Monetary Policy- Summary

The governor of the Reserve Bank of India (RBI), Y.V. Reddy announced the slack season monetary policy for the year 2004-2205 today.

There has been no change in the bank rate, the repo rate and the cash reserve ratio.

The gross domestic product for the year 2005 is expected to be between 6.5 and 7 per cent and inflation for the year has been pegged at 5 per cent. However, the governor said that the inflationary situation needs to be watched closely and there should be no room for complacency on this account in view of global uncertainties and geopolitical risks. On the whole, however, the price situation is unlikely to cause concern for macro-economic stability in 2004-05.

The outlook for external sector accords comfort to the conduct of public policies and the foreign exchange reserves are at comfortable levels. The governor said that despite uncertainties, India's position among the top performers globally in terms of GDP growth is expected to continue in FY-05.

While the RBI would continue to provide a policy environment that avoids excessive and destabilising volatility as a public good, market participants have been asked to take into account the portfolio risks from unexpected developments and provide adequately for them, the governor said.

The governor noted that considerable progress has been made in developing the Indian banking sector into a vibrant, sound and well-functioning system. The RBI's persistent efforts towards strengthening of regulatory and supervisory norms to induce greater accountability and market discipline amongst the participants, adoption of international benchmarks as appropriate to Indian conditions, improvement in management practices and corporate governance, and upgradation of the technological infrastructure have enabled the banking system to emerge as a stronger, efficient and resilient system to meet global competition. While certain changes in the legal infrastructure are yet to be effected, the developments so far have brought the Indian financial system closer to global standards.

The Indian foreign exchange market witnessed orderly conditions despite payments of US $ 5.2 billion in October 2003 on account of redemption of Resurgent India Bonds. The exchange rate of the rupee at Rs.47.50 per US dollar in March 2003 appreciated by 9.5 per cent to Rs.43.39 per US dollar by March 2004, but depreciated by 3.1 per cent against the Euro, 5.9 per cent against Pound sterling and 4.4 per cent against Japanese yen during the period.

The RBI's policy to build a higher level of foreign exchange reserves takes into account anticipated current account deficits and "liquidity at risk" arising from unanticipated capital movements and added that India's foreign exchange reserves increased by US $ 37.6 billion from US $ 75.4 billion at end-March 2003 to US $ 113.0 billion by end-March 2004 and further to US $ 118.6 billion by May 7, 2004. Governor emphasised that exchange rate management was based on flexibility without a fixed target or a pre-announced target or a band with ability to intervene.

During 2003-04, India's exports in US dollar terms increased by 17.1 per cent as compared with 20.3 per cent in the previous year. Imports showed a higher increase of 25.3 per cent as compared with 17.0 per cent in the previous year.

The most distinguishing feature of the external sector during 2003-04 relates to the large capital flows with its inevitable implications for the conduct of domestic monetary policy and exchange rate management. Delving at length on the various modes of policy intervention (categorised as market based vs non-market based), their pros and cons, Governor said that the primary objective of the monetary authorities in this context is to offset the impact of such foreign exchange market intervention, partly or wholly, so as to retain the intent of monetary policy. The degree of impact of such flows on domestic monetary policy, however, depends largely on the kind of exchange rate regime that the authorities follow. While in practice, the central banks do intervene in the forex markets in all countries, in emerging markets, a more intensive approach to intervention may be warranted in the context of large inflows. He also added that the key issue before the monetary authority is to determine whether the capital inflows are of a permanent and sustainable nature or whether such inflows are temporary and subject to reversal. In practice, however, such determination is difficult to achieve.

With regard to credit, the governor mentioned that there is a need for significant efforts to overcome the bottlenecks in flow of bank credit to agriculture and small & medium enterprises. Also, a step-up in investment activity in infrastructure would augment the prospects for credit off-take for productive sectors. He also indicated that the restructuring of development finance institutions is under way and the contemplated restructuring of rural banking sector should help the process of enhancing the quality, purposiveness and reach of banking in India.

Governor pointed out that the financial sector now operates in a more competitive environment than before and intermediates relatively large volumes of international financial flows. Consequently, he said that the monetary policy formulation has become complex and, in particular, has to be alert to a possible build-up of financial imbalances and thus needs to explore ways and means of containing such shocks.
Reiterating the need for maintaining a conducive credit culture, Governor said that as financial institutions expand and grow more complex, it is also necessary to ensure that the quality of service to customers, especially the common person, is focused on and improved.

In order to ensure timely and effective implementation of the measures, RBI has been adopting a consultative approach before introducing policy measures so that the benefits of financial efficiency and stability percolates to the common person and the services of the Indian financial system can be benchmarked against international best standards in a transparent manner.

Governor noted that the draft Banking Deposits Insurance Corporation Bill, 2003 is being revised on the basis of suggestions from the Government. The credit guarantee schemes of the Corporation has been discontinued as the credit institutions have gradually opted out of the scheme.