfolded. Forward premia rose sharply at end-June and remained at elevated levels up to July 2008 after which the premia have tended to ease albeit unevenly across all maturities.
The forward premia went into discount due to dollar shortages towards end-September 2008 but recovered modestly in October 2008. The equity markets have weakened sporadically on cues from global markets, and particularly those in Asia. These developments in domestic financial markets render the macroeconomic outlook unsettled and uncertain.
Signs of deterioration in the fiscal situation appear to be adding to aggregate demand pressures in the economy. The revenue deficit of the Central Government has exceeded 177 per cent of the budget estimates during April-August 2008 and overshooting is also observed in the other deficit indicators. While tax revenues were buoyant and direct taxes raised their contribution to gross tax collections to 45 per cent, current expenditures on subsidies, social and other economic services eroded these gains and widened the deficits at all levels.
Impending expenditures on subsidies and salary revisions could bring additional pressures to bear on the fisc and consequently, on aggregate demand. The Government will need to address the issue of providing subsidies to the public sector oil marketing and fertiliser companies directly in cash instead of the current practice of issuance of oil and fertiliser bonds.
Excess demand conditions are also reflected in the merchandise trade deficit which has expanded by close to 43 per cent in April-August 2008 on a year-on-year basis, though mainly in response to the increase of 77 per cent in the average price of the Indian basket of crude.
Although the outlook remains uncertain at the current juncture, the softening of international crude prices in subsequent months should have a salutary effect in terms of containing the merchandise trade deficit over the rest of the year. Non-oil import growth has remained elevated, albeit considerably moderated from the increase recorded a year ago.
While exports are regaining momentum and international commodity prices, including crude, seem to be retreating, the widening of the trade deficit needs to be viewed in the context of the turmoil in international financial institutions and markets and the evolving environment
