Dr. Y. Venugopal Reddy, Governor,
presented the Mid-term Review of Annual
Policy for the Year 2007-08 today in a meeting with Chief Executives of
major commercial banks. The Mid-term Review consists of two parts: Part I Mid-term
Review of the Annual Statement on Monetary Policy for the Year 2007-08; and Part
II Mid-term Review of the Annual Statement on Developmental and Regulatory Policies
for the Year 2007-08. Highlights - Bank
Rate, Repo Rate and Reverse Repo Rate kept unchanged.
- The
flexibility to conduct overnight repo or longer term repo including the right
to accept or reject tender(s) under the LAF, wholly or partially, is retained.
- CRR
increased by 50 basis points to 7.5 per cent effective fortnight beginning November
10, 2007.
- GDP
growth forecast retained at 8.5 per cent during 2007-08, assuming no further escalation
in international crude prices and barring domestic or external shocks
- Inflation
to be contained close to 5.0 per cent during 2007-08 while resolving to condition
expectations in the range of 4.0-4.5 per cent, with a medium-term objective of
inflation at around 3.0 per cent.
- Moderating
net capital flows so that money supply is not persistently out of alignment with
indicative projection of 17.0-17.5 per cent.
- Covering
of Short-sale and When Issued transactions to be permitted
outside the Negotiated Dealing System Order Matching (NDS-OM) system.
- Systemically
important non-deposit taking NBFCs (NBFC-ND-SI) to be considered as qualified
entities for accessing the NDS-OM using the Constituents Subsidiary
General Ledger (CSGL) route.
- Reinstatement
of the eligible limits under the past performance route for hedging facility to
be permitted.
- Oil
companies to be permitted to hedge foreign exchange exposures by using overseas
over-the-counter (OTC)/ exchange traded derivatives up to a maximum of one year
forward.
- Importers
and exporters having foreign currency exposures to be allowed to write covered
call and put options in both foreign currency/ rupee and cross currency and receive
premia.
- Authorised
Dealers (ADs) to be permitted to run cross currency options books subject to the
Reserve Banks approval.
- ADs
to be permitted to offer American options as well.
- Working
Group to be constituted for preparing a road-map for migration to core banking
solutions (CBS) by Regional Rural Banks (RRBs).
- RRBs
and State/ Central Cooperative Banks to disclose their capital-to-risk weighted
assets ratio (CRAR) as on March 31, 2008 in their balance sheets.
- A
road-map to be evolved for achieving the desired level of CRAR by these banks.M
- High
Level Committee to be constituted to review the Lead Bank Scheme.
- Financial
assistance to RRBs for implementing information and communication technology (ICT)
based solutions.
- Working
group to be constituted to lay down the road-map for cross-border supervision
and supervisory cooperation with overseas regulators, consistent with the framework
envisaged in the Basel Committee on Banking Supervision (BCBS).
- Besides
general market risk, specific risk, especially the credit risk arising out of
deficient documentation or settlement risk to be covered under the supervisory
process.
- Action
plan to be drawn up for implementation of National Electronic Clearing Service
(NECS) with centralised clearing and settlement at Mumbai.
Domestic
Development - Real
GDP growth during the first quarter of 2007-08 is placed at 9.3 per cent as against
9.6 per cent in the corresponding quarter a year ago.
- The
year-on-year (Y-o-Y) wholesale price index (WPI) inflation eased from its peak
of 6.4 per cent on April 7, 2006 to 3.1 per cent by October 13, 2007.
- The
average price of the Indian basket of international crude has increased
to US $ 80.0 per barrel as on October 23, 2007 from US $ 72.1 per barrel in July-September,
2007.
- The Y-o-Y
CPI inflation for industrial workers showed a sharp increase to 7.3 per cent in
August 2007 as against 6.3 per cent a year ago.
- The
Y-o-Y growth in money supply (M3) was higher at 21.8 per cent on October 12, 2007
than 18.9 per cent a year ago.
- The
Y-o-Y growth in aggregate deposits at Rs.5,69,061 crore (24.9 per cent) was higher
than that of Rs.3,88,528 crore (20.4 per cent) a year ago.
- Total
credit exhibited a Y-o-Y growth of Rs.3,81,333 crore (23.3 per cent) as on October
12, 2007 on top of an increase of Rs.3,66,463 crore (28.8 per cent) a year ago.
- The Y-o-Y
growth in total resource flow from scheduled commercial banks (SCBs) to the commercial
sector was 22.1 per cent, over and above the growth of 28.0 per cent a year ago.
- Banks
holdings of Government and other approved securities increased to 30.0 per cent
of their net demand and time liabilities (NDTL) as on October 12, 2007 from 28.0
per cent at end-March 2007.
- The
overhang of liquidity under the LAF, MSS and the Central Governments cash
balances taken together increased to Rs.2,22,582 crore by October 24, 2007 from
Rs.85,770 crore at end-March 2007.
- The
Government of India, in consultation with the Reserve Bank, revised the ceiling
under MSS for the year 2007-08 from Rs.1,10,000 crore to Rs.1,50,000 crore on
August 8, 2007 and further to Rs.2,00,000 crore on October 4, 2007.
- During
the second quarter of 2007-08, financial markets remained generally stable with
conditions of abundant liquidity and interest rates moderated in almost all segments
of the financial system.
- During
AprilOctober 2007, public sector banks (PSBs) decreased their deposit rates,
particularly at the upper end of the range for various maturities, by 25-60 basis
points.
- During
April-October 2007, the benchmark prime lending rates (BPLRs) of private sector
banks moved from a range of 12.50-17.25 per cent to 13.00-16.50 per cent.
- The
range of BPLRs for PSBs and foreign banks, however, remained unchanged at 12.50-13.50
per cent and 10.00-15.50 per cent, respectively, during this period.
- The
BSE Sensex increased from 13,072 at end-March 2007 to 19,243 on October 26, 2007.
- The gross
market borrowings of the Central Government through dated securities at Rs.1,27,060
crore (Rs.1,17,548 crore a year ago) during 2007-08 so far (up to October 26)
constituted 67.3 per cent of the budget estimates (BE) while net market borrowings
at Rs.75,387 crore (Rs.65,951 crore a year ago) constituted 68.7 per cent of the
BE.
External
Sector - Merchandise
exports rose by 18.2 per cent in US dollar terms during April-August 2007 as compared
with 27.1 per cent in the corresponding period of the previous year while import
growth was higher at 31.0 per cent as compared with 20.6 per cent in the previous
year.
- Non-oil
imports rose by 44.3 per cent (10.9 per cent a year ago); oil imports, however,
slowed down to 6.0 per cent (44.5 per cent), mainly on account of moderation in
the price of the Indian basket of crude oil by 0.5 per cent during April-August
2007.
- Indias
foreign exchange reserves increased by US $ 62.0 billion during 2007-08 and stood
at US $ 261.1 billion on October 19, 2007.
- The
rupee appreciated by 10.3 per cent against the US dollar, by 2.4 per cent against
the euro, by 5.4 per cent against the pound sterling and 7.1 per cent against
the Japanese yen during the current financial year up to October 26, 2007.
Global
Developments - The
downside risks to the global economic outlook have increased from a few months
ago, accentuated by the recent financial market turmoil, firm inflationary pressures
and high and volatile crude prices.
- According
to the IMFs World Economic Outlook (WEO) released in October 2007, the forecast
for global real GDP growth on a purchasing power parity basis has been retained
at 5.2 per cent for 2007 as in the July 2007 update, down from 5.4 per cent in
2006, but forecast for 2008 has been revised down to 4.8 per cent in October from
5.2 per cent in the July 2007 update.
- In
the US, real GDP growth had risen to 3.8 per cent in the second quarter of 2007
as compared with 2.4 per cent a year ago - The IMFs October 2007 WEO expects
the US economy to grow at 1.9 per cent in 2007 and 2008 as against 2.9 per cent
in 2006.
- There
was a sudden fall in credit market confidence in late July brought on by the spread
of risks from exposure to the US sub-prime mortgages with credit crunch spreading
into corporate bond markets and equity markets.
- The
European Central Bank and the US Federal Reserve, which have intervened since
August 9 by providing liquidity to the inter-bank market, were joined by central
banks in Canada, Japan, Australia, Norway and Switzerland.
- Bank
of England has provided liquidity support to a mortgage lending bank, while giving
a blanket guarantee to depositors on the safety of their deposits.
- Several
central banks have cut policy rates during the third quarter of 2007 after financial
markets were significantly affected by turbulence, such as the US Federal Reserve,
the Banco Central do Brasil, Bank Indonesia (BI) and the Bank of Thailand.
- The
central banks that have tightened their policy rates include the European Central
Bank; the Bank of England; the Bank of Japan; the Bank of Canada; the Reserve
Bank of Australia; the Reserve Bank of New Zealand; the Peoples Bank of
China; the Bank of Korea; the Banco de Mexico; and the Banco Central de Chile.
- A few central
banks in Asia have used supplementary measures for tightening, besides increasing
key policy rates. The only central bank that has kept policy rates steady is the
Bank Negara Malaysia.
Overall
Assessment - Some
positive elements in the global economy are (i) the global economy is strong and
resilient; (ii) EMEs, by and large, have a better macro-environment than before;
(iii) globally, corporate balance sheets are strong and less leveraged than in
the past; (iv) large financial intermediaries are perhaps adequately capitalised
to absorb the shocks of credit infirmities; and (v) the inflation environment
has been, on the whole, benign.
- The
global environment is fraught with uncertainties with international crude prices
at new highs, having breached the level of US $ 90 per barrel while elevated food
and metal prices would, in current circumstances, pass through to domestic inflation.
- The US Federal
Reserve has been the most aggressive in terms of easing monetary policy, with
a higher than expected rate cut, reflecting the concerns over impact of housing
issues on consumption and, hence, growth.
- The
most important issue for India is the possible impact of global financial market
developments and policy responses by central banks in major economies.
- The
immediate task for public policy in India, therefore, is to manage the possible
financial contagion which is in an incipient stage with highly uncertain prospects
of being resolved soon.
- On
the domestic front, aggregate demand conditions have remained firm and on the
uptrend.
- Key
monetary aggregates, i.e., reserve money and money supply have been running well
above initial projections, reflecting the impact of higher than expected deposit
growth and the exogenous expansionary effects of capital inflows as well as the
drawdown of fiscal cash balances.
- The
incomplete pass-through of international prices of crude, metals, food and commodities
in general to consumer prices is indicative of suppressed inflation which carries
destabilising potential into the future.
- The
policy responses in the form of active liquidity management operations to modulate
expansionary monetary and financial conditions were reflected in a generally orderly
evolution of market liquidity.
- Since
late July, global financial markets have experienced unusual volatility, strained
liquidity and heightened risk aversion.
- While
the trigger was the rising default rates on sub-prime mortgages in the US, the
source of the problem was significant mis-pricing of risks in the financial system.
- Easy
monetary policy, globalisation of liquidity flows, wide-spread use of highly complex
structured debt instruments and inadequacy of banking supervision in coping with
financial innovations also contributed to the severity of the crisis.
- At
the current juncture and looking ahead, on the domestic front, the biggest challenge
for monetary policy is the management of capital flows and the attendant implications
for liquidity and overall stability.
- Yet
another challenge is the rapid escalation in asset prices, particularly equity
and real estate, which are significantly driven by capital flows.
- Over
the next twelve to eighteen months, risks to inflation and inflation expectations
would also continue to demand priority in policy monitoring.
Stance
of Monetary Policy - Real
GDP growth in 2007-08 is placed at 8.5 per cent for policy purposes, as set out
in the Annual Policy Statement of April 2007 and reiterated in the First Quarter
Review.
- Policy
endeavour would be to contain inflation close to 5.0 per cent in 2007-08 and the
resolve, going forward, would be to condition expectations in the range of 4.0-4.5
per cent so that an inflation rate of 3.0 per cent becomes a medium-term objective.
- Moderating
the expansionary effects of net capital flows is warranted so that money supply
is not persistently out of alignment with the indicative projections.
- 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.
- Barring
the emergence of any adverse and unexpected developments in various sectors of
the economy and keeping in view the current assessment of the economy including
the outlook for inflation, the overall stance of monetary policy in the period
ahead will broadly continue to be:
To reinforce the emphasis on
price stability and well-anchored inflation expectations while ensuring a monetary
and interest rate environment that supports export and investment demand in the
economy so as to enable continuation of the growth momentum.
To
re-emphasise credit quality and orderly conditions in financial markets for securing
macroeconomic and, in particular, financial stability while simultaneously pursuing
greater credit penetration and financial inclusion.
To respond swiftly
with all possible measures as appropriate to the evolving global and domestic
situation impinging on inflation expectations, financial stability and the growth
momentum.
To be in readiness to take recourse to all possible options
for maintaining stability and the growth momentum in the economy in view of the
unusual heightened global uncertainties, and the unconventional policy responses
to the developments in financial markets.
Monetary
Measures - The
Bank Rate has been kept unchanged at 6.0 per cent.
- The
repo rate under the LAF is kept unchanged at 7.75 per cent.
- The
reverse repo rate under the LAF is kept unchanged at 6.0 per cent.
- The
Reserve Bank has the flexibility to conduct repo/reverse repo auctions at a fixed
rate or at variable rates as circumstances warrant.
- 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.
- CRR
increased by 50 basis points to 7.5 per cent effective fortnight beginning November
10, 2007.
Developmental
and Regulatory Policies Financial
Markets - Non-Competitive
Bidding Scheme in the Auctions of State Development Loans (SDLs) to be operationalised
by March 31, 2008.
- Re-issuance
of SDLs in the second half of 2007-08.
- The
facility of new issuance structure for floating rate bonds (FRBs) is being built
into the new Negotiated Dealing System (NDS) auction system being developed by
the Clearing Corporation of India Limited (CCIL).
- The
Reserve Bank is committed for permitting market repos in corporate bonds, once
the corporate debt markets develop and the Reserve Bank is assured of availability
of fair prices, and an efficient and safe settlement system based on delivery
versus payment (DvP) III and Straight Through Processing (STP) is in place.
- Covering
of Short-sale and When Issued transactions to be permitted
outside the Negotiated Dealing System Order Matching (NDS-OM) system.
- Systemically
important non-deposit taking NBFCs (NBFC-ND-SI) to be considered as qualified
entities for accessing the NDS-OM using the Constituents Subsidiary
General Ledger (CSGL) route.
- The
facility of permitting all exporters to earn interest on their Exchange Earners
Foreign Currency (EEFC) accounts to the extent of outstanding balances of US $
1 million per exporter is extended up to October 31, 2008 and banks are free to
determine the rate of interest.
- Reinstatement
of the eligible limits under the past performance route for hedging facility provided
that supporting underlying documents are produced during the term of the hedge
undertaken.
- Oil
companies to be permitted to hedge their foreign exchange exposures to the extent
of 50 per cent of their inventory volume as at the end of the previous quarter
by using overseas over-the-counter (OTC)/ exchange traded derivatives up to a
maximum of one year forward.
- Importers
and exporters having foreign currency exposures to be allowed to write covered
call and put options in both foreign currency/ rupee and cross currency and receive
premia.
- Authorised
Dealers (ADs) to be permitted to run cross currency options books, subject to
the Reserve Banks approval.
- ADs
to be permitted to offer American options as well.
Credit
Delivery
- Internal
Working Group to be constituted to examine the recommendations of the Committee
on Agricultural Indebtedness (Chairman: Dr. R. Radhakrishna) relevant to the banking
system in general and the Reserve Bank, in particular.
- Working
Group to be constituted with representatives from the Reserve Bank, the NABARD,
sponsor banks and RRBs for preparing a road-map for migration to core banking
solutions (CBS) by RRBs.
- RRBs
and State/ Central Cooperative Banks should disclose the level of CRAR as on March
31, 2008 in their balance sheets. A road-map may be evolved for achieving the
desired level of CRAR by these banks.
- Working
Group to be constituted to study the recommendations of Sengupta Committee report
on Conditions of Work and Promotion of Livelihood in the Unorganised Sector
relevant to the financial system and suggest an appropriate action plan for implementation
of acceptable recommendations.
- High
Level Committee to be constituted to review the Lead Bank Scheme.
- Proposed
to prepare a concept paper on financial literacy-cum-counseling centres detailing
the future course of action.
- Financial
assistance to RRBs for 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.
Prudential
Measures - Final
guidelines on Credit Default Swaps would be issued by end-November 2007.
- Banks
are urged to follow prescribed specific considerations while engaging recovery
agents. Abusive practices followed by banks recovery agents would invite
serious supervisory disapproval.
- Constitution
of 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).
- In
order to enhance the effectiveness of the banking supervisory system, the process
of consolidated supervision to be integrated with the financial conglomerate monitoring
mechanism for bank-led conglomerates.
- It
is proposed to cover, besides general market risk, specific risk, especially the
credit risk arising out of deficient documentation or settlement risk, under the
supervisory process.
Institutional
Developments - Banks
are urged to ensure that adequate disaster recovery systems are put in place to
fully comply with the requirements.
- Banks
are urged to draw up time-bound action plans for implementation of CBS across
all their branches.
- An
action plan to be drawn up for implementation of National Electronic Clearing
Service (NECS) using the existing infrastructure of National Electronic Funds
Transfer (NEFT) system with centralised clearing and settlement at Mumbai.
- Working
group to be constituted comprising representatives of the Reserve Bank, State
Governments and the Urban Cooperative Banks (UCBs) to examine the various areas
where IT support could be provided by the Reserve Bank to UCBs.
- The
Committee on Financial Sector Assessment (CFSA) (Chairman: Dr.Rakesh Mohan; Co-Chairman:
Dr.D.Subbarao) submitted an interim report delineating its approach and reviewing
the progress of work to the Finance Minister and Governor, Reserve Bank of India
in July 2007. The CFSA is expected to complete the assessment by March 2008 and
lay out a road-map for further reforms in a medium-term perspective.
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