Banks continued to finance strong commercial credit demand by reducing credit to government during the first half of 2005-06. Deposit growth in the banking sector proved a laggard.

Incremental credit-deposit ratio has been over 100 per cent for several quarters now. The rise in banks' advances was led by demand from medium and large industries, housing and real estate.

Demand deposits rose sharply, which could be attributed to a sharp rise in non-food credit with funds getting temporarily parked in demand deposits.

Non-food credit rises 35%

Bank credit to the commercial sector (non-food) was up 35 per cent year on year (y-o-y) in the first half of FY06. The main driver of bank credit growth has been non-food credit, which as on September 30 was up Rs 3,17,146 crore (Rs 3171.46 billion) y-o-y.

Non-food credit grew by 14.84 per cent to Rs 12,16,591 crore (Rs 12165.91 billion) from Rs 10,59,307 crore (Rs 10593.07 billion) as on March 30. Demand for credit has also gone up from oil companies, which are facing huge liquidity demand for oil imports in the face of spiralling crude prices. Crude prices have shot up from a low of $36/37 per barrel to a high of $67 per barrel.

Deposits rise 18.8%

Aggregate deposits with banks went up by 18.8 per cent to Rs 19,09,214 crore (Rs 19092.14 billion) as on September 30 compared with a year earlier. Aggregate deposits have increased by 12.3 per cent since April.

Demand deposits, which are short-term in nature, rose by Rs 47,967 crore (Rs 479.67 billion) to Rs 2,95,994 crore (Rs 2959.94 billion) as on September 30 from Rs 2,48,027 crore (Rs 2480.27 billion) on March 30. The increase in demand deposits during April-September 2004 was just Rs 4,480 crore (Rs 44.8 billion). In the first half of FY06, it has gone up by 88 per cent than in FY05.

On the other hand, time deposits, which are more stable and stretch over a longer maturity, increased by Rs 1,61,049 crore (Rs 1610.49 billion) during the first half to Rs 16,13,220 crore (Rs 16132.2 billion). Analysts said excess liquidity is resulting in a better growth in demand deposits.

This is because mutual funds, insurance companies and non-banking finance companies, which mop up deposits besides the banks, also deploy funds in the banking system temporarily. This explains the sharp increase in demand deposits.

Investment growth blip

The increase in banks' investment slowed to 6.7 per cent in the first half of FY06 from 13.1 per cent a year earlier. Banks' increased their exposure to government securities during April-September 2005 by just Rs 10,135 crore (Rs 101.35 billion) against Rs 29,421 crore (Rs 294.21 billion) in April-September 2004.

Their investments totalled Rs 7,53,436 crore (Rs 7,534.36 billion) as on September 30, up by Rs 14,283 crore (Rs 142.83 billion) since April 2005. The decline in the rate of growth in banks' investments has been owing to robust growth in commercial credit.

With GDP growing at above 8 per cent, non-food credit has shot up, putting pressure on liquidity. In fact, meeting the demand of government borrowing and non-food credit simultaneously remains a challenge for RBI in the current fiscal.

Rupee fell 2.4% in October:

The rupee-dollar exchange rate has been very volatile since the last few weeks. The main reason for depreciation in the rupee has been a slowdown in foreign institutional investor inflows amid a sharp correction in the equity market.

With the dollar gaining strength overseas, a widening trade and current account deficits have contributed to the weakening of the rupee. The rupee has fallen from a high of 43.77 in April to a low of 45.07 last Friday.

The rupee witnessed a low of 45.97 this month due to the cumulative effect of demand from importers, including oil companies, and a slowdown in dollar inflows, primarily FII flows.

Gilt yields on the rise

The interest rate scenario has changed since April with yields firming up which is indicated by both the short-term and medium-term yield curves.

Cut-off yield at which various government papers such as dated securities and treasury bills are auctioned to raise money for meeting the government borrowing programme has gone up uniformly.

The yield on 91-day t-bill has gone up from 5.26 per cent in April to 5.48 per cent in October. Similarly, the yield on the 10-year paper has gone up from 6.68 per cent to 7.16 per cent.

The firming up of yield incorporates the growing demand for liquidity in the system. Government securities yields have moved up in the last three weeks.