Monetary and liquidity aggregates continued to expand during the first quarter of 2008-09. Year-on-year (y-o-y) growth in broad money (M₃) during 2008-09 so far (up to July 4, 2008) was above the indicative trajectory of 16.5-17.0 per cent set out in the Annual Policy Statement (APS) released in April 2008, notwithstanding some moderation mainly reflecting the decline in capital inflows during 2008-09 so far. Accretion to bank deposits, led by time deposits, remained strong, although the pace moderated. Expansion in bank credit to the commercial sector 2008-09 so far was above the Reserve Bank’s policy projection of 20.0 per cent for 2008-09 as indicated in the APS (April 2008). Banks' investments in SLR securities as a proportion of their net demand and time liabilities (NDTL) remained almost at the same level as at end-March 2008. Large capital inflows that remained a key driver of monetary and liquidity conditions during 2007-08 have witnessed slowdown during 2008-09 so far. The Reserve Bank continued to actively manage liquidity by using all the policy instruments at its command, including cash reserve ratio (CRR), issuances of securities under the market stabilisation scheme (MSS), operations under the liquidity adjustment facility (LAF) and conduct of open market operations (OMO).

Broad money (M₃) growth, on a year-on-year (y-o-y) basis, was placed at 20.5 per cent as on July 4, 2008 as compared with 21.8 per cent a year ago, reflecting the impact of some deceleration in time deposits. Expansion in the residency-based new monetary aggregate (NM3) - which does not directly reckon non-resident foreign currency deposits such as FCNR(B) deposits - was lower at 20.8 per cent as on July 4, 2008 than 21.5 per cent a year ago. Growth in liquidity aggregate, L1, at 20.3 per cent at end-June 2008 was marginally lower than that of 20.7 per cent a year ago (Table 22 and Chart 8).

In view of the continued underlying inflationary pressures, monetary policy recognised the need to smoothen and enable an adjustment of overall demand on an economy-wide basis so that inflation expectations were contained. Accordingly, the CRR was raised by 125 basis points in three phases during April-July 2008-09. The estimated amount of liquidity impounded in the first round on account of CRR hikes was Rs.48,000 crore¹. Furthermore, the Reserve

Bank increased the repo rate first by 25 basis points and then by another 50 basis points to 8.5 per cent effective from June 12 and June 25, 2008, respectively.

Currency with the public grew by 20.6 per cent (y-o-y) as on July 4, 2008 as compared with 14.0 per cent a year ago. Growth in demand deposits (y-o-y) as on July 4, 2008 at 16.4 per cent was lower than that of 19.2 per cent a year

ago. Accordingly, narrow money growth (M₁), y-o-y, was 17.7 per cent as on July 4, 2008 as compared with 16.9 per cent a year ago. The growth of time deposits was placed at 21.5 per cent (y-o-y) as on July 4, 2008 as compared with 23.9 per cent a year ago. The strong growth in time deposits could be attributed, inter alia, to robust economic activity, higher interest rates on bank deposits relative to postal deposits and extension of tax benefits under Section 80C for bank deposits. During 2007-08, accretion to postal deposits decelerated significantly up to November 2007. Beginning December 2007 there were net outflow from small saving schemes (Chart 9). In order to revive interest in postal deposits, the Government announced in December 2007 some incentives, including tax benefits for certain postal deposits. However, net outflows continued up to March 2008, the latest period for which the data are available. during 2008-09 (up to July 4, 2008)

On a financial year basis, growth in M₃ was 3.5 per cent as compared with 3.8 per cent during the corresponding period of the previous year. Currency with the public expanded by 5.9 per cent (up to July 4, 2008) as compared with 3.2 per cent during the corresponding previous period (Table 23).

Expansion in the bank credit to the commercial sector increased by 24.0 per cent (y-o-y) as on July 4, 2008, as compared with 22.6 per cent a year ago. Non-food credit by scheduled commercial banks (SCBs) expanded by 25.9 per cent, y-o-y, as on July 4, 2008, higher than 24.6 per cent a year ago. The higher

expansion in credit growth relating to the expansion in deposit growth resulted in an increase in the incremental credit-deposit ratio (y-o-y) of SCBs to 83.5 per cent as on July 4, 2008 from 70.0 per cent a year ago (Chart 10).

Disaggregated sectoral data available up to May 23, 2008 showed that about 43 per cent of incremental non-food credit (y-o-y) was absorbed by industry as compared with 39 per cent in the corresponding period of the previous year. The expansion of incremental non-food credit to industry during this period was led by infrastructure (power, port and telecommunication), petroleum, textiles,

iron and steel, food processing, chemicals, engineering, vehicles and construction industries. The infrastructure sector alone accounted for 33 per cent of the incremental credit to industry as compared with 25 per cent in the corresponding period of the previous year. The agricultural sector absorbed around 10 per cent of the incremental non-food bank credit expansion as compared with 15 per cent in the corresponding period of the previous year. Personal loans accounted for nearly 17 per cent of incremental non-food credit; within personal loans, the share of incremental housing loans was at 44 per cent. Growth in loans to commercial real estate remained high, notwithstanding moderation (Table 24).

In addition to bank credit for financing their requirements, the corporate sector continued to rely on a variety of non-bank sources of funds such as capital markets, external commercial borrowings and internal generation of funds. Resources raised through domestic equity issuances during the first quarter of 2008-09 (Rs.2,031 crore) were significantly lower than those in the corresponding period of the previous year mainly reflecting the decline in investor optimism in the secondary equity market. Net mobilisation through external commercial borrowings (ECBs) during 2007-08 increased by 54 per cent over the preceding year. Mobilisation through issuances of commercial paper (CPs) during April-June 2008-09 was 66 per cent higher than that during the corresponding period of the previous year. Resources raised in the form of equity issuances through American depository receipts (ADRs) and global depository receipts (GDRs) during April-June 2008-09 (Rs.4,056 crore) were more than three times than those during the corresponding period of the previous year. Internal generation of funds continued to provide a strong support to the funding requirements of the corporate sector, despite the profit after tax of select non-financial non-government companies during 2007-08 witnessing some deceleration in comparison with the previous year (Table 25 and Table 12).

Scheduled commercial banks' investment in SLR securities expanded by 19.6 per cent (y-o-y) as on July 4, 2008, as compared with 10.4 per cent a year ago. The higher growth in investment in SLR securities mainly reflected the need to maintain SLR requirements in consonance with the increase in their net demand and time liabilities (Table 26). Commercial banks' holdings of such securities as on July 4, 2008 were 27.7 per cent of their NDTL as compared with

Reserve money growth at 26.5 per cent, y-o-y, as on July 18, 2008 was lower than that of 29.0 per cent a year ago (Chart 12). Adjusted for the first round effect of the hike in CRR, reserve money growth at 18.4 per cent was lower than 21.6 per cent a year ago. Intra-year movements in reserve money largely reflected the Reserve Bank’s market operations and movements in bankers' deposits with the Reserve Bank in the wake of hikes in the CRR and large expansion in demand and time liabilities.

During the financial year 2008-09 (up to July 18, 2008), reserve money grew by 2.5 per cent as compared with an increase of 6.1 per cent in the corresponding period of the previous year. Bankers' deposits with the Reserve Bank decreased by 2.3 per cent (up to July 18, 2008) as against an increase of 14.0 per cent in the corresponding period of 2007-08. Currency in circulation expanded by 5.9 per cent as compared with 2.1 per cent during the corresponding period of the previous year (Table 27). On the sources side, net Reserve Bank’s credit to Government increased by Rs. 54,113 crore (up to July 18, 2008) as compared with an increase of Rs. 19,461 crore in the corresponding period of 2007-08. The Reserve Bank’s foreign currency assets (adjusted for revaluations) declined by Rs. 18,139 crore as against an increase of Rs. 72,947 crore during the corresponding period of the previous year (Chart 13).

Movements in the Reserve Bank’s net credit to the Central Government during 2008-09 so far (up to July 18, 2008) largely reflected the liquidity management operations by the Reserve Bank and movements in Government deposits with the Reserve Bank. Surplus cash balances of the Central Government with the Reserve Bank declined. The Reserve Bank’s holdings of Central Government dated securities decreased reflecting Reserve Bank’s special market operation (SMO) and LAF operations. The sterilisation operations of the Reserve Bank under the MSS led to an increase in Central Government deposits

with the Reserve Bank. Reflecting these developments, the Reserve Bank’s net credit to the Centre increased by Rs.55,581 crore during 2008-09 so far (up to July 18, 2008) as compared with an increase of Rs. 18,875 crore during the corresponding period of the previous year.

The Reserve Bank continued with its policy of active management of liquidity in 2008-09 through appropriate use of the CRR and OMO, including MSS and LAF, and other policy instruments at its command flexibly. The objective is to maintain appropriate liquidity in the system such that all legitimate requirements of credit are met, consistent with the objective of price and financial stability. During 2008-09 so far variations in cash balances of the Central Government, hikes in the CRR and the Reserve Bank’s foreign exchange operations remained the key drivers of liquidity conditions.

Liquidity conditions turned easy after the commencement of 2008-09 mainly due to substantial reduction in the cash balances of the Central Government (Table 28). On a review of the liquidity situation, the Reserve Bank announced on April 17, 2008, a two-stage hike of CRR by 25 basis points each to 8.0 per cent, effective from the fortnights beginning from April 26, 2008 and May 10, 2008, respectively. Auctions under the MSS (which were kept in abeyance since mid-February) were resumed on April 9, 2008 and the balances under the MSS increased to Rs.1,72,444 crore as on April 25, 2008. The daily average net liquidity absorption through the LAF was Rs.26,359 crore during

April 2008. On a review of the evolving liquidity situation, the Annual Monetary Policy Statement issued on April 29, 2008, announced an increase in CRR by 25 basis points to 8.25 per cent with effect from the fortnight beginning May 24, 2008. Reflecting the impact of the CRR hikes, average daily net absorption through LAF declined to Rs.11,841 crore during May 2008. No auction of dated securities under the MSS was conducted during May 2008 and the outstanding balance under the MSS was placed at Rs.1,75,362 crore on May 30, 2008 (Chart 14).

Liquidity conditions eased in the early part of June and the average daily net absorption under the LAF was placed at Rs.15,469 crore during June 1-9, 2008. On a review of the prevailing macroeconomic and overall monetary conditions and with a view to containing inflationary expectations, the Reserve Bank increased the repo rate under the LAF by 25 basis points to 8 per cent with effect from June 12, 2008. Subsequently, with the build-up in Central Government balances in the face of advance tax collections, liquidity conditions turned into a deficit mode and the average daily net injection under LAF during June 10-27, 2008 was Rs.17,288 crore (Chart 15). With a view to containing demand pressures, as reflected in the increase in inflation and inflationary expectations, engendered by unrelenting pressures from international commodity prices, particularly crude and metals, the Reserve Bank increased the repo rate under LAF by 50 basis points to 8.5 per cent with effect from June 25, 2008 and also increased the CRR by 50 basis points to 8.75 per cent in two stages (25 basis

points each) with effect from the fortnights beginning July 5 and July 19, 2008, respectively. No MSS auction was conducted during June 2008 and the outstanding balance as on June 27, 2008, was placed at Rs.1,74,433 crore (Table 29). The average daily net injection through the LAF during June was Rs. 8,622 crore.

Liquidity conditions eased during the first week of July mainly on account of a decline in the cash balances of the Central Government but tightened significantly thereafter mainly due to two stage hike in CRR announced in the previous month. The average liquidity injection during July 1-18, 2008 was at Rs. 23,421 crore.

Keeping in view the systemic implications of liquidity and other related issues currently faced by public sector oil marketing companies (OMCs) arising from the unprecedented escalation in international crude oil prices, the Reserve Bank announced Special Market Operation (SMO) on May 30, 2008, for the smooth functioning of financial markets and for overall financial stability. Under SMO, the Reserve Bank conducts open market operation (outright or repo at its discretion) in the secondary market through designated banks in oil bonds held by public sector OMCs in their own accounts, subject to an overall ceiling of Rs.1,500 crore (revised upwards from Rs.1,000 crore on June 11, 2008) on any single day, and provides equivalent foreign exchange through designated banks at market exchange rate to the oil companies. The settlement of the foreign exchange and the Government securities legs of the operations are synchronised so that there is no liquidity impact on account of these operations. These operations are ad hoc, temporary in nature and subject to review on a continuous basis. These operations commenced from June 5, 2008. The oil bonds purchased by the Reserve Bank under SMO up to July 11, 2008 aggregated Rs. 17,655 crore (face value).