Annual Policy Statement for the Year
2008-09
by Dr. Y. Venugopal Reddy, Governor,
Reserve Bank of India
This Statement consists of two parts:
Part I. Annual Statement on Monetary
Policy for the Year 2008-09; and
Part II. Annual Statement on Developmental
and Regulatory Policies for the Year 2008-09.
An analytical review of macroeconomic
and monetary developments was issued a day in
advance as a supplement to Part I of this Statement,
providing the necessary information and technical analysis
with the help of charts and tables.
2. The Annual Statement on Monetary Policy will be
reviewed on a quarterly basis during 2008-09, whereas
the Annual Statement on Developmental and Regulatory
Policies will be reviewed along with the Mid-Term Review
of Monetary Policy, in continuation of the changes in
the institutional framework of policy formulation that
were initiated in 2005-06. Accordingly, the dates for
the First Quarter Review and the Mid-term Review are
July 29, 2008 and October 24, 2008, respectively.
Part I. Annual Statement
on Monetary Policy
for the Year 2008-09
3. The Annual Statement on Monetary Policy for the
Year 2008-09 consists of three Sections:
I. Review of Macroeconomic and
Monetary Developments during 2007-08;
II. Stance of Monetary Policy for
2008-09; and
III. Monetary Measures.
I. Review of
Macroeconomic and Monetary
Developments during 2007-08
Domestic Developments
4. The growth of real gross domestic product (GDP)
in 2007-08 was placed at 8.7 per cent by the Central
Statistical Organisation (CSO) in its advance estimates
released in February 2008. Economic activity in 2007-08
has evolved in consonance with policy expectations set
out in April 2007, albeit with some moderation as compared
with 9.6 per cent in 2006-07. In retrospect, the slackening
of momentum in 2007-08 appears to have set in as anticipated
and moved gradually over the four quarters. Real GDP
growth was 9.3 per cent, 8.9 per cent, 8.4 per cent
and 8.4 per cent, respectively, in the four quarters
of 2007-08 as against 9.6 per cent, 10.1 per cent, 9.1
per cent and 9.7 per cent in the corresponding quarters
of 2006-07.
5. Real GDP originating in agriculture and allied activities
is estimated to have risen by 2.6 per cent in 2007-08,
lower than 3.8 per cent in the previous year. According
to the third advance estimates of agricultural production
released by the Ministry of Agriculture in April 2008,
total foodgrains production is expected to increase
to an all-time high of 227.3 million tonnes in 2007-08
from 217.3 million tonnes in 2006-07. Kharif foodgrains
production is expected to have risen by 8.6 per cent,
whereas rabi foodgrains production is expected to increase
by 0.5 per cent. Output is estimated to have risen in
the case of rice (2.5 per cent), wheat (1.3 per cent),
coarse cereals (17.0 per cent) and pulses (7.0 per cent).
Among the commercial crops, production is estimated
to have increased under cotton (2.5 per cent), oilseeds
(16.1 per cent) and jute (2.3 per cent) whereas the
production of sugarcane declined by 3.2 per cent.
6. Real GDP originating in industry rose by 8.6 per
cent in 2007-08 as compared with 10.6 per cent in the
previous year. The index of industrial production (IIP)
recorded an increase of 8.7 per cent during April-February
2007-08 vis-à-vis 11.2 per cent a year ago. In
manufacturing, which contributed 89 per cent of the
increase in industrial production, the growth of output
was lower at 9.1 per cent than 12.2 per cent a year
ago. Growth in mining at 5.1 per cent was comparable
with 5.0 per cent a year ago, while growth in electricity
generation moderated to 6.6 per cent as compared with
7.2 per cent. Production of beverages, tobacco and related
products, wood and wood products, leather and leather
products, basic chemicals and products and basic metals
and alloys recorded double-digit growth in 2007-08 (up
to February 2008). The industry groups that registered
deceleration of growth include textiles, paper and paper
products, non-metallic mineral products and transport
equipments and parts. On the other hand, the production
of metal products and parts except machinery and equipments
recorded a decline.
7. In terms of the use-based classification of industries,
the production of capital goods continued to expand
at a sustained pace, increasing by 17.5 per cent during
April-February 2007-08, over and above the increase
of 18.3 per cent a year ago. The basic, intermediate
and consumer non-durable goods segments recorded lower
growth of 7.4 per cent, 9.2 per cent and 8.9 per cent,
respectively, as compared with 10.1 per cent, 11.7 per
cent and 9.5 per cent a year ago. Production of consumer
durables declined by 1.0 per cent as against an increase
of 9.7 per cent a year ago. The output of the six key
infrastructure industries (with a weight of 26.7 per
cent in the IIP) also registered a lower growth of 5.6
per cent during April-February 2007-08 as against 8.7
per cent in the corresponding period of the previous
year.
8. Corporate activity experienced some moderation in
growth relative to the recent past but continued to
remain healthy during 2007-08. During April-December
2007, growth in sales of surveyed non-financial private
companies decelerated to 17.4 per cent from 29.1 per
cent in the corresponding period of the preceding year.
Net profits growth was also lower at 29.8 per cent from
46.6 per cent a year ago due to a combination of several
factors including escalation in input costs and compensation
to employees. Corporates' interest burden continues
to be low with the interest payment to gross profits
ratio estimated at 11.8 per cent, 12.8 per cent and
15.3 per cent in the first three quarters of 2007-08
as against 18.1 per cent and 13.4 per cent in 2005-06
and 2006-07, respectively, and an average of 43.7 per
cent in 2000-05. The differential between sales and
expenditure growth shrank to 20 basis points from 280
basis points in April-December 2006, reflecting pressure
on profits at the operating level, somewhat mitigated
by strong support from income from non-core activities
which rose by 75.5 per cent in April-December 2007 as
compared with 20.9 per cent a year ago. Early results
for the fourth quarter of 2007-08 indicate that growth
in sales and net profits are lower than in the corresponding
quarter a year ago. There was also a larger increase
in expenditure on both raw materials and compensation
to employees for the selected companies. Consequently,
the difference between sales growth and the overall
expenditure growth narrowed, resulting in lower profitability
both in gross and net terms.
9. The Reserve Bank's Industrial Outlook Survey conducted
during February 2008 indicates a mixed picture in the
business sentiment. With a pickup in demand conditions
(including exports), the assessment for January-March
2007-08 shows an improvement over the expectation for
the quarter in the previous round of the survey. The
business expectations index for April-June 2008 at 123.2
has moved up from 118.6 recorded in the previous quarter,
against the seasonal decline, but is still lower than
its level at 127.5 in the corresponding quarter of the
previous year. Production, order book positions and
capacity utilisation growth are expected to pick up
in relation to the previous quarter and increasing number
of respondent firms expect employment levels to go up.
Price pressures are seen as rising mainly on the back
of higher raw material costs. About 27 per cent of respondent
firms expect to pass on the price increase to customers
in April-June 2008 as compared with 23 per cent in the
corresponding quarter of the previous year. While imports
and exports are expected to pick up in April-June 2008
as compared with the previous quarter, the growth in
exports would be lower than in the corresponding quarter
of 2007-08. With nearly one in every four respondents
perceiving higher profit margins and more than 60 per
cent expecting status quo, the optimism on profit margins
for April-June 2008 has improved in relation to January-March
2008, although it is still lower than in April-June
2007.
10. Business confidence surveys conducted by other
agencies convey a somewhat tempered though overall positive
outlook. One survey's Business Optimism Index indicates
a sharp decline in the first quarter of 2008-09 with
respect to the previous quarter and a much sharper fall
when compared to April-June 2007, attributable to less
optimistic sentiment in the services and capital goods
sectors. According to another survey, however, the overall
economic conditions for the next six months are seen
to be positive, with production closely following expectations
of growth in domestic sales and a clear upturn in import
growth. Seasonally adjusted purchasing managers' indices
reflect lower business sentiment for January-March 2008
with some ebbing in relation to the previous quarter
but still higher than a year ago. All the surveys indicate
sustained though somewhat slower growth of manufacturing
with firms trying to protect their profit margins through
improvement in productivity and by passing on cost increases
into selling prices. Investment sentiment remains positive
on expectations of improvement in the financial position,
order books and capacity utilisation.
11. Real GDP originating in the services sector rose
by 10.6 per cent during 2007-08 as compared with 11.2
per cent a year ago. Activity in construction and financing,
insurance, real estate and business services sector
expanded by 9.6 per cent and 11.7 per cent, respectively,
as compared with 12.0 per cent and 13.9 per cent in
2006-07. The growth of trade, hotels and restaurants,
transport, storage and communication was 12.1 per cent
in 2007-08, marginally higher than 11.8 per cent in
2006-07. Growth in community, social and personal services
at 7.0 per cent was comparable to 6.9 per cent in the
previous year.
12. Aggregate demand conditions in 2007-08 continued
to be dominated by investment spending as in recent
years. The growth of real gross fixed capital formation
(GFCF) accelerated to 15.7 per cent from 15.1 per cent
in the previous year. Real private final consumption
expenditure (PFCE) increased by 6.8 per cent as compared
with 7.1 per cent in 2006-07. In nominal terms, PFCE
marginally declined to 55.5 per cent of GDP at current
market prices during 2007-08 from 55.8 in 2006-07 and
57.4 per cent in 2005-06. On the other hand, GFCF increased
to 34.6 per cent of GDP from 32.5 per cent in 2006-07
and 31.0 per cent in 2005-06.
13. The overall moderation in real sector activity
was reflected in the evolution of monetary and banking
developments in 2007-08. Non-food credit extended by
the scheduled commercial banks (SCBs) increased by 22.3
per cent (Rs.4,19,425 crore) as compared with 28.5 per
cent (Rs.4,18,282 crore) in the previous year. The incremental
non-food credit-deposit ratio for the banking system
declined to 72.3 per cent during 2007-08 from 83.2 per
cent in 2006-07, 109.3 per cent in 2005-06 and 130.0
per cent in 2004-05. Food credit of SCBs declined by
Rs.2,121 crore in 2007-08 as against an increase of
Rs.5,830 crore in the previous year.
14. Provisional information on the sectoral deployment
of bank credit available up to February 2008 indicates,
as anticipated, a gradual deceleration over the year.
On a year-on-year basis, credit to services sector recorded
the highest growth (28.4 per cent), followed by industry
(25.9 per cent) and agriculture sector (16.4 per cent).
On the other hand, growth in personal loans decelerated
to 13.2 per cent (30.6 per cent). Growth in housing
and real estate loans decelerated to 12.0 per cent (25.8
per cent) and 26.7 per cent (79.0 per cent), respectively.
Within the industrial sector, there was a sizeable credit
pick-up in respect of infrastructure (42.1 per cent
as against 28.2 per cent a year ago), food processing
(32.0 per cent as against 27.6 per cent) and engineering
(26.2 per cent as against 18.1 per cent). There was
moderation in credit growth to basic metals and metal
products (19.0 per cent as against 33.3 per cent), textiles
(23.0 per cent as against 35.5 per cent), petroleum
(23.3 per cent as against 64.4 per cent) and chemicals
(13.9 per cent as against 19.2 per cent). Credit to
industry constituted 45.2 per cent of the total expansion
in non-food bank credit up to February 2008, followed
by services (29.8 per cent), personal loans (15.8 per
cent) and agriculture (9.2 per cent). The share of infrastructure
in total credit to industry increased from 20.5 per
cent to 23.1 per cent. On the contrary, the share of
credit to metals, textiles, chemicals and petroleum
declined from 12.4 per cent, 11.3 per cent, 8.3 per
cent and 4.9 per cent, respectively, to 11.7 per cent,
11.1 per cent, 7.5 per cent and 4.8 per cent. Priority
sector advances grew by 16.9 per cent with a moderation
in their share in outstanding gross bank credit to 33.3
per cent in February 2008 from 34.7 per cent a year
ago.
15. SCBs' investments in bonds/debentures/shares of
public sector undertakings and the private corporate
sector and commercial paper (CP) increased by 14.2 per
cent (Rs.11,830 crore) during 2007-08 as compared with
an increase of 5.1 per cent (Rs.4,081 crore) in the
previous year. As a result, the total flow of funds
from SCBs to the commercial sector, including non-SLR
investments, increased by 21.9 per cent (Rs.4,31,256
crore) in 2007-08 as against 27.3 per cent (Rs.4,22,363
crore) in 2006-07. Banks' investment in instruments
issued by mutual funds increased by Rs.6,818 crore in
2007-08 as compared with Rs.1,315 crore in 2006-07.
16. Commercial banks' investment in Government and
other approved securities increased by 22.9 per cent
(Rs.1,81,222 crore) during 2007-08 significantly higher
than 10.3 per cent (Rs.74,062 crore) in 2006-07. Accordingly,
their stock of statutory liquidity ratio (SLR) eligible
securities marginally increased to 27.4 per cent of
the banking system's net demand and time liabilities
(NDTL) in March 2008 from 27.3 per cent in March 2007.
Bank's holdings of SLR securities in excess of the prescribed
ratio of 25 per cent amounted to Rs.1,02,422 crore although
several banks are operating their SLR portfolios close
to the prescribed level. Adjusted for collateral securities
under the liquidity adjustment facility (LAF) and issuances
under the market stabilisation scheme (MSS), banks'
investment in SLR-eligible securities would amount to
23.7 per cent of NDTL.
17. Aggregate deposits of SCBs increased by 22.2 per
cent (Rs.5,80,208 crore) during 2007-08 as compared
with 23.8 per cent (Rs.5,02,885 crore) in the previous
year. Demand deposit growth at 20.2 per cent was higher
than 17.9 per cent in 2006-07 but time deposit growth
moderated to 22.6 per cent from 25.1 per cent in the
previous year. In addition to the mobilisation of deposits,
the banking sector's lendable resources were augmented
substantially by capital raised through public issues
and innovative capital instruments during 2007-08.
18. Money supply (M3) increased by 20.7 per cent (Rs.6,86,096
crore) in 2007-08 as compared with 21.5 per cent (Rs.5,86,548
crore) in 2006-07. Bank credit to the commercial sector
increased by 20.3 per cent (Rs.4,32,574 crore) in 2007-08
as compared with the increase of 25.8 per cent (Rs.4,37,074
crore) a year ago. Net bank credit to Government recorded
an increase of Rs.67,363 crore, with increase in banks'
investment of Rs.1,83,338 crore in Government securities
offset by a decline of Rs.1,15,975 crore (net) in Reserve
Bank's credit to Government. The large increase in net
foreign exchange assets of the Reserve Bank was reflected
in the increase of 38.7 per cent (Rs.3,53,118 crore)
in the banking sector's net foreign exchange assets.
19. Reserve money increased by 30.9 per cent (Rs.2,19,326
crore) during 2007-08 as compared with 23.7 per cent
(Rs.1,35,935 crore) in the previous year. While currency
in circulation rose by 17.2 per cent (Rs.86,606 crore)
in 2007-08 as compared with the increase of 17.1 per
cent (Rs.73,523 crore) in the preceding year, bankers'
deposits with the Reserve Bank increased substantially
by 66.5 per cent (Rs.1,31,152 crore) augmented
by the increase of 150 basis points in cash reserve
ratio (CRR) during the year as compared with
the increase of 45.6 per cent (Rs.61,784 crore) in 2006-07.
Among the sources of reserve money, the Reserve Bank's
foreign currency assets (adjusted for revaluation) increased
by Rs.3,70,550 crore as compared with the increase of
Rs.1,64,601 crore in the previous year. The Reserve
Bank's net credit to the Central Government (adjusted
for the Government's deposit balances including the
MSS proceeds) declined by Rs.7,070 crore in 2007-08
as against an increase of Rs.30,888 crore in 2006-07.
Reflecting the liquidity conditions, the Reserve Bank's
credit to banks and the commercial sector declined by
Rs.2,794 crore as compared with an increase of Rs.1,990
crore in the previous year. The ratio of net foreign
exchange assets (NFEA) to currency increased from 171.8
per cent in March 2007 to 209.2 per cent in March 2008.
20. During the year, the financial markets experienced
alternating shifts in liquidity conditions. Tightness
in liquidity on account of year-end adjustments in March
2007 persisted up to April-May, necessitating net repo
injections under the LAF. There was substantial drawdown
in the Centre's cash balances during May-July 2007 and
a dip in MSS outstanding in June-July 2007 due to redemptions.
The total overhang of liquidity as reflected in the
balances under the LAF, the MSS and surplus cash balances
of the Central Government taken together declined from
an average of Rs.97,412 crore in March 2007 to Rs.63,994
crore in July 2007. The resumption of net issuances
under the MSS, accretions to Centre's cash balances
and the increase in CRR by 100 basis points during August-November
2007 led to a reduction in the liquidity in the banking
system and intermittent net liquidity injections of
Rs.2,742 crore and Rs.10,804 crore on a daily average
basis in November and December 2007, respectively. Auctions
of dated securities under MSS were discontinued between
November 2, 2007-January 16, 2008 to ease the stringency
in liquidity. The liquidity overhang ruled steady in
the range of Rs.2,13,847 crore-Rs.2,18,224 crore during
October-December 2007.
21. During the fourth quarter of 2007-08, even though
liquidity conditions were comfortable in January 2008
and MSS auctions were resumed in mid-January 2008, some
tightness emerged during February 18-28, on account
of increase in the Centre's cash balances. In view of
the scheduled advance tax payments in mid-March 2008
and the subsequent bank holidays (March 20-22, 2008),
the Reserve Bank conducted additional three-day repo/reverse
repo auctions on March 14, 2008 (afternoon) and another
seven-day repo auction on March 17, 2008 (afternoon)
over and above the normal LAF arrangements for smooth
liquidity management. Injection of liquidity through
LAF repo and redemption of MSS around mid-February 2008
onwards, mitigated the liquidity tightness. During March
17-31, 2008 there were shortages of liquidity in the
wake of advance tax payments. Net LAF injections rose
to a peak of Rs.53,995 crore on March 31, 2008; however,
in the additional LAF operations conducted on that day
with a view to meeting the banking sector's year-end
liquidity management requirements, there was absorption
of liquidity under the LAF to the tune of Rs.3,645 crore.
The build-up of cash balances of the Central Government
to a peak of Rs.1,04,741 crore on March 27, 2008 also
aggravated the liquidity shortage with banks. The overall
liquidity overhang increased to the intra-year peak
of Rs.2,73,694 crore on March 27, 2008 before declining
to Rs.2,43,879 crore on April 25, 2008.
22. On a net basis, average daily LAF repo injections
which stood at Rs.4,568 crore in the first quarter of
2007-08 changed to net absorption through LAF reverse
repo of Rs.13,472 crore in the second quarter which
declined sharply to Rs.7,820 crore in the third quarter
and further to Rs.2,116 crore during the fourth quarter
of 2007-08. During 2008-09 (up to April 25, 2008), the
average daily net absorption under LAF reverse repo
increased to Rs.28,271 crore. The average outstanding
balances under MSS increased from Rs.64,863 crore at
end-March 2007 to Rs.1,70,554 crore by end-March 2008
and further to Rs.1,74,465 crore on April 25, 2008 indicating
net issuance of Rs.1,05,691 crore during 2007-08. Cash
balances of the Central Government with the Reserve
Bank increased from an average of Rs.55,890 crore in
March 2007 to Rs.79,409 crore in March 2008 before declining
to Rs.36,649 crore as on April 25, 2008.
23. On a year-on-year basis, inflation based on the
wholesale price index (WPI) stood at 7.4 per cent at
end-March 2008 as compared with 5.9 per cent a year
ago. During 2007-08, headline inflation declined from
6.4 per cent at the beginning of the financial year
to a low of 3.1 per cent in mid-October before firming
up from mid-February 2008 onwards. On an annual average
basis, inflation at 4.7 per cent during 2007-08 was
lower than 5.4 per cent in the previous year. As on
April 12, 2008 the headline inflation stood at 7.3 per
cent as against 6.3 per cent a year ago.
24. At a disaggregated level, prices of primary articles
(weight: 22.0 per cent in the WPI basket) registered
a year-on-year increase of 8.9 per cent at end-March
2008 as compared with 10.7 per cent a year ago. The
increase in prices of primary articles during 2007-08
was led by the rise in prices of food articles and non-food
articles such as cotton and oilseeds. As on February
1, 2008 the stock of foodgrains with public agencies
stood at 21.4 million tonnes as against the buffer stock
norm of 20.0 million tonnes applicable for January-March,
2008. The build-up in food stocks on the back of the
jump in foodgrains production during 2007-08 provides
some comfort for supply management. Wheat procurement
during the current rabi marketing season has also risen
by 20.6 per cent on a year-on-year basis, strengthening
food security strategies and conditions for stabilisation
of domestic food prices going forward.
25. Inflation in terms of prices of manufactured products
(weight: 63.8 per cent) was 7.1 per cent as compared
with 6.1 per cent a year ago. Prices of edible oils,
oil cakes, basic metals, alloys and metal products and
basic heavy inorganic chemicals contributed to the rise
in manufacturing prices in 2007-08. On the other hand,
prices of textiles, leather and leather products and
non-ferrous metals declined during the year.
26. The year-on-year increase in prices of the 'fuel,
power, light and lubricants' group (weight: 14.2 per
cent) was 6.7 per cent at end-March 2008 as compared
)with 1.0 per cent a year ago. Excluding the fuel group,
headline inflation was 7.6 per cent (7.4 per cent a
year ago). The average price of the Indian basket of
international crude increased by 27.6 per cent from
US $ 62.4 per barrel during 2006-07 to US $ 79.7 per
barrel in 2007-08. While there has been no revision
in prices of kerosene and domestic LPG during 2007-08,
domestic retail prices of petrol and diesel have been
revised upwards only once during 2007-08 with effect
from February 15, 2008 by 4.5 per cent for petrol and
by 3.25 per cent for diesel (average of four metros).
Among the freely priced petroleum products, however,
prices of naptha, bitumen, furnace oil and aviation
turbine fuel, recorded increases of 33.7 per cent, 36.4
per cent, 37.6 per cent and 38.7 per cent, respectively,
over their levels a year ago.
27. Inflation, on a year-on-year basis, based on the
consumer price index (CPI) for industrial workers (IW)
stood at 5.5 per cent in February 2008 as compared with
7.6 per cent a year ago. The CPI for urban non-manual
employees (UNME), agricultural labourers (AL) and rural
labourers (RL) also declined to 6.0 per cent, 7.9 per
cent and 7.6 per cent, respectively, in March 2008 as
compared with 7.6 per cent, 9.5 per cent and 9.2 per
cent a year ago. On an annual average basis, inflation
based on CPI for IW was 6.1 per cent in February 2008
compared with 6.6 per cent a year ago and that for UNME,
AL and RL were 5.9 per cent, 7.5 per cent and 7.2 per
cent, respectively, in March 2008 as compared with 6.6
per cent, 7.8 per cent and 7.5 per cent a year ago.
28. The revised estimates (RE) of the Central Government's
finances for 2007-08 indicate ongoing improvement in
the fiscal position and lowering of the key deficit
indicators relative to budget estimates (BE). The revenue
deficit estimated at 1.4 per cent of GDP (Rs.63,488
crore) was lower than 1.5 per cent of GDP in the BE
for 2007-08 and 1.9 per cent of GDP in 2006-07. The
gross fiscal deficit (GFD) for 2007-08 constituted 3.1
per cent of GDP (Rs.1,43,653 crore) as against the budget
estimates of 3.3 per cent and 3.5 per cent in 2006-07.
The improvement in key fiscal indicators was largely
enabled by the sustained buoyancy in tax revenue which,
at Rs.4,31,773 crore (RE) was 6.9 per cent higher than
the budget estimates and recorded a growth of 22.9 per
cent over the previous year.
29. During 2007-08, the Central Government's net market
borrowing through dated securities at Rs.1,10,671 crore
was 101.0 per cent of the budgeted amount of Rs.1,09,579
crore and gross market borrowing of Rs.1,56,000 crore
through dated securities was 100.35 per cent of the
budgeted amount of Rs.1,55,455 crore. The Central Government
also issued additional securities amounting to Rs.38,050
crore, outside the market borrowing programme and the
MSS, to public sector oil companies for partial compensation
of under-recoveries, to the State Bank of India and
to various fertiliser companies. During 2006-07, the
Central Government had issued such securities amounting
to Rs.40,321 crore. The State Governments and the Union
Territory of Pondicherry raised Rs.67,779 crore (gross)
and Rs.56,224 crore (net) during 2007-08 under their
market borrowing programme. The combined issuance (net)
of Government securities under the market borrowing
programme of the Centre and States was Rs.1,66,895 crore
in 2007-08 as against Rs.1,21,190 crore in 2006-07,
Rs.1,10,825 crore in 2005-06, Rs.80,012 crore in 2004-05
and Rs.1,35,192 crore in 2003-04.
30. Out of 35 issuances under the market borrowing
programme of the Central Government, one new 10-year
paper was issued and the remaining 34 issues were reissuances
intended to impart liquidity. The actual issuance of
dated securities under the Centre's market borrowing
programme was generally as per the advance calendar
except for one occasion when, in consultation with the
Central Government, securities for Rs.5,000 crore were
issued on June 12, 2007 over and above the scheduled
issuances in the indicative calendar for the first half
of 2007-08. The weighted average yield on primary issuance
of the Central Government's dated securities increased
by 23 basis points to 8.12 per cent in 2007-08 from
7.89 per cent in the previous year whereas the weighted
average maturity of the dated securities issued during
the year increased to 14.90 years from 14.72 years in
the previous year. In the case of market borrowing by
State Governments, the weighted average yields firmed
up by 15 basis points to 8.25 per cent in 2007-08 from
8.10 per cent in 2006-07, whereas the average maturity
of these issues has remained the same at 10.0 years.
31. Movements in interest rates in the domestic financial
markets reflected the factors driving changes in liquidity
with the banking system during 2007-08. The weighted
average call market rates declined from 8.33 per cent
in April 2007 to 0.73 per cent in July 2007 coincident
with a ceiling of Rs.3,000 crore placed on daily reverse
repo from March 5, 2007. The rates moved up in August
following the removal of the ceiling but generally stayed
within the informal LAF rate corridor up to December
2007. As liquidity conditions tightened, call money
rates strayed, albeit marginally, above the repo rate
during the last fortnight of February and in March 2008.
The daily weighted average call rate during March 2008
was much lower at 7.37 per cent as compared with 14.10
per cent in March 2007. In April 2008, call rates declined
further and the weighted average call rate stood at
5.93 per cent as on April 25, 2008. Interest rates in
the CBLO and market repo segments moved in sympathy
with call rates and declined from December 2007 peaks
to 6.37 per cent and 6.72 per cent, respectively, in
March 2008 and further to 4.93 per cent and 5.45 per
cent in April 2008 (up to April 25, 2008). The daily
average volume (one leg) in the call money market declined
from Rs.14,845 crore in April 2007 to Rs.11,182 crore
in March 2008 and further to Rs.9,374 crore in April
2008 (up to April 25, 2008). The corresponding volumes
in the market repo (outside the LAF) were Rs.7,173 crore,
Rs.14,800 crore and Rs.11,911 crore respectively, whereas
in the CBLO segment, the volumes were Rs.18,086 crore,
Rs.37,413 crore and Rs.31,297 crore, respectively.
32. Mobilisation of resources through issuance of commercial
papers (CPs) was stepped up during 2007-08 as the weighted
average discount rate on CP declined by 95 basis points
from 11.33 per cent at end-March 2007 to 10.38 per cent
in end-March 2008 and the outstanding amount of CPs
increased from Rs.17,688 crore to Rs.32,592 crore during
this period. The weighted average discount rate for
certificates of deposit (CDs) also declined from 10.75
per cent at end-March 2007 to 10.00 per cent in end-March
2008, accompanied by a significant increase in outstanding
amounts from Rs.93,272 crore to Rs.1,47,792 crore.
33. In the Government securities market, primary market
yields of 91-day, 182-day and 364-day Treasury Bills
softened over the course of 2007-08, declining by 63-84
basis points to reach 7.23 per cent, 7.36 per cent and
7.35 per cent, respectively, by end-March 2008. By April
25, 2008 the primary market yields of 91-day, 182-day
and 364-day Treasury Bills stood at 7.44 per cent, 7.60
per cent and 7.69 per cent, respectively. In the secondary
market, the yield on Government securities with 1-year
residual maturity declined from 7.55 per cent at end-March
2007 to 7.49 per cent in March 2008 before increasing
to 7.84 per cent as on April 25, 2008. The yield on
Government securities with 10-year residual maturity
declined marginally from 7.97 per cent in March 2007
to 7.93 per cent before rising to 8.23 per cent by April
25, 2008 while the yield on Government securities with
20-year residual maturity increased from 8.23 per cent
at end-March 2007 to 8.31 per cent at end-March 2008
and further to 8.63 per cent as on April 25, 2008. Consequently,
the yield spread between 10-year and 1-year Government
securities increased marginally from 42 basis points
at end-March 2007 to 44 basis points at end-March 2008
before declining to 39 basis points as on April 25,
2008. Similarly, the yield spread between 20-year and
1-year Government securities increased from 68 basis
points at end-March 2007 to 82 basis points at end-March
2008 and subsequently declined marginally to 79 basis
points as on April 25, 2008.
34. Rapid growth in turnover in the foreign exchange
market was sustained by large surplus conditions in
the spot market. The average daily turnover increased
to US $ 57.30 billion at end-March 2008 from US $ 33.18
billion at end-March 2007. With increasing volumes of
current and capital account transactions, the merchant
turnover for the period increased to US $ 16.37 billion
from US $ 8.66 billion, while the inter-bank turnover
increased to US $ 40.88 billion from US $ 24.52 billion.
There was a general softening in forward premia across
all maturities over end-March 2007 but some hardening
was witnessed after September 2007. The six-month forward
premia eased from 4.40 per cent in March 2007 to 2.55
per cent by end-June 2007 and further to 0.78 per cent
by end-September before it increased to 2.50 per cent
at end-March 2008 and further to 2.67 per cent by April
25, 2008.
35. During March 2007-March 2008, pubic sector banks
(PSBs) readjusted their deposit rates downwards by 25-50
basis points, while those offering lower deposit rates
for similar maturity earlier increased their deposit
rates by 50-100 basis points. Similarly, PSBs paying
higher interest rates earlier on shorter term deposits
of up to one year maturity also revised their deposit
rates downwards by 25 basis points. In particular, the
interest rates offered by the PSBs on deposits of above
one year maturity moved from the range of 7.25-9.50
per cent in March 2007 to 8.00-9.25 per cent in March
2008, while deposit rates for shorter term deposits
of up to one year maturity decreased from the range
of 2.75-8.75 per cent to 2.75-8.50 per cent during the
same period. On the other hand, private sector banks
increased their interest rates for long term deposits
of above one year maturity from a range of 6.75-9.75
per cent to 7.25-9.75 per cent during the same period.
Foreign banks set deposit rates lower for maturities
of less than one year while they have marginally raised
their rates for deposits of longer maturities.
36. On the lending side, the benchmark prime lending
rates (BPLRs) of PSBs increased by 75 basis points from
a range of 12.25-12.75 per cent to 12.25-13.50 per cent
during 2007-08. The private sector banks increased their
BPLR from a range of 12.00-16.50 per cent to a range
of 13.00-16.50 per cent, in the same period. The range
of BPLRs for foreign banks, however, remained unchanged
at 10.00-15.50 per cent during the same period. The
median lending rates for term loans (at which maximum
business is contracted) in respect of PSBs moved from
a range of 9.13-12.50 per cent in March 2007 to 10.00-13.00
per cent by March 2008.
37. The Indian equity market witnessed large swings
during 2007-08. The BSE Sensex (1978-79=100) increased
by 19.7 per cent during the year from 13072 at end-March
2007 to 15644 at end-March 2008. The intra-year peak
of 20873 was recorded on January 8, 2008 whereas the
intra-year trough of 12445 was recorded on April 2,
2007. Corporates mobilised large resources through public
issues during the year. Sound macroeconomic fundamentals,
private corporate profitability, institutional buying
support and global macroeconomic conditions were the
major factors determining the movements in equity prices.
As on April 25, 2008 the BSE Sensex stood at 17126.
Developments in the External Sector
38. The Reserve Bank's end-March 2008 release sets
out the balance of payments data for April-December
2007. In US dollar terms, merchandise exports increased
by 24.6 per cent during April-December 2007 from 23.9
per cent in April-December 2006. Provisional information
on commodity-wise trade available from the Directorate
General of Commercial Intelligence and Statistics (DGCI&S)
shows that export growth in 2007-08 was driven by petroleum
products, engineering goods and gems and jewellery.
During the first nine months of 2007-08, merchandise
import growth accelerated to 27.9 per cent from 27.7
per cent a year ago, mainly due to an increase of 29.9
per cent in non-oil imports from 22.7 per cent in April-December
2006. The growth in non-oil imports was mainly due to
capital goods, pearls and precious stones, chemicals,
and gold and silver. Oil imports increased by 24.0 per
cent as against 39.4 per cent during April-December
2006 as the average price of the Indian basket of international
crude recorded an annual increase of 15.9 per cent to
US $ 74.7 per barrel in April-December 2007. On payments
basis, the merchandise trade deficit increased to US
$ 66.5 billion during April-December 2007 from US $
50.3 billion in the corresponding period of 2006-07.
39. Net invisible earnings amounted to US $ 50.5 billion
in April-December 2007 as against US $ 36.3 billion
a year ago. The key contributors to invisibles were
remittances from Indians working overseas, export of
software services and travel earnings. Private transfers,
comprising primarily remittances from overseas Indians,
remained sizeable at US $ 28.8 billion as compared with
US $ 20.2 billion a year ago. While the inward remittances
for family maintenance increased by 39.0 per cent, local
withdrawals from non-resident Indian (NRI) deposit accounts
were higher by 49.0 per cent which may be attributed
to higher returns domestically vis-à-vis NRI
deposits. Software export proceeds amounted to US $
27.5 billion as against US $ 21.8 billion in April-December
2006. Miscellaneous receipts, net of software exports,
stood at US $ 18.1 billion in April-December 2007 as
compared with US $ 17.6 billion a year ago, mainly on
account of business services such as trade-related services,
business and management consultancy, engineering and
technical know-how. Invisible payments increased to
US $ 49.7 billion during the first nine months of 2007-08
as compared with US $ 43.1 billion a year ago. The key
components of invisible payments were travel payments,
transportation, business and management consultancy,
technical services, dividends, profit and interest payments.
With invisible receipts rising faster than payments,
the net invisible surplus increased from US $ 36.3 billion
in April-December 2006 to US $ 50.5 billion in April-December
2007. Reflecting these developments in the merchandise
and invisible accounts, the current account deficit
(CAD) at US $ 16.0 billion was higher than US $ 14.0
billion in the corresponding period of the previous
year.
40. Net capital inflows surged by 172 per cent to US
$ 81.9 billion during April-December 2007 as compared
with US $ 30.1 billion a year ago. While net foreign
direct investment (FDI) increased by US $ 8.4 billion
from US $ 7.6 billion in April-December 2006, portfolio
investment recorded a substantial increase of US $ 33.0
billion from US $ 5.2 billion. Enabled by finer spreads
and in response to rising financing requirements for
domestic capacity expansion, net external commercial
borrowings (ECBs) increased to US $ 16.3 billion as
against an increase of US $ 9.8 billion in the previous
year. During the first nine months of 2007-08, NRI deposits
registered a net outflow of US $ 0.9 billion as against
an increase of US $ 3.7 billion in April-December 2006,
responding to the reduction in the ceiling on interest
rate on NRI deposits in April 2007. Net short-term trade
credit rose to US $ 10.8 billion as compared with US
$ 5.7 billion a year ago. On the whole, debt flows (net)
in the form of external assistance, ECBs, NRI deposits
and short-term credit put together increased to US $
27.5 billion in April-December 2007 from US $ 20.2 billion
a year ago.
41. There was a large accretion of US $ 67.2 billion
to foreign exchange reserves, excluding valuation changes,
during April-December 2007 as against US $ 16.2 billion
in April-December 2006. Valuation gains, reflecting
the appreciation of major currencies against the US
dollar, accounted for US $ 8.9 billion of the total
accretion to the reserves during April-December 2007.
Including these valuation effects, the foreign exchange
reserves recorded an increase of US $ 76.1 billion and
rose to reach a level of US $ 275.3 billion by end-December
2007. India's external debt increased by US $ 31.8 billion
from end-March 2007 to US $ 201.4 billion at end-December
2007. The increase was mainly under ECBs (US $ 15.3
billion) and short-term credit (US $ 8.8 billion). Valuation
changes due to the depreciation of the US dollar vis-à-vis
major international currencies and the Indian rupee,
accounted for US $ 6.0 billion of the increase in external
debt during the period. In the total external debt stock,
ECBs accounted for the highest share (28.3 per cent),
followed by NRI deposits (21.4 per cent), multilateral
debt (18.8 per cent) and bilateral debt (8.6 per cent).
At end-2007, the ratio of short-term debt to total debt
was 17.5 per cent. The share of US dollar-denominated
debt in total debt was highest at 54.5 per cent, followed
by 17.1 per cent in rupee-denominated debt and 11.2
per cent in Japanese yen-denominated debt.
42. Information available for subsequent months from
the DGCI&S indicates that merchandise exports increased
by 22.8 per cent in US dollar terms during April-February
2007-08 as compared with 23.2 per cent in the corresponding
period of the previous year. On the other hand, imports
showed an increase of 30.1 per cent as compared with
25.2 per cent. While the increase in oil imports was
lower at 26.4 per cent as compared with 31.2 per cent,
non-oil import recorded a higher growth of 31.8 per
cent as compared with 22.6 per cent. During April-February
2007-08, the trade deficit widened to US $ 72.5 billion
which was 46.8 per cent higher than the deficit of US
$ 49.4 billion in the corresponding period of the previous
year.
43. The sustained strength of capital flows during
the year is noteworthy. Net portfolio flows on account
of investments by FIIs surged to US $ 20.3 billion in
2007-08 from US $ 3.2 billion in the previous year.
Net inflows in the form of FDI rose to US $ 25.5 billion
in April-February 2007-08 from US $ 19.6 billion a year
ago. Net inflows under ADRs/GDRs increased to US $ 8.7
billion from US $ 3.8 billion. On the other hand, net
accretions to NRI deposits amounted to US $ 0.1 billion
as against US $ 3.9 billion. During 2007-08, the foreign
exchange reserves increased by US $ 110.5 billion to
US $ 309.7 billion by end-March 2008 and stood at US
$ 313.5 billion as on April 18, 2008.
44. The Indian foreign exchange market witnessed generally
orderly conditions during 2007-08 with the exchange
rate exhibiting two-way movements. The exchange rate
of the rupee against the US dollar, which was Rs.43.59
at end-March 2007 appreciated by 5.6 per cent to Rs.41.29
at end-April 2007 and further to Rs.39.27 by January
8, 2008. In the subsequent period the exchange rate
depreciated, easing to Rs.39.97 per US dollar by end-March
2008. The rupee-euro exchange rate depreciated from
Rs.58.14 at end-March 2007 to Rs.63.09 by end-March
2008. Overall, during 2007-08, the rupee appreciated
by 9.1 per cent against the US dollar and by 7.5 per
cent against pound sterling but depreciated by 7.7 per
cent against the Japanese yen, and by 7.8 per cent against
the euro. As on April 25, 2008 the exchange rate of
the rupee was Rs.40.18 per US dollar, Rs.62.90 per euro,
Rs.79.25 per pound sterling and Rs.38.47 per 100 Japanese
yen.
45. The exchange rate policy in recent years has been
guided by the broad principles of careful monitoring
and management of exchange rates with flexibility, without
a fixed target or a pre-announced target or a band,
coupled with the ability to intervene, if and when necessary.
The overall approach to the management of India's foreign
exchange reserves takes into account the changing composition
of the balance of payments and endeavours to reflect
the 'liquidity risks' associated with different types
of flows and other requirements.
Developments in the Global Economy
46. Global economic activity decelerated somewhat in
relation to earlier expectations, mainly on account
of the slowdown in the US economy. During the first
quarter of 2008, the unfolding of the subprime mortgage
crisis coupled with growing concerns about a contraction
of economic activity in the US in 2008 appears to be
feeding into a deterioration in the outlook for global
growth which has remained relatively resilient so far.
There are some signs that the slowdown in the US may
spill over to the euro area, China and Japan with potential
implications for the emerging market economies (EMEs)
through trade, financial markets and other linkages.
According to the World Economic Outlook (WEO) of the
International Monetary Fund (IMF) released in April
2008, the forecast for global real GDP growth, on a
purchasing power parity basis, is expected to slow from
4.9 per cent in 2007 to 3.7 per cent in 2008
as compared with the projection of 4.1 per cent published
in January 2008 and 3.8 per cent in 2009. World
real GDP growth, on the basis of market exchange rates,
is estimated to decelerate from 3.7 per cent in 2007
to 2.6 per cent in 2008 and 2009.
47. In the US, real GDP grew by 0.6 per cent in the
fourth quarter of 2007 as compared with 2.1 per cent
a year ago and 4.9 per cent in the previous quarter.
In the first quarter of 2008, labour markets weakened
with the unemployment rate rising to 5.1 per cent in
March 2008. Household and consumption demand is likely
to be affected with home prices having fallen by 10.7
per cent in the year ending January 2008, bank seizures
having more than doubled in March 2008 over the level
a year ago and the year-on-year monthly foreclosure
continuing to increase in March 2008 for the 27th consecutive
month. US real GDP growth is expected to slow further
during 2008 as the housing market downturn deepens and
the financial market turmoil spreads across the financial
system with macroeconomic implications as apprehended
by the IMF in its April 2008 Global Financial Stability
Report. The index of leading indicators increased marginally
in March after a continuous decline up to February 2008.
However, consumer sentiment was at its lowest level
in 26 years in April 2008. The US economy is expected
to show some improvement in the second half of 2008,
when tax rebates in the fiscal stimulus package could
lift growth. The IMF's April 2008 update of its WEO
expects the US economy to grow at a slower pace of 0.5
per cent in 2008 as against 2.2 per cent in 2007, but
projects some recovery to 0.6 per cent in 2009.
48. Real GDP in the euro area grew by 2.3 per cent
in the fourth quarter of 2007 on a year-on-year basis
as compared with 3.3 per cent a year ago. Real activity
appears to have strengthened in the first quarter of
2008. Unemployment fell in January-February 2008 to
a record low of 7.1 per cent notwithstanding currency
appreciation, surging oil prices and the US slowdown.
Growth in European service industries has accelerated
above projections with optimism on export prospects.
However, European retail sales fell in March after rising
for the first time in five months in February. Retailers
continue to lack pricing power with consumer spending
held down by inflation at its highest level in 14 years.
The April 2008 update of the IMF's WEO has placed real
GDP growth of the euro area at 1.4 per cent in 2008
and 1.2 per cent in 2009 as against 2.6 per cent in
2007.
49. The Japanese economy grew by 3.7 per cent in the
fourth quarter of 2007 as compared with 2.2 per cent
a year ago. In the first quarter of 2008, lead indicators
point to some slackening of momentum while consumer
and business sentiment has weakened. Japan's factory
production fell in January-February 2008 as a deepening
US slowdown weakened demand for cars and electronics.
Exports and production are slowing and wages remain
subdued. Consumer sentiment in Japan has been worsening
with higher crude oil prices and the rising prices of
daily necessities. The April 2008 WEO of the IMF has
projected that Japan's economy, the world's second largest,
will grow by 1.4 per cent in 2008 and by 1.5 per cent
in 2009 as compared with the estimated growth of 2.1
per cent in 2007.
50. These unusual developments in global economy indicate
heightened uncertainties and emerging challenges for
the conduct of monetary policy, especially for EMEs.
The IMF has forecast that the emerging and developing
economies growth will slow to 6.7 per cent in
2008 from 7.9 per cent in 2007 and further to 6.6 per
cent in 2009. Developing Asia will slow by 1.5 percentage
points to a still-rapid 8.2 per cent. However, downside
risks are emerging to the extent EMEs' growth has depended
heavily on external demand and also due to the possibility
of capital inflows drying up in the present risk-averse
scenario. Rise in risk aversion has already dampened
private bond issuance in several EMEs. Most importantly,
inflation has raised its head in several EMEs and this
might complicate monetary policy decision-making even
further, particularly in view of the greater weight
for food in consumer prices as well as inflation perceptions
in EMEs.
51. The Chinese economy grew by 11.9 per cent in 2007
as compared with 11.1 per cent in 2006 in spite of measures
to cool down the pace of growth, including reduction
of export rebates and restrictions on processing exports.
In the first quarter of 2008, however, growth has moderated
to 10.6 per cent as compared with 11.7 per cent a year
ago. Reflecting the slowdown in export growth, China's
trade surplus fell year-on-year by 10.8 per cent in
March 2008 to US $13.4 billion. The total foreign exchange
reserves, however, increased to US $ 1.7 trillion in
March 2008 as compared with US $ 1.2 trillion in March
2007. In 2008, the Chinese economy is expected to moderate
to a growth of 9.3 per cent as tightening policies take
effect. The CSI 300 Index, which tracks yuan-denominated
A shares listed on China's two exchanges, has fallen
by 28.8 per cent to 3803.1 on April 25, 2008 after increasing
six-fold in the two years through 2007. The Chinese
authorities are making efforts to resolve problems such
as overheated growth in fixed asset investment, excessive
supplies of money and credit and a huge trade surplus.
52. Among other major Asian economies, the Korean economy
grew by 5.0 per cent in 2007, decelerating marginally
from 5.1 per cent in 2006 despite higher exports to
emerging markets such as China. Economic activity is
expected to slow down further to 4.2 per cent in 2008
before accelerating to 4.4 per cent in 2009. In Thailand,
economic activity is expected to grow by 5.3 per cent
in 2008 and further to 5.6 per cent in 2009 as against
4.8 per cent in 2007, as stronger domestic demand growth
and expansionary public expenditures offset slowing
export growth.
53. Continuing strong demand and dwindling stocks are
reflected in a tight supply-demand food situation globally,
leading to the emergence of food price inflation as
a key risk to global stability. The FAO's global food
price index, which rose by 40 per cent in 2007 to the
highest level on record, has continued to increase in
the first quarter of 2008 as well, as world food stocks
have fallen to their lowest levels in 25 years. Food
import bills in the low-income food-deficit countries
are likely to rise by 35 per cent for the second consecutive
year in 2008. Shortages and high prices for all kinds
of food have caused social tensions around the world
in recent months in Haiti, Indonesia, Pakistan and several
African countries. China has imposed price controls
on cooking oil, grain, meat, milk and eggs. In Egypt,
the Government has significantly raised food subsidies
and signed a bilateral agreement with Kazakhstan for
1 million tonnes of wheat at a preferential price to
be delivered during 2008. Indonesia has removed the
5 per cent duty on wheat import and suspended a 10 per
cent duty on imported soybeans. In April 2008, the global
food crisis appears to have intensified with Kazakhstan
one of the world's biggest wheat exporters
curbing exports, alongside restrictions in Russia, Ukraine
and Argentina. These curbs are likely to trigger similar
moves in other foodgrain exporting countries in the
face of rising domestic prices worldwide.
54. In the global foodgrains market, prices of major
crops such as corn, soyabeans and wheat have increased
by 58.2 per cent, 86.3 per cent and 56.5 per cent, respectively,
by April 25, 2008 from a year ago in response to surging
demand. The increase in overall foodgrain prices has
gained momentum from higher energy and fertiliser prices,
low levels of inventories, shortfalls in certain crops
mainly caused by weather-related factors such as the
ongoing drought in Australia and strong increases in
the demand for crops. Higher rice prices are also contributing
to inflation in many developing countries as the price
of rice, a staple in the diets of nearly half the world's
population, has almost doubled on international markets
in the last three months. Drawing down of costly stockpiles
of rice in recent years has removed an effective price
dampener in the face of adverse demand-supply imbalances.
Rising prices and a growing fear of scarcity have prompted
some of the world's largest rice producers India,
Vietnam, Egypt and Cambodia at end-March 2008
to announce drastic limits on the amount of rice they
export which have driven prices on the world market
even higher. Philippines has started to track down rice
hoarders. Rice prices in Thailand have trebled over
their level in the beginning of 2008. With Indonesia
joining other major rice exporters in banning exports,
international near-month futures price of rice on Chicago
Board of Trade (CBOT) has risen to a high of US $ 23.8
per hundredweight on April 25, 2008 _ up by 71 per cent
since January 2008. On the same day, futures prices
were quoted higher at US $ 24.18 for July 2008, but
the quotes moderated for September 2008 to US $ 22.09
and for May 2009 to US $ 22.38.
55. Wheat prices remained generally firm and volatile
since October 2007 on account of repeated downward revisions
of production forecasts in a number of major exporting
countries, most notably Australia. World wheat output
is now estimated to have risen by only 1.6 per cent
in 2007. Trade is expected to contract because of high
and volatile prices, coupled with soaring freight rates.
One month wheat futures at the CBOT rose from US $ 9.15
per bushel on January 2, 2008 to US $ 12.8 on February
27, 2008 before falling to US $ 8.01 on April 25, 2008.
On the same day, futures prices for wheat were quoted
higher for July 2008 at US $ 8.16, for December 2008
at US $ 8.49 and for May 2009 at US $ 8.68.
56. Strong demand for animal feed as well as for ethanol
is the main driver in global coarse grain markets, but
supply tightness in several exporting countries is also
providing support to prices. The futures prices of corn
on CBOT, which had moderated somewhat up to July 2007,
started moving up thereafter and reached US $ 5.77 on
April 25, 2008. On the same day, futures prices for
corn were quoted higher for July 2008 at US $ 5.90,
for September 2008 at US $ 6.00 and for May 2009 at
US $ 6.25.
57. Metal prices have increased by 23.7 per cent during
first three months of 2008 after declining by 8.1 per
cent during 2007 following increases of 53.6 per cent
in 2006 and 36.3 per cent in 2005. In the futures markets,
aluminium, zinc and lead prices are showing a downward
trend since October 2007. Copper prices have been buoyed
up by the depreciating US dollar and high demand. Futures
price of copper on the New York Mercantile Exchange
(Nymex) increased to a record level of US $ 4.03 per
pound on April 9, 2008. As on April 25, 2008 the May
2008 futures prices for copper which stood at US $ 3.96
per pound were quoted lower for July 2008 at US $ 3.91,
at US $ 3.89 for September 2008 and at US $ 3.78 for
May 2009. Spot gold rose to US $ 1000.10 an ounce on
March 13, 2008 the highest since January 1980
as the dollar fell to a record low against the
euro and on concerns about declining supply on mine
shutdowns in South Africa, before declining to US $
885.15 an ounce on April 25, 2008.
58. Prices of crude oil, which have rebounded since
July 2007, increased by 83.2 per cent up to April 25,
2008 from their level a year ago and near-month futures
prices have ruled at the record level of US $ 119.64
per barrel on April 25, 2008 the highest since
trading began on the Nymex in 1983. On the same day,
oil futures ruled at a lower level of US $ 115.77 for
September 2008 and US $ 114.06 for December 2008 and
US $ 111.6 for May 2009. According to the Energy Information
Administration (EIA), tight fundamentals, reflected
by low available crude oil surplus production capacity,
combined with supply concerns in several oil exporting
countries, have continued to put upward pressure on
world crude oil prices. The outlook over the next two
years points to some easing of the oil market balance
due to increased production outside of the Organization
of the Petroleum Exporting Countries (OPEC) and planned
additions to OPEC capacity. However, delays to capacity
additions in both OPEC and non-OPEC nations could alter
the outlook, as could OPEC production decisions. According
to the EIA, the price of West Texas Intermediate (WTI)
crude oil is expected to be at US $ 100.61 per barrel
in 2008 and US $ 92.50 per barrel in 2009. Surplus production
capacity is projected to decelerate from its current
level of a little over 2 million barrels per day (bbl/d)
to more than 1 million bbl/d by the end of 2009.
59. In the US, consumer prices increased from 2.8 per
cent in March 2007 to 4.0 per cent in March 2008. In
the euro area, inflation increased to 3.6 per cent in
March 2008 the highest level since the introduction
of the euro from 1.9 per cent a year ago. In
Japan, inflation increased to a decade-high rate of
1.2 per cent in March 2008 from (-) 0.1 per cent a year
ago on account of rising oil and food costs. In the
UK, CPI inflation decelerated to 2.5 per cent in February-March
2008 from 2.8 per cent a year ago. At the retail level
(in terms of retail prices index or RPI), inflation
rose to 4.8 per cent in the UK in March 2007
the highest since 1991 but declined thereafter
to 3.8 per cent in March 2008 with some fluctuations
in between. Inflation pressures have also raised concerns
in some of the EMEs such as China, Malaysia, Indonesia
and Chile.
60. Core CPI inflation in the US increased to 2.4 per
cent in March 2008 from 2.3 per cent in February 2008.
In the UK, core CPI inflation has been declining in
tandem with the headline rate and stood at 1.2 per cent
in February-March, down from 1.3 per cent in January
2008. In the euro area, core CPI inflation increased
to 2.0 per cent in March 2008 from 1.8 per cent in February
2008. Core inflation in Japan turned positive (0.1 per
cent) in March 2008 as compared with -0.1 per cent in
February 2008. The increase in producer prices has been
sharper than in consumer prices, reflecting increased
input costs. In the US, producer prices increased from
3.1 per cent in March 2007 to 6.9 per cent in March
2008. In the euro area, producer prices increased from
2.8 per cent in March 2007 to 5.3 per cent in March
2008. In the UK, producer prices increased to 6.2 per
cent in March 2008 from 2.7 per cent in March 2007.
Wholesale price inflation in Japan increased from 1.2
per cent in February 2007 to 3.4 per cent in February
2008. Overall, the persistence of high food and oil
prices sustained at elevated levels and continued high
prices of other commodities pose significant inflation
risks for the global economy and challenges for monetary
policy worldwide.
61. In the EMEs, the recent jump in headline inflation
caused by higher energy and food prices are of concern
since this requires a balanced response in controlling
inflation while being alert to decelerating impulses
from the slowdown in the developed countries and the
possibilities of a prolonged global financial market
turmoil. Even though higher headline inflation may be
driven initially by rising food and energy prices, it
could quickly lead to broader price and wage pressures
in the EMEs which are witnessing rapid growth. In China,
inflation accelerated to 8.7 per cent in February 2008
before easing to 8.3 per cent in March as compared with
3.3 per cent in March 2007 despite the central bank's
repeated efforts to rein in inflation through monetary
tightening policies. At end-March 2008, the Chinese
State Council decided to increase budgetary subsidies
for grain production and the government's minimum grain
procurement prices to address the potential shortfall
in grain production. Farmers' interest in grain production
has been declining as raw material costs were rising
faster than grain prices. Consumer price inflation in
Korea accelerated to 3.9 per cent in March 2008 from
2.2 per cent in March 2007 which is causing concern.
Inflation increased to 5.3 per cent in March 2008 in
Thailand from 2.0 per cent in March 2007.
62. Concerns about a US slowdown and the uncertainty
surrounding the financial health of some of the biggest
US financial entities have imparted considerable volatility
in the US equity markets since January 2008. On January
21, 2008 equity markets across the world experienced
sharp declines with fall in Asian stocks as well. The
volatility and bearishness in equity markets have continued
in February-April 2008 on account of weak US economic
data and substantial write-offs by financial institutions.
The Dow Jones Industrial Average, Standard and Poor's
(S&P) 500 and Nasdaq Composite exhibited considerable
volatility and posted declines of 1.5 per cent, 6.5
per cent and 4.9 per cent, respectively, by April 25,
2008 over their levels a year ago. In the fixed income
segment, Government bond yields in the major economies,
which had firmed up in the first half of 2007, have
softened thereafter since demand for government debt
has increased as investors shifted their funds to the
treasuries acknowledging the likelihood that the economy
is already in a recession and seeking safety. The US
10-year bond yield increased from 4.70 per cent at end-December
2006 to 5.29 per cent on June 12, 2007 before falling
to 3.87 per cent on April 25, 2008. The 10-year bond
yield in the euro area increased from 3.95 per cent
at end-December 2006 to 4.68 per cent on July 9, 2007
before falling to 4.18 per cent on April 25, 2008. The
Japanese 10-year bond yield has increased from 1.68
per cent at end-December 2006 to 1.97 per cent on June
13, 2007 before falling to 1.61 per cent on April 25,
2008. These recent developments are indicative of evolving
uncertainties in international financial markets with
implications for EMEs.
63. On a trade-weighted basis, the US dollar has been
depreciating since 2006 with intermittent fluctuations.
After the cuts in the Fed funds rates since September
2007, the US dollar has weakened against other currencies.
The pound sterling moved to the level of US $ 1.99 on
April 25, 2008 close to the 26-year high of US
$ 2.11 reached on November 8, 2007 amidst concerns
relating to the US subprime mortgage market. The euro,
which has also been strengthening against the US dollar
since June 2007, rose to a peak of US $ 1.60 on April
22, 2008 before declining to US $ 1.56 on April 25,
2008. The Canadian dollar appreciated against the US
dollar to a 33-year high to reach US $ 1.09 on November
6, 2007 before declining to US $ 1.01 on April 25, 2008.
Turkey experienced a sharp appreciation in its currency
vis-a-vis the US dollar to reach the level of 86.95
cents on January 10, 2008 before moving to 77.95 cents
on April 25, 2008. The New Zealand dollar had appreciated
to 81.10 cents to reach a 22-year peak against the US
dollar on July 24, 2007 before declining to 78.07 cents
on April 25, 2008.
64. Since the beginning of the turbulence in August
2007, central banks of advanced economies have responded
with both conventional and unconventional measures to
ease liquidity stress in financial markets and solvency
issues among large financial institutions. There has,
however, been several aspects that differentiate the
approaches of the central banks. Some central banks,
notably the ECB, the Reserve Bank of Australia and the
Swiss National Bank have responded by providing liquidity
to inter-bank markets, implicitly viewing the financial
turmoil as essentially a problem of liquidity tightness.
These central banks have provided liquidity through
fine-tuning operations aimed at assuring orderly conditions
in their respective money markets. On the other hand,
some central banks like the US Fed, the Bank of England
and the Bank of Canada have responded in a more diverse
fashion, regarding the market stress as reflecting both
liquidity seizure as well as broader threats to financial
stability, coupled with dangers of the slowdown in economic
activity becoming protracted. Accordingly, they have
moved to inject liquidity into money markets through
normal and special facilities. They have also relaxed
the class of eligible securities for liquidity availment
from the central bank. Furthermore, they have also cut
policy rates substantially amid fears that the subprime
crisis could turn into a major credit crunch with adverse
implications for the real sector. The US Fed has also
been involved in resolution of problems arising in non-bank
entities like investment banks and insurance companies.
The Bank of England has provided generalised and institution-specific
emergency liquidity and facilities for swapping securities.
65. In the second phase of central bank intervention
in December 2007 (the first phase being spread over
August-September), major central banks such as the Federal
Reserve, the Bank of Canada, the Bank of England, the
European Central Bank and the Swiss National Bank (SNB)
injected liquidity in a coordinated manner. Actions
taken by the Federal Reserve included the establishment
of a temporary Term Auction Facility (TAF) against a
wide variety of collateral that can be used to secure
loans at the discount window; the establishment of foreign
exchange swap lines with the ECB and the SNB which will
provide dollars in amounts of up to US $ 20 billion
and US $ 6 billion to the ECB and the SNB, respectively,
for use in their jurisdictions; a Term Securities Lending
Facility announced on March 11, 2008; and a Primary
Dealer Credit Facility (PDCF) on April 22, 2008. The
Fed has also conducted nine auctions amounting to US
$ 340 billion having 28-day maturity and an auction
of US $ 20 billion having 35-day maturity.
66. Since December 2007, the ECB has conducted seven
US dollar TAF auctions amounting to US $ 85 billion
up to April 24, 2008 for 28 days maturity each. The
Bank of Canada has conducted five 28-day auctions amounting
to US $ 10 billion till April 17, 2008. The SNB has
conducted four auctions amounting to US $ 20 billion
for 28 days each up to April 22, 2008. The Bank of England
increased liquidity injections from £2.85 billion
to £11.35 billion for its operations in December
2007-January 2008 of which £10 billion was offered
for 3-month maturity. It also announced that long term
repo operations would be held against a wider range
of high quality collateral. In April 2008, the Bank
of England launched a scheme to allow banks to swap
temporarily their high quality mortgage-backed and other
securities for UK Treasury Bills. It has so far allotted
amounts of £44.9 billion (three months), £2.95
billion (six months), £1.6 billion (nine months)
and £ 0.8 billion (12 months) in four long-term
repo auctions since December 2007.
67. Some central banks have cut policy rates since
the third quarter of 2007 when the financial market
turmoil surfaced. During September 18, 2007 to March
18, 2008 the US Federal Reserve cut its policy rate
by 300 basis points to 2.25 per cent after seventeen
increases to 5.25 per cent between June 2004 and June
2006. The Bank of England reduced its repo rate to 5.0
per cent by 25 basis points each in February and April
2008. The Bank of Canada reduced its rate to 3.0 per
cent by 25 basis points reductions each in December
2007 and January 2008 and 50 basis points each in March
and April 2008. Central banks of several countries,
including the euro area, New Zealand, Japan, Korea,
Malaysia, Thailand and Mexico have not changed their
rates since the last quarter of 2007. Some central banks
that have tightened their policy rates in recent months
include the Reserve Bank of Australia (Cash Rate raised
by 25 basis points in February-March 2008 to 7.25 per
cent); the People's Bank of China (lending rate raised
to 7.47 per cent in December 2007 from 7.29 per cent
in September 2007); the Banco Central de Chile (benchmark
lending rate raised to 6.25 per cent in January 2008
from 5.75 per cent in October 2007), and Banco Central
do Brasil (overnight Selic rate raised by 50 basis points
to 11.75 per cent in April 2008).
68. Large capital flows to EMEs have elicited various
responses from central banks for managing and stabilising
these flows including monetary tightening involving
either hikes in policy rates or in reserve requirements
or both. In China, the required reserve ratio was raised
from 8 per cent in July 2006 to 16.0 per cent on April
25, 2008. After a gap of 17 years, the Bank of Korea
raised reserve requirements from 5 per cent to 7 per
cent for local currency deposits and short-term foreign
currency deposits in November and December 2006, respectively.
Meanwhile, in several EMEs including China and Korea,
central bank bonds have continued to absorb liquidity
from the banking system.
69. Measures directly aimed at managing capital flows
are also in evidence in many EMEs. On December 18, 2006
Thailand imposed unremunerated reserve requirements
(URR) of 30 per cent on most capital inflows, requiring
them to be deposited with the central bank for one year.
However, with effect from March 3, 2008 the Bank of
Thailand has lifted the URR on short-term capital inflows
and said it would introduce three supporting measures
to temper the impact of the change. These measures involve
(a) an increase in the foreign investment limit to US
$30 billion to allocate to securities companies, mutual
funds and individual investors, (b) an improvement in
measures to prevent baht speculation and (c) a revision
to the structure of non-residential baht accounts so
as to help monitor fund flows of non-residents. In May
2007, Colombia introduced a package of measures, including
a 40 per cent URR on external borrowing to be held for
six months in the central bank. Additionally, a new
ceiling on the foreign exchange position of banks, including
gross positions in derivative markets, was stipulated
to limit circumvention of the URR and banks' exposure
to counterparty risk. The PBC raised the amount of foreign
currencies that lenders must keep as reserves to 5 per
cent from 4 per cent of their foreign-currency deposits
from May 15, 2007. The Bank of Korea is investigating
large volume trading of currency forward contracts by
exporters and financial companies to limit gains in
the won, which appreciated to a 10-year high in 2007.
Chile and Brazil's central bank have bought up substantial
amount of inflows from the spot market to add to reserves
and also conducted sizeable operations in the forward
markets.
70. Over the year gone by, global developments have
brought forward several new realities that pose severe
challenges to monetary policy globally. First, concerns
relating to the US slowdown and its intensity have mounted
in view of the potential spillover on to the global
economy. Second, threats to the global economy are emanating
from advanced economies in sharp contrast to earlier
crises which stemmed from the emerging world. Third,
there are indications that protectionist tendencies
have increased around the world in anticipation of the
growing possibilities of slower growth in advanced economies.
In several key commodity-producing economies, policy
measures are in place and are being intensified to restrict
the availability of supplies to the international markets.
Fourth, linkages between financial sector developments
and the real sector have become more worrisome than
before, with apprehensions that financial turmoil may
spillover to the real sector with adverse implications
for employment and growth. With financial institutions
reporting tightening in lending standards, deterioration
in asset quality and deceleration in consumer loan demand,
there are signals that events in the financial markets
are beginning to have a persisting impact on other dimensions
of the real economy as well. Fifth, higher and more
volatile prices of food, energy and other commodities
have imparted a significant upside bias to inflation
and inflation expectations across the world, complicating
the conduct of monetary policy at a time of severe financial
stress. In several countries, there are threats to food
availability with consequent social tensions. Sixth,
terms-of-trade losses due to soaring commodity prices
and exchange rate appreciation are reducing the capacity
of the euro area and Japan to contribute to a re-balancing
of the world economy. Seventh, EMEs are exhibiting resilience
so far in the face of the global financial turmoil reflecting
relatively stronger macroeconomic framework and sustainable
macroeconomic balances. Thus, there is so far some divergence
in terms of growth performance between mature economies
and EMEs but whether, how long and to what extent it
will persist is uncertain. On the other hand, inflationary
pressures appear to be common to mature economies and
EMEs but the latter are under heavier pressure.
71. There are several issues emerging out of recent
financial developments that are interacting with global
macroeconomic changes and carry implications for the
conduct of monetary policy globally. First, financial
markets are currently at the heart of the turmoil and
are regarded as sources of higher potential instability
going forward. Despite sizeable central bank action
over a wide spectrum, market interest rates and policy
rates continue to be widely divergent. Second, there
are renewed concerns about the gaps in the financial
architecture and its limited capability for withstanding
shocks or for preventing spillovers. Third, the effectiveness
of financial regulations and supervision has come under
scrutiny, especially in the context of appropriately
assessing capital adequacy in large financial institutions,
complex financial products and vehicles and risk management
practices. In this context, it is important to note
that even the Basel II and related processes are being
reviewed in their granularities. Fourth, the role of
credit rating agencies is being subjected to critical
reassessment, particularly in view of their envisaged
role under Basel II. There is active discussion on the
need for credit rating agencies to clearly differentiate
the ratings for structured products, improve their disclosure
of rating methodologies, and assess the quality of information
provided by originators, arrangers, and issuers of structured
products. Fifth, current practices relating to transparency
and disclosure are being subject to careful appraisal
in view of their inadequacy in the context of structured
financial products and special purpose vehicles. Sixth,
the role of investment banks and their adequacy of capital
needs to be reviewed, along with stipulation of separate
yet complementary sets of best practices for hedge fund
investors and asset managers to increase accountability
for participants in this industry.
Overall Assessment
72. While aggregate supply capacities expanded and
alleviated domestic macro-imbalances in 2007-08 to some
extent, available indicators suggest that economic activity
in India currently continues to be mainly demand-driven.
The rate of gross fixed capital formation at current
prices rose by 2.1 percentage points of GDP at current
market prices in 2007-08, more than compensating for
the decline of 0.3 percentage points in the rate of
private final consumption expenditure and that of 0.2
percentage points in the rate of government final consumption
expenditure. Looking ahead, the Union Budget for 2008-09
is likely to provide a stimulus to both private and
government consumption in view of the proposals for
effective reduction of the tax burden under personal
income and excise as well as the revenue expenditure
implications emanating from the recommendations of the
Sixth Pay Commission. The dominance of investment demand
in the economy is likely to persist in 2008-09 and beyond,
supported as it were by the buoyancy in corporate saving
in view of the sustained resilience of sales and profitability,
and the ongoing improvement in public sector saving.
Furthermore, patterns of domestic industrial output
and imports remain skewed in favour of capital goods,
indicative of ongoing expansion in capacity, both new
and existing. Moreover, resources raised through public
issues as well as investment intentions more than doubled
in 2007-08, pointing to the corporate sector's positive
assessment of evolving demand conditions and underlying
plans for expanding production capacities. Finally,
the sharp widening of the merchandise trade deficit
reflects the spillover of domestic demand into the external
sector with implications for the year ahead.
73. The pick-up in inflation during the fourth quarter
of 2007-08 has, however, mainly emanated from supply-side
pressures such as the one-off increase in domestic petrol
and diesel prices to partially offset the global crude
oil price increase over the year; continuous hardening
of prices of petroleum products that are not administered,
rising prices of wheat and oilseeds and the adjustment
in steel prices in March 2008 due to the surge in international
prices. In recognition of the unanticipated supply-sided
origin of pressures in the recent months, partly due
to global developments, the first response of public
policy to the hardening of inflation has been in terms
of reducing import duty on rice and edible oils, followed
by a ban on exports of non-basmati rice and pulses,
an increase in the minimum export price relating to
basmati rice, reduction of customs duty on butter, ghee
and maize, and administrative measures to enable imposition
of stock limits on selected agricultural products. There
are growing concerns that this upsurge in inflation
in India has occurred at a time when global commodity
prices have been volatile at historically elevated levels
and central banks in mature and emerging economies alike
have been articulating heightened inflation concerns.
Consequently, there are concerns that demand pressures,
which have been reasonably contained so far, are being
coupled with supply-side factors which, if not temporary
in view of global demand-supply imbalances, could impact
domestic inflation significantly.
74. Monetary and financial conditions appear to have
gone through underlying shifts in the fourth quarter
of 2007-08. While the rate of money supply has dipped
from mid-February 2008 in tandem with a moderation in
the growth of time deposits, it remains high in relation
to indicative projections. On the other hand, the moderation
in non-food credit growth that was evident in the first
half of 2007-08 appears to have extended into the fourth
quarter of the year. The deceleration has been marked
in respect of interest-sensitive sectors such as housing,
personal loans and real estate as well as in some categories
of services such as trade, professional and other services,
shipping, transport operators, tourism, hotels and restaurants
which had been recording significantly elevated growth
rates in preceding years. These movements in banking
aggregates have enabled a better balance between banks'
sources and uses of funds than before, as reflected
in the decline in the incremental non-food credit deposit
ratio to below 75 per cent for the first time since
August 2004.
75. During the fourth quarter of 2007-08, financial
markets were impacted by unusual swings and high volatility
in foreign exchange flows as well as in cash balances
of the Government with the Reserve Bank with consequent
shifts in liquidity conditions. These variations were
smoothened by active liquidity management through a
combination of instruments such as the MSS, the LAF
and the CRR so that volatility in overnight interest
rates was broadly contained within the informal LAF
corridor. As a result, advance tax payments did not
produce the usual spikes in money market rates. Generally
orderly conditions were also observed in the Government
securities market with some widening of yield spreads
across maturities on concerns about rising inflation
domestically, recent escalations in food, energy and
metal prices internationally, and the atmosphere of
heightened uncertainty. In the credit market, while
deposit rates have been adjusted downwards, lending
rates have edged up. In the foreign exchange market,
two-way movements in spot rates have been in evidence
in the fourth quarter of 2007-08 and in April 2008.
On the other hand, asset prices, particularly equity
prices, rose to record highs in January 2008 before
declining dramatically in February-March 2008.
76. Finances of the Central Government have undergone
further consolidation in 2007-08 in consonance with
the path charted under the FRBM. Sustained buoyancy
in corporation and personal income taxes lifted gross
tax revenues above the budgeted level by 0.8 percentage
points of GDP. Reflecting the fruits of a better balancing
of the tax structure, marked improvement in compliance
and efficiency gains in tax administration, the tax-GDP
ratio has moved up from 9.2 per cent in 2003-04 to 12.5
per cent in 2007-08 and is likely to reach 13.0 per
cent in 2008-09. While aggregate expenditure was 0.7
percentage points of GDP higher than budgeted, this
was essentially on account of revenue (non-Plan) expenditure
in the form of interest payments and subsidies. Capital
expenditure, however, declined in relation to budget
estimates. There was also a sizeable recourse to mobilisation
of resources through extra-budgetary transactions in
the form of issuances of securities to public sector
entities. These developments are indicative of potential
pressures in the period ahead, notwithstanding the marginal
reduction achieved in the revenue deficit and in the
gross fiscal deficit in relation to GDP.
77. Within India's growing integration with the global
economy, some aspects of India's external sector developments
in 2007-08 merit attention. First, there has been a
sizeable widening of the trade deficit on sustained
demand for non-oil imports particularly for capital
goods, export-related inputs and bullion and
as a result of escalating international crude oil prices.
Second, net capital flows in April-December 2007 were
2.7 times those in April-December 2006 and 1.8 times
of the net flows in the full year 2006-07. Gross capital
inflows to India constituted 18 per cent of gross private
capital flows to emerging and developing economies in
2007 reported by the IMF's WEO. Third, outward FDI has
more than doubled, reflecting the growing global reach
of the Indian corporate sector. Fourth, the level of
reserves is currently the third largest stock of reserves
among the EMEs but still lower than India's international
liabilities at US $ 371 billion at book value at end-September
2007.
78. The global economic outlook has worsened since
the Third Quarter Review of January 2008. Until October
2007, there appeared to have been reasonable confidence
in the resilience of the world economy to cope with
the freeze in US financial markets world GDP
growth was expected by the IMF to be 0.3 percentage
points above its initial April 2007 forecast for 2007
but lower by 0.1 percentage points for 2008. Since January
2008, this confidence appears to have eroded rapidly.
In April 2008, the IMF's forecast for 2008 has been
lowered by 1.2 percentage points and by 1.1 percentage
points for 2009 from the April 2007 projections. Risks
of contagion from the financial turmoil are regarded
as high with a 25 per cent probability of it spreading
into a global recession world real GDP growth
of 3 per cent or less. According to the IMF, a one per
cent reduction in US GDP growth leads to a 0.5 percentage
points decline in growth in advanced European economies
with a six month lag, and about a 0.75 percentage points
decline in the growth of EMEs, taking into account the
joint effect of a slowdown in the US and Europe. World
trade is also expected to decelerate by 1.2 percentage
points by the IMF and by 1.0 percentage points by the
World Trade Organisation in 2008 reflecting the
expectations of slower global growth.
79. Globally, inflation has risen considerably from
its level a year ago in mature economies and EMEs alike.
While the upsurge in inflation is reflected in varying
degrees in consumer prices, both headline and core,
the increase in producer prices on the back of commodity
price pressures has been relatively higher reflecting
the sharp increase in input costs. The resurgence of
inflation risks worldwide from food and energy prices
has also exacerbated the concerns about slowdown in
activity in the context of compressed real disposable
incomes and consumer purchasing power. Other factors
imparting upside pressures to inflation are persistent
strength in underlying demand, especially from EMEs,
and low levels of inventories. Supply side pressures
are expected to persist in the coming months with considerable
uncertainties surrounding the evolution of key commodity
prices and second order effects.
80. Growth forecasts for EMEs have been moderated in
the face of the financial turbulence and the anticipated
slowdown in the US economy. The underlying macroeconomic
fundamentals of the EMEs remain resilient and the robust
momentum of domestic demand in large emerging economies
of Asia and Latin America could withstand a protracted
weakening of growth in advanced economies. They, however,
remain vulnerable to negative effects in terms of slower
export growth and volatility in financial flows. Furthermore,
asset prices have declined and equity markets in EMEs
seem coupled and volatile in tandem with US markets,
indicating that some rebalancing is still underway.
A key risk to the outlook for EMEs is rising food, energy
and commodity prices that are already imparting inflationary
pressures and raising concerns about impacting the momentum
of growth in these economies. Several EMEs are increasingly
having to deal with rising public intolerance to high
food inflation which appears to be setting into a structural
phenomenon due to more frequent crop failures than before
and diversion of acreage for bio-fuels, supported in
the US by fiscal subsidies. Moreover, the rising international
commodity prices have impacted EMEs differently with
commodity exporters benefiting from sizeable terms of
trade gains while commodity importers have experienced
wider trade deficits and higher domestic inflation.
Finally, the recent monetary policy responses in the
US have also heightened the uncertainties facing EMEs
by widening interest rate differentials and increasing
the costs of sterilisation, especially in a period when
inflationary pressures warrant tightening. It is in
the context of these concerns that EMEs have generally
been reluctant to lower key policy rates in consonance
with the US. Some EMEs have recently raised policy rates
on domestic economy considerations while the majority
have kept interest rates on hold.
81. The outlook for the global financial system is
overcast by the rising incidence of losses and write-offs
in banking systems in the US and Europe amidst dislocations
in the securitised credit market. Banks are facing capital
constraints, as credit/market risks associated with
off-balance sheet investments have to be re-intermediated.
Credit to housing is the worst affected. Banks in the
US and Europe have reported a widespread tightening
in credit standards. There are also growing uncertainties
surrounding the viability of financial guarantors and
doubts about their business models as well as the approach
of rating agencies with potential systemic implications.
Global financial markets have exhibited heightened uncertainty
and bearish sentiment in the early months of 2008, exacerbated
by weakening macroeconomic prospects. Credit markets
continue to be seized up with spreads even on investment
grade credits continuing to remain widened and those
on sub-investment grade credits at prohibitive levels.
Global equity markets dropped sharply in January 2008
and weakened again in March-April with volatility well
above long-term averages. In the continuing turmoil,
bond markets have re-emerged as safe havens. In the
currency markets, the US dollar has been weakening against
the backdrop of monetary policy actions, already undertaken
and prospective.
82. In the overall assessment, there have been significant
shifts in both global and domestic developments in relation
to initial assessments. While global growth was expected
to moderate in the Annual Policy Statement of April
2007, the outlook for the global economy deteriorated
from the time of the Mid-Term Review of October, and
sharply after the Third Quarter Review of January 2008.
The dangers of global recession have increased at the
current juncture although consensus expectations do
not rule out a soft landing. Globally, inflationary
pressures were evident in April 2007 in the elevated
levels of commodity and asset prices. From January 2008,
the upside pressures from international food and energy
prices appear set to impart a degree of persistent upward
pressure to inflation globally. At the end of July 2007,
risks from financial markets had enhanced the vulnerability
of the global financial system, with amplified exchange
rate fluctuations and large changes in the magnitude
and direction of capital flows. There was growing uncertainty
as to when, how and to what extent would the withdrawal
of liquidity take place and impact economies like India.
By January 2008, it was clear that the subprime mortgage
crisis carries by far the gravest risks for the world
economy. On the domestic front, the outlook remained
positive up to January 2008, with indications of moderation
in industrial production, service sector activity, business
confidence and non-food credit, as anticipated. In the
ensuing months, consensus assessment of the prospects
for growth in the year ahead have been trimmed. Since
January 2008, risks to inflation and inflation expectations
from the upside pressures due to international food,
crude and metal prices have become more potent and real
than before. Volatile capital flows, large movements
in the cash balances of the Government and consequent
changes in liquidity conditions continue to complicate
monetary management.
II. Stance of
Monetary Policy for 2008-09
83. The Third Quarter Review of January 29, 2008 had
noted with concern the unfolding of global developments
and the responses of monetary authorities which seemed
to provide an indication of the threat to growth and
financial stability worldwide. Consequently, developments
in global financial markets in the context of the subprime
crisis warranted more intensified monitoring and swift
responses with all available instruments to preserve
and maintain domestic macroeconomic and financial stability.
In addition, risks to inflation from high and volatile
international prices of fuel, food and metal prices
had intensified, complicating the task of monetary authorities
in assuaging liquidity and solvency stress in financial
markets and institutions. It was also indicated that
liquidity management will continue to assume priority
in the conduct of monetary policy. In this context,
financial markets continued to be under careful and
continuous surveillance with a readiness to respond
flexibly and pre-emptively to ensure orderly liquidity
conditions, particularly in the context of the management
of volatile and large movements in capital flows. Against
this backdrop, it was emphasised that monetary policy
has to be vigilant and proactive in cushioning the real
economy from excess volatility in financial markets
while recognising that India cannot be totally immune
to global developments. Accordingly, the Third Quarter
Review reaffirmed the stance of monetary policy set
out in the Annual Policy Statement of April 2007 and
subsequent Reviews of reinforcing the emphasis on price
stability and well-anchored inflation expectations while
ensuring a monetary and interest rate environment conducive
to continuation of the growth momentum and orderly conditions
in financial markets. While credit quality continued
to receive priority, credit delivery, in particular,
for employment-intensive sectors was emphasised while
pursuing financial inclusion. Reckoning global factors
as becoming increasingly relevant even though domestic
factors dominated the policy stance, the Third Quarter
Review committed to monitor the evolving heightened
global uncertainties and the domestic situation impinging
on inflation expectations, financial stability and the
growth momentum in order to respond swiftly with both
conventional and unconventional measures, as appropriate.
84. It is observed that domestic financial markets
have not been seriously impacted by the turbulence overseas,
except for equity markets which have reflected the widespread
risk aversion and the increase in uncertainty in the
international financial environment. On the other hand,
localised factors such as banks' balance sheet adjustments
in the run-up to the year-end closure of accounts, advance
tax flows and sizeable movements in Government cash
balances produced large swings in market liquidity.
Consequently, the LAF switched from an absorption mode
up to mid-February into persistent daily injections
during the rest of the month. In the first half of March,
the LAF returned to moderate daily absorption, but switched
into sizeable liquidity injections during March 17-31,
as expected. In accordance with the priority assigned
to liquidity management in the Third Quarter Review,
MSS auctions were held in abeyance from mid-February
2008 in view of the tightening of liquidity conditions.
Furthermore, in pursuance of the policy of active demand
management of liquidity using all the policy instruments
flexibly, including the option to conduct overnight
or longer term repo/reverse repo under LAF, additional
arrangements were instituted at the request of a number
of banks in view of the schedule of advance tax payments
in mid-March 2008 and the subsequent bank holidays (March
20-22, 2008). As stated earlier, additional LAF operations
on March 14, 17 and 31, 2008 were held to enable banks
to manage year-end liquidity conditions. MSS auctions
were resumed from April 9, 2008 in conjunction with
LAF reverse repos to manage large surpluses in financial
markets. These liquidity management operations have,
by and large, smoothed market interest rates and enabled
their orderly evolution. It is important to recognise,
however, that the unwinding of the specific factors
currently in evidence will have implications for the
evolution of market liquidity in the period ahead in
an environment of heightened uncertainty and volatility
in global markets and the danger of potential spillovers
to domestic equity and currency markets. Against this
backdrop, liquidity management will continue to receive
priority in the hierarchy of policy objectives, going
forward. In particular, the volatility in capital flows
and in cash balances of the Government will continue
to necessitate active liquidity management with a combination
of instruments as warranted.
85. Notwithstanding the moderation in industrial activity
which was anticipated in the Mid-Term Review and the
Third Quarter Review, the outlook for sustaining the
underlying growth momentum appears to be reasonably
well embedded into the medium-term. In the Third Quarter
Review, it was indicated that while the moderation in
private consumption expenditure merits consideration,
a disaggregate analysis of supply and demand factors
across select sectors would enable appropriate public
policy responses. The recent measures announced in the
Union Budget 2008-09 to inter alia raise personal disposable
incomes and to reduce and rationalise excise duties
reflects this approach. Institutional and procedural
changes to improve credit delivery to productive sectors,
especially those with relatively higher employment intensity,
have been undertaken by the Reserve Bank. Going forward,
the combination of these measures should provide a conducive
environment for the revival of consumption demand. Investment
demand is robust and likely to remain the driving force
of overall economic activity, powered by rising domestic
saving, ongoing improvement in productivity and the
actualisation of the sizeable expansion of supply capabilities
that has been underway since 2003-04. At the same time,
it is important to recognise that the threats to growth
and stability from global developments have increased
considerably with highly uncertain likelihood of early
resolution. Besides the dangers surrounding the unfolding
of events in international financial markets referred
to earlier, potential inflationary pressures from international
food and energy prices appear to have amplified and,
by current indications, are likely to remain so for
some time. Furthermore, there is now much higher probability
of a global economic and credit slowdown than was anticipated
till recently.
86. Initial forecasts predict a near-normal rainfall
at 99 per cent of the long period average for the country
as a whole in the 2008 south-west monsoon season, auguring
well for the sustenance of trend growth in agriculture.
The expected decline in world GDP growth in 2008 in
relation to the preceding year could temper the prospects
of growth in the industrial and service sectors at the
margin although the underlying momentum of expansion
in these sectors is likely to be maintained. In view
of these factors, overall, for policy purposes, real
GDP growth in 2008-09 may be placed in the range of
8.0 to 8.5 per cent, assuming that (a) global financial
and commodity markets and real economy will be broadly
aligned with the central scenario as currently assessed
and (b) domestically, normal monsoon conditions prevail.
87. In view of the lagged and cumulative effects of
monetary policy on aggregate demand and assuming that
supply management would be conducive, capital flows
would be managed actively and in the absence of new
adversities emanating in the domestic or global economy,
the policy endeavour would be to bring down inflation
from the current high level of above 7.0 per cent to
around 5.5 per cent in 2008-09 with a preference for
bringing it as close to 5.0 per cent as soon as possible,
recognising the evolving complexities in globally transmitted
inflation. The resolve, going forward, would continue
to be to condition policy and perceptions for inflation
in the range of 4.0-4.5 per cent so that an inflation
rate of around 3.0 per cent becomes a medium-term objective
consistent with India's broader integration into the
global economy and with the goal of maintaining self-accelerating
growth over the medium-term.
88. Money supply has risen above indicative projections
persistently through 2005-07 on the back of sizeable
accretions to the Reserve Bank's foreign exchange assets
and a cyclical acceleration in credit and deposit growth,
particularly the latter, in 2007-08. In view of the
resulting monetary overhang, it is necessary to moderate
monetary expansion and plan for a rate of money supply
in the range of 16.5-17.0 per cent in 2008-09 in consonance
with the outlook on growth and inflation so as to ensure
macroeconomic and financial stability in the period
ahead. Consistent with the projections of money supply,
the growth in aggregate deposits in 2008-09 is placed
at around 17.0 per cent or around Rs.5,50,000 crore.
Based on an overall assessment of the sources of funding
and the overall credit requirements of the various productive
sectors of the economy, the growth of non-food credit
including investments in bonds/debentures/shares of
public sector undertakings and private corporate sector
and commercial paper (CP) is placed at around 20.0 per
cent in 2008-09 consistent with the monetary projections.
89. The escalated levels of international food and
crude prices carry some pressures for the external sector.
On the whole, it is prudent to assume for policy purposes
a continued strong and sustainable external sector though
with a marginally higher order of overall trade and
current account deficits in 2008-09 than in the preceding
year. It is likely that net capital flows would comfortably
meet the external financing requirements in 2008-09.
90. The Union Budget for 2008-09 has placed the GFD
at 2.5 per cent of GDP for 2008-09, down from 3.1 per
cent in the revised estimates for 2007-08 and within
the FRBM target. The revenue deficit has been placed
at 1.0 per cent of GDP in 2008-09, rescheduled from
the target on account of enhanced allocations for the
social sector. The net market borrowing programme of
the Centre for 2008-09 is budgeted at Rs.99,000 crore
as against Rs.1,10,727 crore in the previous year. The
moderate reduction in the size of the Government borrowing
programme is consistent with the path of the GFD envisaged
in the FRBM.
91. Fiscal developments, especially on account of evolving
expenditure commitments related to the implementation
of the farm debt waiver scheme, the recommendations
of the Sixth Pay Commission, issuance of Government
bonds to oil and fertiliser companies to cover their
under-recoveries/subsidy need to be continuously monitored
in view of the prevailing conditions characterised by
high and volatile global food prices and the incomplete
pass-through of the escalation of international crude
prices to prices of domestic petroleum products.
92. The heightened uncertainty surrounding global financial
markets and the unusual policy responses of major central
banks provides some indications of the threats to global
growth and stability that loom over the near-term horizon.
High volatility, still frozen credit markets and massive
losses suffered by large financial institutions could
impact India's external financing conditions
trade, capital flows and asset prices and, therefore,
the evolving monetary policy stance in 2008-09. While
India's foreign trade is well-diversified and the reliance
on external finance has averaged around one per cent
of GDP, domestic activity and sentiment cannot remain
immune to these developments. The major source of the
direct impact is through the financial flows, in particular,
in the equity markets and, consequently, on the foreign
exchange market in India.
93. Recent global developments have considerably heightened
the uncertainty surrounding the outlook on capital flows
to India, complicating the conduct of monetary and liquidity
management. In view of the strong fundamentals of the
economy and massive injections of liquidity by central
banks in advanced economies, there could be sustained
inflows, as in the recent past. If the pressures intensify,
it may necessitate stepped up operations in terms of
capital account management and more active liquidity
management with all instruments at the command of the
Reserve Bank. At the same time, it is necessary in the
context of recent global events not to exclude the possibility
of reversals of capital flows due to any abrupt changes
in sentiments or global liquidity conditions. In this
scenario, it is important to be ready to deal with potentially
large and volatile outflows along with spillovers. In
this context, there is headroom with the Reserve Bank
to deal with both scenarios in terms of the flexibility
in the deployment of instruments such as the MSS, the
CRR, the SLR and the LAF for active liquidity management
in both directions, complemented by prudential regulations
and instruments for capital account management.
94. In assessing the prospects for the global economy
in 2008-09, it is useful to recognise the anticipated
global slowdown and heightened uncertainties in addition
to mounting inflationary pressures. Whether the slowdown
would have a moderating effect on inflationary pressures
or whether the global economy would slip into stagflation
is not yet clear. Inflationary pressures seem common
to the global and our domestic economy with some elements
of contagion. Overall, uncertainties in regard to the
Indian economy, however, appear less relative to those
in the global economy and moderation in growth rather
than a significant slowdown appears likely in the case
of India. In regard to the interaction between global
and national economies, some early signs of revival
of protectionism are seen globally, especially in regard
to food and fuel policies. This makes the assessment
of impact of the global economy on India, particularly
in regard to inflation and capital flows, extremely
difficult. However, domestic factors will continue to
dominate the policy setting, with a contextual emphasis
on inflation expectations while recognising the significance
of maintaining hard-earned gains in terms of both outcomes
of and positive sentiments on India's growth momentum.
95. In brief, given the unprecedented complexities
involved and the heightened uncertainties at this juncture,
there are some key factors that govern the setting of
the stance of monetary policy for 2008-09. First, there
is the immediate challenge of escalated and volatile
food and energy prices which possibly contain some structural
components. It is necessary, however, to recognise that
there are also cyclical components in their evolution.
Second, while demand pressures persist, there has been
some improvement in the domestic supply response alongside
a build-up of additional capacities, enabled by a conducive
policy environment. Accordingly, even as investment
demand remains strong, supply elasticities can be expected
to improve further and new capacities should come on
stream in the months ahead. Third, monetary policy has
lagged and cumulative effects as demonstrated in the
positive outcomes relating to growth and stability at
the current juncture, barring recent episodes of external
shocks. Calibrated monetary policy actions undertaken
since September 2004 thus continue to have some stabilising
influence on the economy. Further, the very recent initiatives
in regard to supply-management by the Government of
India and measures relating to the cash reserve ratio
by the Reserve Bank are in the process of impacting
the economy, while a more reliable assessment of crop
prospects is underway. Fourth, critical to the setting
of monetary policy is the importance of anchoring expectations
relating to both global and domestic developments. Accordingly,
policy responses for managing expectations should consider
the evolving global and domestic uncertainties surrounding
the slowing down of global output growth and also the
potential for exaggerated bearishness in the Indian
context. Fifth, while monetary policy has to respond
proactively to immediate concerns, it cannot afford
to ignore considerations over a relatively longer term
perspective of, say, one to two years, with respect
to overall macroeconomic prospects. At the same time,
it is critical at this juncture to demonstrate on a
continuing basis a determination to act decisively,
effectively and swiftly to curb any signs of adverse
developments in regard to inflation expectations. In
view of the above unprecedented uncertainties and dilemmas,
it is important to take informed judgements with regard
to the timing and magnitude of policy actions; and such
judgements need to have the benefit of evaluation of
incoming information on a continuous basis.
96. The Reserve Bank will continue with its policy
of active demand management of liquidity through appropriate
use of the CRR stipulations and open market operations
(OMO) including the MSS and the LAF, using all the policy
instruments at its disposal flexibly, as and when the
situation warrants.
97. In sum, barring the emergence of any adverse and
unexpected developments in various sectors of the economy,
assuming that capital flows are effectively managed,
and keeping in view the current assessment of the economy
including the outlook for growth and inflation, the
overall stance of monetary policy in 2008-09 will broadly
be:
- To ensure a monetary and interest rate environment
that accords high priority to price stability, well-anchored
inflation expectations and orderly conditions in financial
markets while being conducive to continuation of the
growth momentum.
- To respond swiftly on a continuing basis to the
evolving constellation of adverse international developments
and to the domestic situation impinging on inflation
expectations, financial stability and growth momentum,
with both conventional and unconventional measures,
as appropriate.
- To emphasise credit quality as well as credit delivery,
in particular, for employment-intensive sectors, while
pursuing financial inclusion.
III. Monetary
Measures
(a) Bank Rate
98. The Bank Rate has been kept unchanged at 6.0 per
cent.
(b) Repo Rate/Reverse Repo Rate
99. The repo rate under the LAF is kept unchanged at
7.75 per cent.
100. The reverse repo rate under the LAF is kept unchanged
at 6.0 per cent.
101. The Reserve Bank has the flexibility to conduct
repo/reverse repo auctions at a fixed rate or at variable
rates as circumstances warrant.
102. The Reserve Bank retains the option to conduct
overnight or longer term repo/reverse repo under the
LAF depending on market conditions and other relevant
factors. The Reserve Bank will continue to use this
flexibility including the right to accept or reject
tender(s) under the LAF, wholly or partially, if deemed
fit, so as to make efficient use of the LAF in daily
liquidity management.
(c) Cash Reserve Ratio
103. Scheduled banks are required to maintain cash
reserve ratio (CRR) of 7.75 per cent with effect from
the fortnight beginning April 26, 2008 and 8.0 per cent
with effect from the fortnight beginning May 10, 2008
as announced on April 17, 2008. On a review of the evolving
liquidity situation, it is considered desirable to increase
the CRR by 25 basis points to 8.25 per cent with effect
from the fortnight beginning May 24, 2008.
First Quarter Review
104. The First Quarter Review of this part of the Annual
Policy Statement for the year 2008-09 will be announced
on July 29, 2008.
Part II. Annual
Statement on Developmental and
Regulatory Policies for the Year 2008-09
105. The Annual Statement of April 2007 and subsequently
the Mid-Term Review of October 2007 set the stance of
developmental and regulatory policies for the year 2007-08
in terms of emphasis on credit quality, orderly conditions
in financial markets, greater credit penetration and
financial inclusion. In the Third Quarter Review of
January 2008, heightened vigilance in the context of
potential spillovers from the global financial turbulence
was accorded priority, along with preparedness for swift
responses to ensure financial stability. During 2007-08,
development of the financial market infrastructure,
liberalisation of foreign exchange transactions, strengthening
risk management in banks and supervisory processes in
response to financial innovations engaged the Reserve
Bank, alongside the refinement of credit delivery mechanisms
with specific focus on agriculture, micro, small and
medium enterprises and financial inclusion.
106. The setting of developmental and regulatory policies
for 2008-09 will continue to focus on developing a sound,
efficient and vibrant financial system that ensures
the efficient provision of financial services to the
widest sections of society. In the context of recent
financial developments internationally, the securing
and maintenance of financial stability will continue
to receive priority from a policy perspective. Credible
communication, adequate and timely availability of information
and a broad-based, participative and consultative approach
in the conduct of its developmental and regulatory policies
with involvement of all stakeholders would shape the
Reserve Bank's responses to the emerging challenges.
107. Recent financial developments have brought to
the fore several issues that carry implications for
the health of the financial sector. First, there is
close scrutiny of the business strategies of banks and
financial institutions which are based on the model
of 'originate and distribute'. Second, issues relating
to securitisation are being debated in the context of
incentive structures that provide for economising on
capital requirements and enhancement of off-balance
sheet exposures relative to considerations of financial
soundness. Third, recent events have also underscored
the need for enhanced market transparency relating to
disclosures of off-balance sheet exposures, particularly
with regard to liquidity commitments to conduits, valuations
regarding structured credit products and the like. Fourth,
the apparent inadequacy of financial institutions' capital
cushions has been exposed. In this context, the role
of sovereign wealth funds as providers of capital is
being carefully assessed by supervisory authorities
across the world. Fifth, the sharp repricing of risk
that began in the middle of 2007 has raised issues relating
to the marking to market of portfolios of financial
institutions and attendant issues relating to capital
provision. Sixth, there are concerns that existing risk
pricing and management tools and techniques employed
in banks and financial institutions are inadequate in
relation to the evolving risks. Seventh, there is a
progressive blurring of the boundaries between liquidity
and solvency stress in situations of generalised uncertainty
and loss of confidence among financial entities. Eighth,
the role of structured investment vehicles (SIVs), the
potential liquidity demands that could crystallise on
balance sheets and the degree of leverage embedded in
the global financial system has been largely underestimated
with implications for the soundness and efficiency of
the financial sector. Ninth, the functioning of the
credit rating agencies and excessive reliance of institutional
investors on the ratings are under scrutiny.
108. Against this backdrop, several measures have been
suggested for mitigating the impact and improving the
global financial system. According to the Institute
of International Finance (IIF), banks should commit
themselves to follow best practices in a number of areas
where the financial crisis has revealed weaknesses.
Best practice should not imply legal obligations
but high standards for entities to develop their own
tailor-made solutions. The proposals made by the Financial
Stability Forum (FSF) [a forum of select senior representatives
of national financial authorities _ including central
banks, supervisory authorities and treasury departments
_ international financial institutions, international
regulatory and supervisory groupings and committees
of central bank experts] and ratified in early April
2008 by the G-7 to be implemented over the next 100
days are comprehensive and cover full and prompt disclosure
of risk exposures, write downs and fair value estimates
for complex and illiquid instruments; urgent action
by setters of accounting standards and other relevant
standard setters to improve accounting and disclosure
standards for off-balance sheet or entities and to enhance
guidance on fair value accounting, particularly on valuing
financial instruments in periods of stress; strengthening
of risk management practices, supported by supervisors'
oversight, including rigorous stress testing; and strengthening
of capital positions as needed. In addition, proposals
made by the FSF for implementation by end-2008 include:
strengthening prudential oversight of capital, liquidity,
and risk management under Basel II, especially for complex
structured credit instruments and off-balance sheet
vehicles; enhancing transparency and valuation for off-balance
sheet entities, securitisation exposures, and liquidity
commitments under the Basel Committee's guidance; enhancing
due diligence in the use of ratings; adherence by credit
rating agencies to the revised code of conduct of the
International Organisation of Securities Commissions
(IOSCO); strengthening the authorities' responsiveness
to risk through cooperation and exchange of information
so as to act swiftly to investigate and penalise fraud,
market abuse, and manipulation; implementing robust
arrangements for dealing with stress in the financial
system such as liquidity support from the central banks;
and, strengthening arrangements for dealing with weak
and failing banks, domestically and cross border. It
may be noted that the International Monetary and Financial
Committee (IMFC) has welcomed the above policy recommendation
of FSF [The IMFC is a Committee of select Board of Governors
of the IMF of which the Finance Minister, Shri P. Chidambaram
is a member].
109. In the light of the current macroeconomic environment
and global developments as discussed in Part I of the
Statement, the Annual Statement on Developmental and
Regulatory Policies focuses on certain key areas: new
financial instruments, carrying forward development
of various segments of financial markets and strengthening
financial market infrastructure; developing a safe,
secure and integrated real time payment and settlement
system; further liberalisation of foreign exchange transactions;
cross-border supervision, risk-based supervision and
bank-led financial conglomerates; strengthening the
supervisory framework as appropriate to evolving requirements;
enhancing public confidence and consolidation in urban
cooperative banks (UCBs) and regional rural banks (RRBs);
improved credit delivery mechanisms and conducive credit
culture, customer service and financial inclusion.
110. The Annual Statement on Developmental and Regulatory
Policies for the year 2008-09 is divided into four sections.
I. Financial Markets;
II. Credit Delivery Mechanism and
Other Banking Services;
III. Prudential Measures; and
IV. Institutional Developments.
I. Financial Markets
Government Securities Market
111. The Reserve Bank has taken significant steps to
further broaden and deepen the Government securities
market in consultation with market participants. In
this direction, the following initiatives are proposed:
(a) Central Government Securities
(i) Floating Rate Bonds: Status
112. The Mid-Term Review of October 2007 had indicated
that a new issuance structure for floating rate bonds
(FRBs) is being built into the Negotiated Dealing System
(NDS) auction format being developed by the Clearing
Corporation of India Limited (CCIL) to simplify the
methodology for pricing of FRBs in the secondary market.
The CCIL is currently developing the primary auction
module for the dated Government securities which would
cover all types of instruments, including FRBs. The
issuance of FRBs would be considered at an appropriate
time, taking into account the market conditions.
(ii) Ways and Means Advances to the Government of
India: Status
113. The Reserve Bank, in consultation with the Government
of India, has retained the extant arrangements for the
Ways and Means Advances (WMA) for the fiscal year 2008-09.
As per the arrangements, the WMA limits would continue
to be fixed on a half-yearly basis and are placed at
Rs.20,000 crore for the first half and Rs.6,000 crore
for the second half of 2008-09. The applicable interest
rate on WMAs and overdrafts would continue to be linked
to the repo rate, as hitherto. The Reserve Bank, however,
retains the flexibility to revise the limits in consultation
with the Government of India, taking into consideration
the prevailing circumstances.
(iii) Auction Process of Government of India Securities
114. An Internal Working Group (Chairman: Shri H.R.
Khan) was constituted to review the auction procedure
for the Government securities and make suggestions to
reduce the time taken for completion of the auction
process with a view to improving efficiency on par with
the best international practices. Some of the important
recommendations made by the Working Group include: reduction
in the time gap between bid submission and declaration
of auction results; withdrawal of the facility of bidding
in physical form; submission time for the non-competitive
bids to be de-linked from that of competitive bids;
competitive bids to be submitted only through the Negotiated
Dealing System (NDS); and designing of a secured web
system facilitating direct participation of non-NDS
members in the auctions of Government securities. The
modalities for implementing the recommendations of the
Working Group are being worked out.
(iv) Restructuring of Primary Dealers' Activities:
Status
115. Primary Dealers (PDs) were permitted in July 2006
to manage risks inherent in their business by diversifying
into other business lines, i.e., corporate debt, money
market, equity and securitisation instruments, subject
to certain prudential limits, while retaining the requirement
of predominance of Government securities business. They
were also allowed to offer certain fee-based services.
PDs, however, are not permitted to set up step-down
subsidiaries in order to ensure that the balance sheets
of the PDs do not get affected by the spillover of risks
from other businesses/subsidiaries and that the regulation
of PDs is focused on their primary dealership activities.
In compliance with the guidelines, all the nine standalone
PDs have restructured their operations for undertaking
permissible activities.
(v) The Government Securities Act, 2006: Status
116. The Government Securities (GS) Act, 2006 was passed
and was published in the Gazette of India on August
31, 2006 for general information. The Government Securities
Regulations, 2007 were framed by the Reserve Bank in
terms of Section 32(1) of the GS Act, which came into
force from December 1, 2007. The main features of the
Regulations include investor friendly automatic redemption
facility, i.e., no physical discharge is required if
the investors submit bank account details for receiving
redemption proceeds of Government security held in the
form of bond ledger account (BLA), subsidiary general
ledger (SGL) or stock certificate; facility of pledge,
hypothecation or lien of Government security; simplified
procedure for recognition of title to a Government security
of a deceased holder; nomination facility for stock
certificate and BLAs; simplified procedure for issue
of duplicate Government promissory note; and simplified
procedure for making vesting order. For better customer
service, it is proposed to widely disseminate these
investor friendly features of the regulations through
media publicity and the website of the Reserve Bank
by way of easy to understand material and frequently
asked questions (FAQs).
(b) Debt Management for State Governments
(i) Non-Competitive Bidding Scheme in the Auctions
of the State Development Loans
117. The Mid-Term Review of October 2007 indicated
that a scheme for non-competitive bidding facility in
the auctions of State Development Loans (SDLs) was incorporated
in the Revised General Notification issued by all State
Governments on July 20, 2007 with a view to widening
the investor base and enhancing the liquidity of SDLs.
The business requirement specification relating to this
scheme has been incorporated in the dated securities
auction module of the NDS auction which is being developed
by the CCIL. The module is expected to become functional
by September 2008.
(ii) Ways and Means Advances Limits of the States:
Status
118. On a review of the State-wise limits of normal
WMA for the year 2007-08, the Reserve Bank has kept
these limits unchanged for the year 2008-09. Accordingly,
the aggregate normal WMA limit for State Governments
is placed at Rs.9,925 crore, including the WMA limit
of Rs.50 crore for the Government of the Union Territory
of Puducherry. Other terms and conditions of the Scheme
remain unchanged.
(c) Development of Market Infrastructure
(i) Introduction of Interest Rate Futures
119. A Working Group on Interest Rate Futures (Chairman:
Shri V.K. Sharma) was constituted to review the experience
gained with interest rate futures since its introduction
in India in June 2003 with particular reference to product
design issues. The recommendations of the Group were
presented to the Technical Advisory Committee (TAC)
for Money, Foreign Exchange and Government Securities
Markets and their suggestions/views were taken into
consideration in the Group's report which has been placed
on the Reserve Bank's website on March 3, 2008 for comments/suggestions.
Action on the recommendations of the report would be
initiated on the basis of the feedback received.
(ii) Separate Trading for Registered Interest and
Principal of Securities
120. A Working Group (Chairman: Shri M.R. Ramesh) comprising
banks and market participants was constituted to suggest
guidelines in order to operationalise Separate Trading
for Registered Interest and Principal of Securities
(STRIPS) in Government securities. The Working Group
submitted its report which was placed on the Reserve
Bank's website for wider dissemination. An implementation
group also examined the issue of operationalisation
of STRIPS. With the enactment of the Government Securities
Act, 2006 effective from December 1, 2007, it is proposed
to introduce STRIPS in Government securities by the
end of 2008-09. The activity of stripping/reconstitution
of securities would be carried out on the Public Debt
Office (PDO)-NDS platform.
(iii) Multi-modal Settlement
121. A new settlement mechanism in Government securities
through settlement banks is being formulated in order
to facilitate direct access of NDS and NDS-OM participants
who do not maintain current accounts but maintain SGL
accounts with the Reserve Bank. This new system would
facilitate phasing out of current accounts of non-banks
and non-PD entities with the Reserve Bank. The CCIL
has developed the required software changes and has
also entered into arrangements with three banks to function
as settlement banks for the present. The new arrangement
is expected to be operationalised in May 2008.
(iv) NDS-OM: Extension of Access through the CSGL
Route
122. Access to the order matching segment on NDS (NDS-OM),
which was launched in August 2005, was initially allowed
to commercial banks and primary dealers and later to
other NDS members such as insurance companies, mutual
funds and large provident funds for their proprietary
deals. Access to NDS-OM was extended to other entities
maintaining gilt accounts with NDS members, i.e., banks
and PDs through the Constituents Subsidiary General
Ledger (CSGL) route from May 2007. Initially, permission
was accorded to deposit-taking NBFCs, provident funds,
pension funds, mutual funds, insurance companies, cooperative
banks, RRBs and trusts. With effect from November 2007,
the facility has also been extended to the systemically
important non-deposit taking NBFCs (NBFCs-ND-SI). These
entities can place orders on NDS-OM through direct NDS-OM
members, i.e., banks and PDs, using the CSGL route.
Such trades are settled through the CSGL account and
current account of the NDS-OM members.
123. Certain segments of investors such as other non-deposit
taking NBFCs, corporates and FIIs do not have access
to NDS-OM through the CSGL route. In the light of requests
received, it is proposed:
to allow these participants also to access the NDS-OM
through the CSGL route.
(v) Clearing and Settlement of OTC
Rupee Interest Rate Derivatives
124. It was announced in the Annual Policy Statement
of May 2004 that a clearing and settlement arrangement
through the CCIL was being considered to strengthen
the over-the-counter (OTC) derivatives market and mitigate
the risks involved. With some of the underlying issues
having been addressed with the enactment of the Payment
and Settlement Systems Act, 2007 a clearing and settlement
arrangement for OTC rupee derivatives is proposed to
be put in place. The modalities for operationalising
the clearing and settlement system for the OTC rupee
interest rate derivatives would be worked out in consultation
with the CCIL.
(d) Repo in Corporate Bonds
125. Most of the recommendations of the High Level
Committee on Corporate Bonds and Securitisation (Chairman:
Dr. R.H. Patil) have been taken up for implementation.
The Union Budget, 2008-09 has abolished tax deduction
at source (TDS) on corporate bonds. The trading platforms
started by the Bombay Stock Exchange (BSE) and the National
Stock Exchange (NSE) have now been in operation since
July 2007. The Fixed Income Money Market and Derivatives
Association of India (FIMMDA) trade reporting platform
for capturing the OTC trade data has also been operational
since September 2007.
126. These initiatives will ensure development of a
healthy secondary market once there is adequate incentive
for more public issuances and listing. The Securities
and Exchange Board of India (SEBI) is in the process
of simplification of the issuance procedures and rationalisation
of the listing norms for corporate bonds.
127. As indicated in the Mid-Term Review of October
2007, introduction of repo in corporate bonds would
be considered once the prerequisites viz., efficient
price discovery through greater public issuances and
secondary market trading, and an efficient and safe
settlement system based on Delivery versus Payment (DvP)
III and Straight Through Processing (STP) are met.
Foreign Exchange Market
128. Measures towards further liberalisation and improvement
of foreign exchange facilities are set out below.
(a) Expansion of Hedging Facilities
129. With a view to facilitating domestic crude oil
refining companies to hedge their commodity price risk
exposures, it is proposed to:
permit domestic crude oil refining companies to hedge
their commodity price risk on domestic purchase of crude
oil and sale of petroleum products on the basis of underlying
contracts which are linked to international prices on
overseas exchanges/markets.
permit domestic crude oil refining companies to hedge
their commodity price risk on crude oil imports in overseas
exchanges/markets on the basis of their past performance
up to 50 per cent of the volume of actual imports during
the previous year or 50 per cent of the average volume
of imports during the previous three financial yeas,
whichever is higher. The companies will have to ensure
regularisation of the contracts booked under this facility
by production of supporting import orders during the
currency of the hedge.
(b) Introduction of Currency Futures
130. The draft report of the Internal Working Group
on Introduction of Currency Futures in India (Chairman:
Shri Salim Gangadharan) was placed on the Reserve Bank's
website on November 16, 2007. The comments received
from the public, banks, market participants, academicians
and the Government of India were discussed in the meetings
of the TAC on Money, Foreign Exchange and Government
Securities Markets. Taking into account the feedback
and expert views of the TAC, the report has been finalised
and has been placed on the Reserve Bank's website on
April 28, 2008. An RBI-SEBI Standing Technical Committee
has been set up to advise on operational aspects in
regard to trading of currency futures on exchanges.
In consultation with the SEBI, it has been decided that
currency futures will be introduced in the eligible
exchanges and the broad framework is expected to be
finalised by the end of May 2008.
(c) Overseas Direct Investment
131. With a view to further liberalising the policy
on overseas investment, it is proposed:
to allow Indian companies to invest overseas in energy
and natural resources sectors such as oil, gas, coal
and mineral ores in excess of the current limits with
the prior approval of the Reserve Bank.
(d) Capitalisation of Export Proceeds
132. In order to rationalise the policy on capitalisation
of outstanding exports and to align it with the export-import
policy, it is proposed that:
Indian parties may now approach the Reserve Bank for
capitalisation of export proceeds for exports outstanding
beyond the prescribed period of realisation.
(e) Liberalisation of Settlement of Claims Relating
to Export Bills
133. In order to liberalise further the procedures
relating to settlement of claims in respect of export
bills, it is proposed to permit authorised dealer (AD)
banks to write off, in addition to claims settled by
the Export Credit Guarantee Corporation of India (ECGC),
the outstanding export bills settled by other insurance
companies which are regulated by the Insurance Regulatory
Development Authority (IRDA). Accordingly, AD banks
shall henceforth, on an application received from the
exporter, supported by documentary evidence from the
ECGC/insurance companies confirming that the claim in
respect of the outstanding bills has been settled and
that the export incentives, if any, have been surrendered,
write off the relative export bills.
(f) Liberalisation of the Period for Realisation
and Repatriation of Export Proceeds
134. At present, exporters are required to realise
and repatriate to India the full export value of goods
or software exported within six months from the date
of export. Exporters who have been certified as `Status
Holder' in terms of Foreign Trade Policy, 100 per cent
Export-Oriented Units (EOUs) and units set up under
Electronic Hardware Technology Parks (EHTPs), Software
Technology Parks (STPs) and Biotechnology Parks (BTPs)
Schemes are permitted to realise and repatriate the
full value of export proceeds within a period of 12
months from the date of export. Where the goods or software
are exported by the units in the Special Economic Zones
(SEZs), the stipulation of the period of realisation
and repatriation to India of the full export value of
goods or software is not applicable. Requests have been
received to extend the period of realisation of exports
proceeds in view of the external environment. It is,
therefore, proposed in consultation with the Government
of India:
to enhance the present period for realisation and repatriation
to India of the full export value of goods or software
exported from six months to twelve months from the date
of export, subject to review after one year.
II. Credit Delivery
Mechanisms andOther Banking Services
(a) Augmenting RRBs' Funds for Lending to Agriculture
and Allied Activities
135. With a view to augmenting RRBs' funds/resource
base, commercial banks/sponsor banks have been allowed
to classify loans granted to RRBs for on-lending to
agriculture and allied activities as indirect finance
to agriculture in their books.
(b) Weaker Sections' Lending Target: Ensuring
Adherence
136. In terms of the revised guidelines on lending
to priority sector effective from April 30, 2007 domestic
SCBs are required to lend 40 per cent of adjusted net
bank credit (net bank credit plus investments made by
banks in non-SLR bonds held in the held to maturity
category) or credit equivalent of off-balance sheet
exposures, whichever is higher, to the priority sector.
These SCBs are also required to lend at least 18 per
cent to the agriculture sector and 10 per cent to weaker
sections covering small and marginal farmers with land
holding of five acres and less; landless labourers,
tenant farmers and share croppers; artisans, village
and cottage industries where individual credit limits
do not exceed Rs. 50,000; beneficiaries of Swarnjayanti
Gram Swarozgar Yojana (SGSY), Swarna Jayanti Shahari
Rozgar Yojana (SJSRY), the Scheme for Liberation and
Rehabilitation of Scavengers (SLRS) and the Differential
Rate of Interest (DRI) scheme; scheduled castes and
scheduled tribes; self-help groups (SHGs); and distressed
poor who have to prepay their debt to the informal sector
against appropriate collateral or group security. It
has been observed that banks have not been achieving
the sub-target of 10 per cent for lending to weaker
sections. At present, domestic SCBs having shortfall
in the priority sector lending target and/or the agriculture
sub-target are allocated amounts for contribution to
the Rural Infrastructure Development Fund (RIDF) maintained
with the National Bank for Agriculture and Rural Development
(NABARD). It is, therefore, proposed:
to take into account shortfall in lending to weaker
sections also for the purpose of allocating amounts
to the domestic SCBs for contribution to RIDF or funds
with other financial institutions as specified by the
Reserve Bank, with effect from April 2009.
(c) Increasing Opportunities for Flow of Credit
to Priority Sectors
137. In terms of the revised guidelines on lending
to the priority sector, SCBs can undertake outright
purchase of any loan asset eligible to be categorised
under the priority sector from other banks and financial
institutions and classify the same under the respective
categories of priority sector lending (direct or indirect),
provided the loans purchased are held at least for a
period of six months. To enable greater flow of credit
to the priority sectors, it is proposed:
to allow RRBs to sell loan assets held by them under
priority sector categories in excess of the prescribed
priority sector lending target of 60 per cent.
(d) Simplification of Lending Procedures for
Crop Loans
138. The Working Group (Chairman: Shri C.P.Swarnkar)
appointed by the Reserve Bank and the Committee on Agricultural
Indebtedness (Chairman: Dr.R.Radhakrishna) appointed
by the Government of India made several recommendations
to address credit constraints faced by farmers, including
the issue of availability of cash throughout the year
for agricultural operations. The report of the Internal
Working Group (Chairman: Shri V.S.Das), set up by the
Reserve Bank to examine the recommendations of the Radhakrishna
Committee, has been placed on the Reserve Bank's website
for wider consultation.
139. While action on the recommendation of the Radhakrishna
Committee will be finalised based on comments/responses
received, it is proposed:
to ask each domestic commercial bank, including RRBs,
to select one district for introduction, on a pilot
basis, of a simplified cyclical credit product for farmers
to enable them to continuously utilise a core component
of 20 per cent of the credit limit. This arrangement
should ensure minimum year-round liquidity as long as
the interest is serviced.
to introduce a simplified procedure for crop loans
to landless labourers, share croppers, tenant farmers
and oral lessees whereby banks can accept an affidavit
giving details of land tilled/crops grown by such persons
for loans up to Rs.50,000 without any need for independent
certification. Banks could also encourage the Joint
Liability Group (JLG)/SHG mode of lending for such persons.
(e) Promotion of Livelihood in the Unorganised Sector:
Role of Financial System
140. The National Commission for Enterprises in the
Unorganised Sector (Chairman: Dr. Arjun K. Sengupta)
had submitted to the Central Government a report on
'Conditions of Work and Promotion of Livelihood in the
Unorganised Sector' which had suggested a package of
measures for addressing some critical issues relating
to farm and non-farm sectors. The report of the Internal
Working Group constituted within the Reserve Bank to
study the recommendations of the National Commission
that are relevant to the financial system and to suggest
an appropriate action plan would be placed on the Reserve
Bank's website by May 15, 2008.
(f) Banking Code for Micro and Small Enterprises
141. In collaboration with the Indian Banks' Association
(IBA), the Banking Codes and Standards Board of India
(BSCBI) is evolving a banking code for small and micro
enterprises which will go a long way in empowering the
sector.
(g) Working Group on Rehabilitation/Nursing of
Potentially Viable Sick SME Units
142. As indicated in the Mid-Term Review of October
2007, a Working Group (Chairman: Dr.K.C.Chakraborty)
was constituted with representatives from banks and
the Small Industries Development Bank of India (SIDBI)
to examine the feasibility of SMEs bringing in additional
capital through alternative routes such as equity participation
and venture financing and to suggest remedial measures
for those potentially viable sick units that can be
rehabilitated at the earliest. The report of the Group
has been placed on the Reserve Bank's website for wider
dissemination/response.
(h) Strengthening Regional Rural Banks and Enhancement
of their Operational Efficiency: Status
143. As indicated in the Mid-Term Review of October
2007, a Working Group (Chairman: Shri G.Srinivasan)
has been constituted with representatives from the NABARD,
sponsor banks and RRBs in order to prepare RRBs to adopt
appropriate technology and migrate to core banking solutions
for better performance and improved customer services.
The Group is expected to submit its report by June 30,
2008.
144. The Task Force for Improving the Operational Efficiency
of RRBs (Chairman: Dr.K.G.Karmakar), set up in 2006,
had submitted its report to the Reserve Bank in February
2007. While some action points have been referred to
the Government of India, action has already been taken
on accepted recommendations and the remaining are under
examination.
(i) Revival of Rural Co-operative Credit Structure:
Status
145. Based on the recommendations of the Task Force
on Revival of Rural Co-operative Credit Institutions
(Chairman: Prof.A.Vaidyanathan) and in consultation
with State Governments, the Government of India had
approved a package for revival of the short-term rural
cooperative credit structure. So far, 20 States (Andhra
Pradesh, Arunachal Pradesh, Bihar, Chhattisgarh, Gujarat,
Haryana, Jammu and Kashmir, Karnataka, Madhya Pradesh,
Maharashtra, Meghalaya, Nagaland, Orissa, Punjab, Rajasthan,
Tamilnadu, Tripura, Uttarkhand, Uttar Pradesh and West
Bengal) have executed Memoranda of Understanding (MoUs)
with the Government of India and the NABARD, as envisaged
under the package. Seven States have made necessary
amendments in their Cooperative Societies Acts. An aggregate
amount of Rs.3,325.12 crore has been released by the
NABARD as the Government of India's share and State
Governments have released their shares to the tune of
Rs.333.93 crore to seven States for recapitalisation
assistance of Primary Agricultural Credit Societies
(PACS).
146. Implementation and monitoring of the revival package
are being overseen by the National Implementing and
Monitoring Committee (NIMC) set up by the Government
of India. Furthermore, a study of the long-term cooperative
credit structure was entrusted to the Task Force by
the Government of India, which had submitted its report
in August 2006. It was announced in the Union Budget
2008-09 that the Central Government and the State Governments
have reached an agreement on the content of the package
for revival of the long-term cooperative credit structure.
The cost of the package is estimated at Rs.3,074 crore,
of which the Central Government's share will be Rs.2,642
crore.
(j) Micro-finance: Status
147. The SHG-bank linkage programme has emerged as
the major micro-finance programme in the country and
is being implemented by commercial banks, RRBs and cooperative
banks. As on March 31, 2007, 28.94 lakh SHGs had outstanding
bank loans of Rs.12,366.49 crore. While commercial banks
accounted for 70.8 per cent of the outstanding loans,
RRBs and cooperative banks accounted for 22.7 per cent
and 6.5 per cent, respectively.
148. Out of 290 banks reporting data on recovery to
the NABARD as on March 31, 2007, 73 per cent of banks
had more than 80 per cent recovery on loans given to
SHGs.
(k) Financial Inclusion
(i) Pilot Project of State Level Bankers' Committees
(SLBCs) for 100 per cent Financial Inclusion
149. So far, 277 districts have been identified for
100 per cent financial inclusion and the target has
been achieved in 134 districts in 18 States and five
Union Territories. Notably, all districts of Haryana,
Himachal Pradesh, Karnataka, Kerala, Uttarakhand, Puducherry,
Daman and Diu, Dadra & Nagar Haveli and Lakshadweep
have achieved 100 per cent financial inclusion. An evaluation
of the progress made in achieving 100 per cent financial
inclusion in these districts is being undertaken to
draw lessons for further action in this regard.
(ii) General Purpose Credit Cards and Overdrafts
Against 'No-frills' Account as Indirect Finance to Agriculture
Under Priority Sector
150. With a view to providing credit card like facilities
in rural areas with limited point-of-sale (POS) and
limited automated teller machine (ATM) facilities, all
SCBs, including RRBs, were advised in December 2005
to introduce a General Credit Card (GCC) Scheme for
their constituents in rural and semi-urban areas, based
on the assessment of income and cash flow of the household
similar to that prevailing under normal credit cards.
Banks also provide a small overdraft facility against
basic banking 'no-frills' accounts. At present, 50 per
cent of the credit outstanding under GCC is allowed
to be classified as indirect finance to agriculture
under the priority sector. It is proposed:
to permit banks to classify 100 per cent of the credit
outstanding under GCC and overdrafts up to Rs.25,000
against 'no-frills' accounts in rural and semi-urban
areas as indirect finance to agriculture under the priority
sector.
(iii) Working Groups on Improvement of Banking Services
in Lakshadweep, Himachal Pradesh and Jharkhand
151. As indicated in the Mid-Term Review of October
2007, Working Groups were constituted to undertake studies
of banking services in the Union Territory of Lakshadweep
and States of Himachal Pradesh and Jharkhand. The Working
Groups have submitted their reports and their recommendations
have been forwarded to the respective agencies through
regional offices of the Reserve Bank for implementation.
(iv) Differential Rate of Interest (DRI) Scheme:
Eligibility Limits Raised
152. The limit of loans under the DRI Scheme was raised
from Rs.6,500 to Rs.15,000 and that of housing loans
under the Scheme from Rs.5,000 to Rs.20,000 per beneficiary,
on the basis of the announcements made in the Union
Budget for 2007-08. Consequent upon the announcement
made in the Union Budget for 2008-09 the borrower's
eligibility criterion in terms of annual family income
has been raised to Rs.18,000 in rural areas and Rs.24,000
in urban areas.
(v) Concept Paper on Financial Literacy and
Counselling Centres
153. The Mid-Term Review of October 2007 had indicated
that a concept paper on Financial Literacy and Counselling
Centres would be prepared and placed on the Reserve
Bank's website. Accordingly, a concept paper on Financial
Literacy and Counselling Centres has been prepared and
placed on the Reserve Bank's website on April 3, 2008
for public feedback in order to take this initiative
forward.
(vi) Financial Literacy
154. Lack of knowledge among common persons with respect
to financial services and financial planning is a major
reason for financial exclusion. The Reserve Bank launched
Project Financial Literacy with a view to creating awareness,
especially among common persons, on matters relating
to banking, finance and the central bank for promoting
financial inclusion. The literacy campaign is targeted
at groups such as rural folk, urban poor, school/college
children, women, senior citizens and defence personnel.
A multilingual website for common persons was launched
in July 2007. This was followed by a number of initiatives
such as having a section on financial education on the
Reserve Bank's website, educational books for children
and rural folk in the form of comics, participation
in fairs/exhibitions through educational displays/exhibits/
interactive games. Notably, the Reserve Bank put up
an exhibition on the evolution of banking in India since
Independence aboard the Azadi Express, a train run by
the Government of India all over the country to celebrate
60 years of India's Independence. The Reserve Bank also
organised essay competitions across the country to generate
interest among the children in the area of banking and
finance. A Young Scholar's Internship Award Scheme,
designed at giving opportunity to young college students
to work as interns with the Reserve Bank during their
vacations, is under implementation.
(vii) Assistance to RRBs for Adoption of ICT Solutions
155. As indicated in the Mid-Term Review of October
2007, a Working Group (Chairman: Shri G. Padmanabhan)
was constituted to examine providing financial assistance
to RRBs for defraying a part of their initial cost in
implementing Information and Communication Technology
(ICT)-based solutions, including installation of solar
power generating devices for powering ICT equipment
in remote and under-served areas. The Group has since
submitted its report, which is under examination.
(viii) Ex-Servicemen, Retired Government/Bank Employees
to act as Business Correspondents
156. In the Union Budget for 2008-09, the Finance Minister
indicated that individuals such as retired bank officers,
ex-servicemen and others would be allowed to be appointed
as credit counsellors. Accordingly, guidelines for allowing
retired bank/government employees and ex-servicemen
as business correspondents were issued on April 24,
2008.
(l) Review of Lead Bank Scheme
157. The Lead Bank Scheme, introduced in 1969, aimed
at coordinating the activities/efforts of banks, State
Governments and other developmental agencies for promoting
overall development of the rural sector. Although the
Scheme was reviewed in 1989 when the service area approach
was adopted, there have been significant changes in
the financial system in the post-reform period. More
recently, there is increased focus on financial inclusion.
At the same time, planning has become more decentralised
with greater devolution of expenditure to the grassroots
levels. In the revised context and in order to improve
the effectiveness of the Scheme as announced in the
Mid-Term Review of October 2007, a High Level Committee
(Chairperson: Smt. Usha Thorat) with members drawn from
various financial institutions, banks and State Governments
was constituted to review the Lead Bank Scheme. The
Committee has so far held seven meetings and has interacted
with most of the State Governments and banks. Interactions
are also proposed with academics and Non-Governmental
Organisations (NGOs). The Committee is expected to submit
its report by July 2008.
(m) Credit Delivery, Credit Pricing and Credit Culture
158. In the Mid-Term Review of Monetary and Credit
Policy of November 2003, the importance of adequate,
timely and hassle free credit delivery, appropriate
credit pricing related to risk and a conducive credit
culture was emphasised. Since then, there have been
several developments including doubling of credit to
agriculture, significant rise in credit to the small
and medium enterprises (SMEs) sector, administered interest
rates for crop loans, one time settlement (OTS) and
rescheduling/restructuring schemes for distressed farmers,
simplification of procedures and other measures such
as adoption of business correspondent (BC) model and
use of smart cards. The regulations under the Credit
Information Companies Act have been notified and soon
new credit information companies will be authorised
to commence business. This is expected to reduce information
asymmetry and facilitate efficient credit allocation
and pricing while fostering a better credit culture.
While concessional credit and debt relief schemes are
intended to alleviate farmers' distress and reopen the
credit lines that have been choked, sustaining an appropriate
credit culture going forward would require incentive
systems for greater flow and efficient allocation of
credit. Accordingly, it is proposed:
to set up an Internal Working Group to look at issues
relating to credit delivery, credit pricing and credit
culture in a holistic manner.
(n) Banks' Services to the Common Person and Transparency
in Charges Levied
159. In the last few years, the Reserve Bank has been
focusing on safeguarding the interest of common persons
in their interface with banks while improving the ease
and efficiency of conducting banking transactions. The
measures taken by the Reserve Bank include setting up
of the Banking Codes and Standards Board of India, revamping
the Banking Ombudsman scheme, constitution of board-level
customer service committees in banks, dissemination
of customer-centric information in local languages and
promoting fair and transparent policies and practices,
especially in the matter of bank charges, interest rates,
customer acquisition and debt collection. Banks have
also responded positively, including adoption of the
Code of Commitment to their customers. Nevertheless,
analyses of the types, frequency and trends of complaints
reaching the Reserve Bank and the offices of the Banking
Ombudsmen suggest that the essence of the Code still
needs to percolate down to the level of the customer
service delivery interface in banks. Banks, therefore,
need to pay closer attention to these aspects, particularly,
sensitivity of the staff to meeting the legitimate expectations
of customers. They also need to ensure that they have
in place effective internal arrangements for customer
grievance redressal.
160. In 2007, on account of concerns about high bank
charges and excessive interest rates in personal segment,
the Reserve Bank laid down principles for ensuring reasonableness
of bank charges and communicating them in respect of
identified basic banking services. Banks were also cautioned
against excessive interest rates, which are not sustainable
and may be seen as usurious and broad guidelines in
this regard were laid down. For greater transparency
in setting interest rates banks were advised that they
must use external or market-based rupee benchmark interest
rates for pricing their floating rate loan products.
The Reserve Bank has, thus, attempted to involve banks'
boards in implementation of various guidelines to ensure
fairness, reasonableness and transparency in bank charges
for various services and setting interest rates and
use of external transparent benchmark for this purpose
while giving them flexibility on consideration of commercial
judgement. It is expected that banks' boards will take
necessary care that these objectives are met and need
for more prescriptive regulation is avoided.
161. With a view to bringing about greater transparency,
the Reserve Bank is in the process of collecting details
of various charges levied by banks for public dissemination.
(o) Currency Management
162. Currency management continues to be guided by
benchmarks set in terms of operational efficiency and
improved customer service. All currency chest branches
of banks have been equipped with note sorting machines
to ensure quality and genuineness of bank notes in circulation.
These machines segregate notes into fit and unfit categories
and facilitate timely detection of counterfeit notes.
During 2007-08, soiled notes to the tune of 27 per cent
of notes in circulation were withdrawn from circulation
while fresh notes to the extent of 37 per cent were
introduced with a view to ensuring adequate supply of
notes of all denominations and to improve the quality
of bank notes in circulation. In order to ensure that
all bank branches provide better customer services to
members of public at bank counters for exchange of notes,
it is proposed:
to introduce a scheme of incentives and penalties for
bank branches (including currency chests), based on
their performance in rendering such services.
III. Prudential
Measures
(a) Prudential Norms on Income Recognition, Asset
Classification and
Provisioning pertaining to Advances: Infrastructure
Projects
Involving Time Overrun
163. In terms of the current guidelines, banks had
been advised that as regards industrial projects to
be financed by them, the date of completion of the project
should be clearly spelt out at the time of financial
closure of the project and if the date of commencement
of commercial production extends beyond a period of
six months after the date of completion of the project
as originally envisaged, the account should be treated
as a sub-standard asset. For infrastructure projects,
however, the period for recognising asset impairment
was extended to one year with effect from March 31,
2007.
164. On a representation made in regard to delays in
completion of infrastructure projects for legal and
other extraneous reasons, the Reserve Bank undertook
a review of select projects and concluded that there
is merit in this representation. Accordingly, it has
been decided that:
in case of infrastructure projects to be financed by
banks, the date of completion of the project should
be clearly spelt out at the time of financial closure
of the project and if the date of commencement of commercial
production extends beyond a period of two years (as
against the current norm of one year) after the date
of completion of the project as originally envisaged,
the account should be treated as sub-standard. The revised
instructions will be effective from March 31, 2008.
(b) Off-Balance Sheet Exposures of Banks
165. The Reserve Bank has, in the light of domestic
developments, taken steps to strengthen the prudential
framework in respect of on-balance sheet exposures of
banks. Such measures included additional risk weights
and provisioning requirements for exposures to specific
sectors. In view of the recent developments in the global
financial markets and drawing from suggestions for ensuring
financial stability, it is proposed:
to review current stipulations regarding conversion
factors, risk weights and provisioning requirements
for specific off-balance sheet exposures of banks and
prescribe prudential requirements as appropriate. The
guidelines in this regard would be placed on the Reserve
Bank's website by May 15, 2008.
166. In view of the risks associated with international
financial developments impacting the balance sheets
of corporates and banks, the Third Quarter Review of
January 2008 had urged banks to review large foreign
currency exposures and put in place a system for monitoring
such unhedged exposures on a regular basis so as to
minimise risks of instability in highly uncertain conditions.
Banks were also urged to carefully monitor corporate
activity in terms of treasury/trading activity and sources
of other income to the extent that embedded credit/market
risks pose potential impairment to the quality of banks'
assets.
167. The Reserve Bank has also issued comprehensive
guidelines on derivatives laying down broad generic
principles for undertaking all derivative transactions,
management of risks and sound corporate governance requirements
as also adoption of suitability and appropriateness
policy. Banks and their clients who have scrupulously
followed the extant guidelines, including the Regulations
framed under the FEMA, both in letter and spirit, would
be well equipped to meet any potential consequences.
(c) Review of Loans to Commodities Sector by Banks
168. In view of the current public policy concerns
in regard to trading in food items, banks are required
to review their advances to traders in agricultural
commodities including rice, wheat, oilseeds and pulses
as also advances against warehouse receipts. They are
further advised to exercise caution while extending
such advances to ensure that bank finance is not used
for hoarding. The first such review should be completed
by May 15, 2008 and forwarded to the Reserve Bank for
carrying out supervisory review of banks' exposure to
the commodity sector.
(d) Prudential Norms for Housing
169. On a review of recent developments, it has been
decided to enhance the limit of Rs.20 lakh to Rs.30
lakh in respect of bank loans for housing in terms of
applicability of risk weights for capital adequacy purposes.
Accordingly, such loans will carry a risk weight of
50 per cent.
(e) Credit Information Companies
170. The Reserve Bank had issued a press release on
April 18, 2007 inviting applications from companies
interested in continuing/commencing the business of
credit information. The last date for submission of
such applications was July 31, 2007. In response, 13
applications have been received. An external High Level
Advisory Committee (HLAC) (Chairman: Dr.R.H.Patil) has
been set up by the Reserve Bank for screening the applications
and recommending the names of the companies to which
certificates of registration can be granted by the Reserve
Bank. After the announcement of the FDI policy for Credit
Information Companies, the processing of applications
has been taken up and the Reserve Bank would complete
the process by June 30, 2008.
(f) Three-Track Approach for Basel II
171. The Reserve Bank has adopted a three-track approach
to capital adequacy regulation in India with the norms
stipulated at varying degrees of stringency for different
categories of banks given the variations in size, nature
and complexity of operations and relevance of different
types of banks to the Indian financial sector, the need
to achieve greater financial inclusion and to provide
an efficient credit delivery mechanism. Accordingly,
commercial banks, which account for a major share in
the total assets of the banking system and are Basel
II standards compliant, would be on Track I, banks which
are Basel I compliant would be on Track II and banks
which are in the nature of local community banks would
be on Track III.
172. An Internal Technical Group (Chairman: Shri Prashant
Saran) has been constituted to propose criteria for
the applicability of Basel norms to State Cooperative
Banks/District Central Cooperative Banks/RRBs. The Group
is expected to submit its report by June 30, 2008.
(g) Cross-border Supervision
173. The Mid-Term Review of October 2007 proposed to
constitute a Working Group to lay down the road-map
for adoption of a suitable framework for cross-border
supervision and supervisory cooperation with overseas
regulators, consistent with the framework envisaged
in the Basel Committee on Banking Supervision (BCBS).
Accordingly, an Internal Working Group (Chairman: Shri
S.Karuppasamy) has been constituted which is currently
studying the cross-country practices, including the
legal issues in this regard.
(h) Consolidated Supervision and Financial Conglomerates
174. The Mid-Term Review of October 2007 proposed to
integrate the process of consolidated supervision with
the financial conglomerate monitoring mechanism in order
to enhance the effectiveness of the banking supervisory
system for bank-led conglomerates. Accordingly, realignment
of various internal supervisory processes for implementing
an enhanced consolidated supervision process would be
completed by August 31, 2008.
(i) Supervisory Review Process on Activities of
the
Trusts/SPVs Set up by Banks
175. Special purpose vehicles (SPVs) and Trusts are
set up by banks to carry out a number of activities
such as facilitating securitisation, asset management
and investing in other entities. These entities are
generally unregulated and are subject to inadequate
independent board oversight. Besides, the downstream
activities of these entities are normally not captured
in the financial statements of the bank. As the activities
of these entities could be a potential risk to the parent
bank and could also pose systemic risk, there is a need
for placing them under suitable supervisory oversight.
Accordingly, it is proposed:
to constitute a Working Group to study and recommend
a suitable supervisory framework for activities of SPVs/Trusts
set up by banks.
(j) New Model of Risk-Based Supervision: Evolution
176. Risk-based supervision (RBS) was introduced on
a pilot basis in eight selected banks in 2003-04, which
was extended to 15 banks in 2004-05, four more banks
in 2005-06 and eight more banks in 2006-07. On the basis
of the experience gained from these pilot runs and with
a view to evolving an appropriate model of RBS, a departmental
Group has been set up to study international practices
on such systems. The study would focus on impact assessment,
periodic reviews of horizontal risks across the system,
inclusion of supervisory review process prescribed under
Pillar 2 of Basel II framework in the RBS assessment,
simplification of the existing system of risk profiling
and would recommend an appropriate RBS framework with
a view to integrating the RBS system with the existing
supervisory process based on capital adequacy, asset
quality, management, earnings, liquidity, and systems
(CAMELS) evaluation.
(k) Overseas Operations of Indian Banks: Review
of Existing Off-Site Monitoring Framework
177. In view of the rapid expansion of overseas operations,
introduction of new products and processes, increasing
off-balance sheet exposures including derivative products,
a need has arisen for a review of the reporting system.
Accordingly, an inter-departmental Group has been constituted
to review the existing regulatory and supervisory framework
for overseas operations of Indian banks and recommend
appropriate changes, including off-site reporting systems.
(l) Financial Stability Forum (FSF) Report: Status
178. As already mentioned, in the wake of the turmoil
in global financial markets, the FSF brought out a report
in April 2008 identifying the underlying causes and
weaknesses in the international financial markets. The
Report contains, inter alia, proposals of the FSF for
implementation by end-2008 regarding strengthening prudential
oversight of capital, liquidity and risk management,
enhancing transparency and valuation, changing the role
and uses of credit ratings, strengthening the authorities'
responsiveness to risk and implementing robust arrangements
for dealing with stress in the financial system. The
Reserve Bank had put in place regulatory guidelines
covering many of these aspects, while in regard to others,
actions are being initiated. In many cases, actions
have to be considered as work in progress. In any case,
the guidelines are aligned with global best practices
while tailoring them to meet country-specific requirements
at the current stage of institutional developments.
The proposals made by the FSF and status in regard to
each in India are narrated below:
1. Strengthened Prudential Oversight of Capital,
Liquidity and Risk Management
(i) Capital requirements: Specific proposals will
be issued in 2008 to:
Raise Basel II capital requirements for certain complex
structured credit products;
Introduce additional capital charges for default and
event risk in the trading books of banks and securities
firms;
Strengthen the capital treatment of liquidity facilities
to off-balance sheet conduits.
Changes will be implemented over time to avoid exacerbating
short-term stress.
(ii) Liquidity:
Supervisory guidance will be issued by July 2008 for
the supervision and management of liquidity risks.
(iii) Oversight of risk management:
Guidance for supervisory reviews under Basel II will
be developed that will:
Strengthen oversight of banks' identification and management
of firm-wide risks;
Strengthen oversight of banks' stress testing practices
for risk management and capital planning purposes;
Require banks to soundly manage and report off-balance
sheet exposures;
Supervisors will use Basel II to ensure banks' risk
management, capital buffers and estimates of potential
credit losses are appropriately forward looking.
(iv) Over-the-counter derivatives:
Authorities will encourage market participants to act
promptly to ensure that the settlement, legal and operational
infrastructure for over-the-counter derivatives is sound.
179. The road-map for the implementation of Basel II
in India has been designed to suit the country-specific
conditions. The phased implementation process got underway
with the Basel II Accord being made applicable to foreign
banks operating in India and Indian banks having operational
presence outside India with effect from March 31, 2008.
All other commercial banks (except Local Area Banks
and RRBs) are encouraged to migrate to Basel II in alignment
with them but in any case not later than March 31, 2009.
The process of implementation is being monitored on
an on-going basis for calibration and fine-tuning.
180. The minimum capital to risk-weighted asset ratio
(CRAR) in India is placed at 9 per cent, one percentage
point above the Basel II requirement. Further, regular
monitoring of banks' exposure to sensitive sectors and
their liquidity position is also undertaken. In India,
off-balance sheet vehicles in the form of SPVs for the
purpose of securitisation are in existence for which
extensive guidelines, in line with the international
best practices, have already been issued. Liquidity
facilities to such SPVs are subject to capital charge.
Banks have been required to put in place appropriate
stress test policies and relevant stress test frameworks
for various risk factors by March 31, 2008.
181. In order to further strengthen capital requirements,
it has been decided to review the credit conversion
factors, risk weights and provisioning requirements
for specific off-balance sheet items including derivatives.
Further, in India, complex structures like synthetic
securitisation have not been permitted so far. Introduction
of such products, when found appropriate, would be guided
by the risk management capabilities of the system.
182. The Reserve Bank had issued broad guidelines for
asset-liability management and banks have flexibility
in devising their own risk management strategies as
per board-approved policies. However, in regard to liquidity
risks at the very short end, the Reserve Bank has taken
steps to mitigate risks at the systemic level and at
the institution level as well. The Reserve Bank has
introduced greater granularity to measurement of liquidity
risk by splitting the first time bucket (1-14 days,
at present) into three time buckets, viz., next day,
2-7 days and 8-14 days. The net cumulative negative
mismatches in the three time buckets have been capped
at 5 per cent, 10 per cent, 15 per cent of the cumulative
cash outflows.
183. The Reserve Bank had recognised the risks of allowing
access to unsecured overnight market funds to all entities
and, therefore, restricted the overnight unsecured market
for funds only to banks and primary dealers (PD). Since
August 2005, the overnight call market is a pure inter-bank
market. Accordingly, trading volumes have shifted from
the overnight unsecured market to the collateralised
market.
184. Greater inter-linkages and excessive reliance
on call money borrowings by banks could cause systemic
problems. The Reserve Bank has, therefore, introduced
prudential measures to address the extent to which banks
can borrow and lend in the call money market. On a fortnightly
average basis, call market borrowings outstanding should
not exceed 100 per cent of capital funds (i.e., sum
of Tier I and Tier II capital) in the latest audited
balance sheet.
185. Recognising the potential of 'purchased inter-bank
liabilities' (IBL) to create systemic problems, the
Reserve Bank had issued guidelines in March 2007 prescribing
that IBL of a bank should not exceed 200 per cent of
its net worth (300 per cent for banks with a CRAR more
than 11.25 per cent).
2. Enhancing Transparency and Valuation
(i) Robust risk disclosures:
The FSF strongly encourages financial institutions
to make robust risk disclosures using leading disclosure
practices at the time of their mid-year 2008 reports.
Further guidance to strengthen disclosure requirements
under Pillar 3 of Basel II will be issued by 2009.
(ii) Standards for off-balance sheet vehicles and
valuations: Standard setters will take urgent action
to:
Improve and converge financial reporting standards
for off-balance sheet vehicles;
Develop guidance on valuations when markets are no
longer active, establishing an expert advisory panel
in 2008.
(iii) Transparency in structured products:
Market participants and securities regulators will
expand the information provided about securitised products
and their underlying assets.
186. The Reserve Bank has, over the years, issued guidelines
on valuation of various instruments/assets in conformity
with the international best practices while keeping
India-specific conditions in view. In order to encourage
market discipline, the Reserve Bank has developed a
set of disclosure requirements which allow the market
participants to assess key pieces of information on
capital adequacy, risk exposure, risk assessment processes
and key business parameters which provide a consistent
and understandable disclosure framework that enhances
comparability. Banks are also required to comply with
the Accounting Standard (AS) on Disclosure of Accounting
Policies issued by the Institute of Chartered Accountants
of India (ICAI).
187. In recognition of the fact that market discipline
can contribute to a safe and sound banking environment
and as part of the ongoing efforts to implement the
Basel II Accord, the Reserve Bank issued guidelines
on minimum capital ratio (Pillar 1) and market discipline
(Pillar 3) in April 2007 and guidelines for Pillar 2
(supervisory review process) were issued in March 2008.
Under these guidelines, non-compliance with the prescribed
disclosure requirements would attract a penalty, including
financial penalty.
3. Changes in the Role and Uses of Credit Ratings
Credit rating agencies should:
Implement the revised IOSCO Code of Conduct Fundamentals
for Credit Rating Agencies to manage conflicts of interest
in rating structured products and improve the quality
of the rating process;
Differentiate ratings on structured credit products
from those on bonds and expand the information they
provide.
Regulators will review the roles given to ratings in
regulations and prudential frameworks.
188. The Reserve Bank has undertaken a detailed process
of identifying the eligible credit rating agencies whose
ratings may be used by banks for assigning risk weights
for credit risk. Banks should use the chosen credit
rating agencies and their ratings consistently for each
type of claim, for both risk weighting and risk management
purposes. Banks are not allowed to cherry pick
the assessments provided by different credit rating
agencies. If a bank has decided to use the ratings of
some of the chosen credit rating agencies for a given
type of claim, it can use only the ratings of those
credit rating agencies, despite the fact that some of
these claims may be rated by other chosen credit rating
agencies whose ratings the bank has decided not to use.
External assessments for one entity within a corporate
group cannot be used to risk weight other entities within
the same group.
189. Banks must disclose the names of the credit rating
agencies that they use for the risk weighting of their
assets, the risk weights associated with the particular
rating grades as determined by the Reserve Bank through
the mapping process for each eligible credit rating
agency as well as the aggregated risk weighted assets
as required.
190. In India, complex structures like synthetic securitisations
have not been permitted so far. As and when such products
are to be introduced, the Reserve Bank would put in
place the necessary enabling regulatory framework, including
calibrating the role and capacity building of the rating
agencies.
4. Strengthening the Authorities' Responsiveness
to Risks
A college of supervisors will be put in place by
end-2008 for each of the largest global financial institutions.
191. In the Indian context, there have been exchange
of supervisory information on specific issues between
the Reserve Bank and few other overseas banking supervisors/regulators.
Supervisory cooperation has been working smoothly and
efficiently.
192. The Mid-Term Review of October 2007 had announced
the constitution of a Working Group to lay down a road-map
for adoption of a suitable framework for cross-border
supervision and supervisory cooperation with overseas
regulators, consistent with the framework envisaged
in the Basel Committee on Banking Supervision (BCBS).
A Working Group has been constituted in March 2008 and
would complete the work by August 2008. A number of
overseas regulators of countries such as the USA, the
UK, Canada, Hong Kong, Australia and Singapore have
been formally approached to share systems and practices,
including legal positions, in the matter of supervisory
cooperation and sharing of information with overseas
regulators. The response from a few countries has been
received and is being examined. The 'Supervisory College'
arrangement for this purpose is also being examined
by the Group.
5. Robust Arrangements for Dealing with Stress in
the Financial System
Central banks will enhance their operational frameworks
and authorities will strengthen their cooperation for
dealing with stress.
193. In the Reserve Bank, there is an institutional
arrangement in place to oversee the functioning of the
financial markets on a daily basis. There is a Financial
Market Committee monitoring and assessing the functioning
of different financial markets. Based on such an oversight,
appropriate and prompt action is taken, whenever necessary.
194. The Reserve Bank has the necessary framework for
provision of liquidity to the banking system, in terms
of Sections 17 and 18 of the Reserve Bank of India Act,
1934. The regular liquidity management facilities of
the Reserve Bank include the LAF, OMO and MSS besides
standing facilities such as export credit refinance
(ECR) and the liquidity facility for standalone PDs.
The Reserve Bank can undertake purchase/sale of securities
of the Central or State Governments and can purchase,
sell and rediscount bills of exchange and promissory
notes drawn on and payable in India and arising out
of bona fide commercial or trade transactions for provision/absorption
of liquidity for normal day-to-day liquidity management
operations as also for provision of emergency liquidity
assistance to the banks under the lender of last resort
function.
195. The Reserve Bank is empowered under the existing
legal framework to deal with the resolution of weak
and failing banks. The Banking Regulation Act provides
the legal framework for voluntary amalgamation and compulsory
merger of banks under Sections 44 (A) and 45, respectively.
The Deposit Insurance and Credit Guarantee Corporation
(DICGC) offers deposit insurance cover in India. The
mergers of many weak private sector banks with healthy
banks has improved overall stability of the system.
Not a single scheduled commercial bank in the country
has capital adequacy ratio which is less than the minimum
regulatory requirement of nine per cent.
IV. Institutional
Developments
Payment and Settlement Systems
(a) Payment and Settlement Systems Act, 2007
196. The Payment and Settlement Systems Bill was passed
by the Parliament and became an Act known as 'Payment
and Settlement Systems Act, 2007' after receiving the
assent of the President on the December 20, 2007. The
Act empowers the Reserve Bank to regulate and supervise
the payment and settlement systems in the country; gives
it authority to permit the setting up/continuance of
such systems and to call for information/data and issue
directions from/to payment system providers. The Act
defines a payment system and gives legal recognition
to multilateral netting and settlement finality. Accordingly,
the Reserve Bank has placed the draft regulations under
the Payment and Settlement Systems Act, 2007 on its
website inviting public comments to be received latest
by May 15, 2008. The regulations will be finalised in
consultation with the Government of India.
(b) IT-based Financial Inclusion Products and Services
197. Information Technology (IT) has enhanced the scope
of financial inclusion with low cost technology by reaching
out to hitherto unexplored sectors of the economy. The
usage of card-based products for multiple applications
is cost-effective and holds potential for large-scale
deployment. With a wide range of IT-based products such
as smart cards, hand held devices and secured message
transfers, there is an imperative need to ensure that
these instruments blend seamlessly with the existing
operative systems at the bank level. Accordingly, banks
are urged to ensure that security of banking transactions
is adequately addressed while using such products.
(c) Real Time Gross Settlement (RTGS): Compliance
with the Core Principles
198. The RTGS system implemented by the Reserve Bank
has been in operation for nearly four years. The system
has also stabilised over the years and has been witnessing
increased coverage in terms of bank branches and transaction
volume. The Bank for International Settlements (BIS)
has published a set of Core Principles in 2001 which
are in the nature of standards to measure the efficiency
of the systemically important payment systems and the
Reserve Bank has been assessing the compliance of the
Indian RTGS system with these principles on annual basis.
As per the latest review, the system is fully compliant
with six core principles, broadly compliant with three,
and one principle is not applicable for the Indian RTGS
system. Out of the four responsibilities of the central
bank under the core principles, full compliance has
been achieved in respect of two core principles, broad
compliance with one and one responsibility is not applicable
in the Indian context.
(d) Electronic Payment Products: Status
199. The coverage of the RTGS system has increased
significantly. By March 31, 2008 RTGS connectivity was
available in more than 43,500 bank branches. The Reserve
Bank continues to improve the quality of services through
the RTGS.
200. The launch of the pilot project for Cheque Truncation
System, which aims at enhancing efficiency in the retail
cheque clearing section, has become operational from
February 1, 2008 in 10 banks.
201. The Committee (Chairman: Dr.R.B.Barman), constituted
for introduction of the National Settlement System (NSS),
examined various models and recommended the Centralised
Funds Transfer System (CFTS) model for implementation.
Under the CFTS model, banks would be able to transfer
funds across all Deposit Accounts Departments (DADs)
on real time basis. So far, CFTS has been implemented
at 16 centres.
202. The Electronic Clearing Service (ECS), which facilitates
bulk payments, is currently available at 68 centres.
The Mid-Term Review of October 2007 had proposed to
operationalise the National Electronic Clearing Service
(NECS) using the existing infrastructure of National
Electronic Funds Transfer (NEFT) system with a view
to widening the geographical coverage of the ECS in
consultation with banks. Software development and testing
has been completed for the first phase covering the
existing ECS centres and the testing report has been
approved for implementation.
203. Considering that the potential for a shift from
paper-based system to electronic system is large, the
processing charges for ECS / EFT / NEFT were waived
up to March 31, 2008. The Reserve Bank, in its role
as promoter and facilitator of electronic funds transfer
would like to continue this approach for one more year.
Accordingly, the processing charges for all electronic
payment products, viz., ECS, EFT, NEFT and RTGS are
waived for another year i.e., up to March 31, 2009.
(e) Regulatory Guidelines: Mobile Payments
204. The reach of mobile phones has been increasing
at a rapid pace in India. There were about 231 million
mobile phone connections in the country at the end of
December 2007. The rapid expansion of this mode of communication
has thrown up a new payment delivery channel for banks.
Many countries in the world have adopted this mode of
delivery to successfully spread the reach of the banking
facility to the remote parts of their respective countries.
This channel facilitates small value payments to merchants,
utility service providers and the like and money transfers
at a low cost.
205. The Reserve Bank is in the process of formulating
the regulatory guidelines for mobile payments systems
in India and is in discussion with banks, service providers
and industry bodies for this purpose. The draft guidelines
will be placed on the Reserve Bank's website by June
15, 2008.
(f) Electronic Based Social Security Payments
206. The report of the Committee (Chairman: Dr.R.B.Barman),
set up by the Reserve Bank to examine matters relating
to electronic based payments by the Central and State
Governments under various social welfare schemes like
social security pension payment, National Rural Employment
Guarantee Scheme (NREGS) and insurance scheme for persons
living below the poverty line, has been placed on the
Reserve Bank's website.
(g) Migration from Paper Based Payment Systems to
Electronic Payment Systems: Mandating
207. The Reserve Bank has been continuously taking
initiatives to migrate from paper-based payment to electronic
payment systems by creating the appropriate technological
infrastructure. In this context, an Internal Group was
constituted to examine various issues connected with
the use of electronic payment systems. Based on the
Group's report, an approach paper was placed on the
Reserve Bank's website inviting comments/suggestions
from the public. On the basis of the feedback, effective
from April 1, 2008 all payment transactions of Rs. one
crore and above in the money, Government securities
and foreign exchange markets and the regulated entities
(banks, PDs and NBFCs) have been made mandatory to be
routed through the electronic payment mechanism.
(h) Eligibility Criteria for Access to Payment Systems
208. An Internal Working Group, constituted to prepare
comprehensive draft guidelines on minimum eligibility
criteria for direct members of the clearing houses,
submitted its report in September 2007 which was placed
on the Reserve Bank's website for public comments. Final
guidelines in this connection have been made effective
from January 1, 2008 and banks have been advised to
implement these guidelines.
Urban Cooperative Banks
(a) Creation of Umbrella Organisation and Revival
Fund for Urban Cooperative Banks: Setting up of a Working
Group
209. The Working Group (Chairman: Shri N.S.Vishwanathan),
constituted to explore various options and alternate
instruments/avenues for raising of regulatory capital
funds of urban cooperative banks (UCBs), observed that
creating a legal framework for facilitating the emergence
of umbrella organisation(s) like those prevalent in
other parts of the world appears to be the only long-term
solution for raising of capital in the UCB sector. There
have also been requests from the sector for creation
of a revival/liquidity support fund. Accordingly, it
is proposed:
to constitute a Working Group comprising representatives
of the Reserve Bank, Central/State Governments and the
UCB sector to suggest measures, including the appropriate
regulatory and supervisory framework, to facilitate
emergence of umbrella organisation(s) for the UCB sector
in the respective States.
(b) Opening of On-site ATMs by UCBs: Liberalisation
210. At present, UCBs are allowed to open on-site ATMs
subject to certain eligibility norms, including minimum
deposit criterion of Rs.100 crore. With a view to liberalising
this facility, it is proposed:
to dispense with the extant eligibility norms for opening
on-site ATMs for well-managed and financially sound
UCBs in the States that have signed MoUs with the Reserve
Bank and those registered under the Multi-State Cooperative
Societies Act, 2002.
(c) Branch Licensing Norms: Liberalisation
211. As proposed in the Annual Policy Statement of
April 2007, well-managed and financially sound UCBs
in States that have signed MoUs with the Reserve Bank
and those registered under the Multi-State Cooperative
Societies Act, 2002 were permitted to open branches
and extension counters subject to fulfilling certain
eligibility criteria. With a view to liberalising and
rationalising the branch licensing norms for such UCBs,
it is proposed:
to consider approvals for branch expansion, including
off-site ATMs, based on annual business plans, subject
to maintenance of minimum CRAR of 10 per cent on a continuing
basis and other regulatory comfort.
(d) Insurance Business by UCBs: Liberalisation of
Norms
212. At present, UCBs registered in States that have
signed MoUs with the Reserve Bank or registered under
the Multi-State Cooperative Societies Act, 2002 with
a minimum net worth of Rs.10 crore are permitted to
undertake insurance business as corporate agents without
risk participation, subject to certain conditions. Taking
into consideration the representations from UCBs, it
is proposed:
to dispense with the minimum net worth criterion for
undertaking such insurance business provided other criteria
as prescribed from time to time are met.
(e) Individual Housing Loan: Enhancement of Limit
213. As per extant norms, UCBs can grant housing loans
to individuals up to a maximum of Rs.25 lakh. Based
on the representations made by UCBs, it is proposed:
to increase the extant limit on individual housing
loans from Rs.25 lakh to a maximum of Rs.50 lakh in
respect of Tier-II UCBs, subject to certain conditions.
(f) Information Technology Support to UCBs
214. As proposed in the Mid-Term Review of October
2007 and in pursuance of commitments made under the
Memoranda of Understanding (MoUs) signed with various
State Governments and the Central Government, a Working
Group (Chairman: Shri R.Gandhi) was constituted comprising
representatives of the Reserve Bank, State Governments
and the UCBs to examine various areas where IT support
could be provided by the Reserve Bank. The Group submitted
its report on April 17, 2008 which is under consideration.
Non-Banking Financial Companies
Financial Regulation of Systemically Important NBFCs:
Review of Prudential Regulations
215. In 2006, regulatory guidelines covering the prudential
norms for systemically important NBFCs and banks' relationship
with them were put in place. The Reserve Bank has been
monitoring the functioning of systemically important
NBFCs and banks' exposure to them.
216. It is observed that many systemically important
non-deposit taking NBFCs are highly leveraged and use
short-term sources to fund their activities. In the
light of international developments and increasing bank
exposure to these systemically important NBFCs, it has
now been decided to review the regulations in respect
of capital adequacy, liquidity and disclosure norms.
Revised instructions will be issued by May 31, 2008.
Committee on Financial Sector Assessment: Developments
217. The Mid-Term Review of October 2007 had outlined
the progress made by the Committee on Financial Sector
Assessment (CFSA) (Chairman: Dr.Rakesh Mohan; Co-Chairman:
Dr.D.Subbarao). Since then, the four Advisory Panels
constituted by the Committee covering Financial Stability
Assessment and Stress Testing, assessment of relevant
international standards and codes as applicable to Financial
Regulation and Supervision, Institutions and Market
Structure and Transparency Standards have prepared their
draft reports and these reports have been sent to external
peer reviewers in relevant subject areas. The comments
from the peer reviewers on five out of eleven reports
have already been received. Two external experts have
also been undertaking an overarching review of all draft
reports. The peer reviews are expected to be completed
by May 2008 and the CFSA has proposed a two-day seminar
in Mumbai for closer interaction with peer reviewers.
The reports of the CFSA as also those of Advisory Panels
are expected to be finalised by end-June 2008 and will
be placed thereafter on the Reserve Bank's website.
Mid-term Review
218. A review of the Annual Statement on Developmental
and Regulatory Policies will be undertaken on October
24, 2008.
Mumbai
April 29, 2008
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