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RBI and Monetary Policy in India
RBI and Monetary Policy in India
Monetary Magnitudes
M1 = Currency with public+ Demand deposits with banks+ Other Deposits with RBI M2 = M1+ Post Office Deposits M3 = M1+ Time Deposits with Banks M4 = M3+ Total Post Office Deposits
Credit Policy
Central Bank may directly affect the money supply to control its growth. Or it might act indirectly to affect cost and availability of credit in the economy. In modern times the bulk of money in developed economies consists of bank deposits rather than currencies and coins. So central banks today guide monetary developments with instruments that control over deposit creation and influence general financial conditions. Credit policy is concerned with changes in the supply of credit. Central Bank administers both the Credit and Monetary policy
Contd..
Price Stability contributes improvements in the standard of living of people. It promotes saving in the economy while discouraging unproductive investment. Stable prices enable exports to compete in international markets and contribute to the strengthening of BoP. Price stability leads to interest rate stability, and exchange rate stability (via export import stability). It contributes to the overall financial stability of the economy.
Instruments
1. Discount Rate (Bank Rate) 2.Reserve Ratios 3. Open Market Operations
Intermediate Target
Monetary Aggregates(M3) Long term interest rates
Ultimate Goals
Total Spending Price Stability Etc.
Adjusted non-food credit projected to increase by around 20 per cent, implying a calibrated deceleration from a growth of around 30 per cent ruling currently. Appropriate liquidity to be maintained to meet legitimate credit requirements, consistent with price and financial stability. Primary Dealers to be permitted to diversify their activities. 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 at this juncture will be: to ensure a monetary and interest rate environment that enables continuation of the growth momentum consistent with price stability while being in readiness to act in a timely and prompt manner on any signs of evolving circumstances impinging on inflation expectations. to focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic, in particular, financial stability. to respond swiftly to evolving global developments.
Excluding the end-March effect, the year-on-year increase in aggregate deposits during 2005-06 (March 31, 2006 over April 1, 2005) was 16.9 per cent (Rs.3,02,534 crore) as against an increase of 12.8 per cent (Rs.1,92,269 crore), net of conversion, in the previous year. Excluding the end-March build-up, the year-on-year increase in non-food bank credit during 2005-06 (over April 1, 2005) was 30.8 per cent (Rs.3,42,493 crore) on top of 27.5 per cent (Rs.2,21,602 crore), net of conversion, a year ago. Financial markets remained generally stable during 2005-06 although interest rates firmed up in all segments and the uncollateralised overnight call market experienced persistent tightness during the last quarter of the year. A noteworthy and desirable development during the year was the substantial migration of money market activity from the uncollateralised call money segment to the collateralised market repo and collateralised borrowing and lending obligations (CBLO) markets. The total overhang of liquidity as reflected in outstandings under the Liquidity Adjustment Facility (LAF), the Market Stabilisation Scheme (MSS) and surplus cash balances of the Central Government taken together declined from an average of Rs.1,14,192 crore in March 2005 to Rs.74,334 crore in March 2006. For the first time since 1969, investment by SCBs in Government and other approved securities declined by Rs.11,576 crore in 2005-06 in contrast to an increase of Rs.49,373 crore, net of conversion, in 2004-05. During 2005-06, the Central Governments net market borrowings at Rs.95,370 crore were 86.5 per cent of the budgeted amount of Rs.1,10,291 crore and gross market borrowings of Rs.1,58,000 crore were 88.5 per cent of the budgeted amount of Rs.1,78,487 crore.
External Developments
In US dollar terms, merchandise exports increased by 24.7 per cent during 2005-06 as compared with 26.4 per cent in the previous year. Imports showed an increase of 31.5 per cent as compared with 36.4 per cent in the previous year. While the increase in oil imports was higher at 46.8 per cent as compared with 45.2 per cent in the previous year, non-oil imports showed an increase of 25.6 per cent as compared with 33.3 per cent in the previous year. Indias foreign exchange reserves increased by US $ 10.1 billion from US $ 141.5 billion at end-March 2005 to US $ 151.6 billion by end-March 2006. The foreign exchange market remained orderly in 2005-06 with the exchange rate exhibiting two-way movements. During 2005-06, the rupee depreciated by 1.9 per cent against the US dollar but appreciated by 4.4 per cent against the euro, by 5.5 per cent against the pound sterling and by 7.5 per cent against Japanese yen.
Global Developments
Global growth moderated in the fourth quarter (Q4) of 2005, but is estimated to have risen to 4.8 per cent by the International Monetary Fund (IMF) for the full year in view of the broad-based expansion in economic activity. Though price stability has been maintained in major industrial countries in the face of the oil shock, risks loom large in the form of lagged second order effects of oil price increases, geopolitical tensions, the probability of disorderly and rapid adjustment of current account imbalances and the risks emanating from the housing market, particularly when the cycle turns down.
Overall Assessment
Macroeconomic and financial conditions have evolved as stronger than expected. Inflation has been contained well within the projected range as reflected in the relative stability of long-term interest rates. There are indications of improvement in the fiscal situation and the return to the path of correction set by the Fiscal Responsibility and Budget Management Rules. Global growth has also exhibited considerable resilience. Downside risks to the economic outlook internationally continue in the form high and volatile oil prices, geo-political tensions and supply shocks, elevated asset prices, global imbalances and tightening of monetary policy globally. In the domestic economy, non-food credit growth, deposit growth and money supply growth were higher than the projections. Asset prices have registered a substantial increase. Ensuring credit quality and increasing the pace of investment in infrastructure is important.
The Reserve Bank will continue to ensure that appropriate liquidity is maintained in the system so that all legitimate requirements of credit are met, consistent with the objective of price and financial stability. Towards this end, RBI will continue with its policy of active demand management of liquidity through OMO including MSS, LAF and CRR, and 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 at this juncture will be: to ensure a monetary and interest rate environment that enables continuation of the growth momentum consistent with price stability while being in readiness to act in a timely and prompt manner on any signs of evolving circumstances impinging on inflation expectations. to focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic, in particular, financial stability. to respond swiftly to evolving global developments.
Monetary Measures
As on 18th April 2006: Bank Rate kept unchanged at 6.0 per cent. Reverse Repo Rate and Repo Rate kept unchanged at 5.5 per cent and 6.5 per cent, respectively. Cash reserve ratio (CRR) kept unchanged at 5.0 per cent. As on 15th Oct 2006: Policy Rates Bank Rate: 6% Repo Rate: 7% Reverse Repo Rate: 6% Reserve Ratios CRR: 5% SLR: 25%
Domestic Developments
During 2005-06: real GDP growth projected at around 7.0 % inflation rate in a range of 5.0-5.5 % and Money supply (M3) growth rate at 14.5 % For 2004-05: GDP growth placed at 6.9 % Inflation rate stood at 5.0 % at end-March 2005. M3 increased by 12.8 %. RBIs foreign currency assets increased by Rs.1,15,044 Crore. The expansionary impact of foreign currency assets was neutralised to a large extent by market stabilisation scheme (MSS) in conjunction with reverse repo operations under liquidity adjustment facility (LAF).
Non-food credit increased by 26.5 per cent. Total flow of funds from Scheduled Commercial Banks increased by 23.6 per cent exceeding the growth of 19.0 per cent anticipated in October 2004. Combined market borrowings of the Centre and States were lower. During 2004-05, financial markets remained generally stable. While interest rates in money and government securities markets rose intra-year, they stabilised in the later part of the year, albeit at higher levels. While the share of sub-PLR lending rose, lending rates remained stable.
External Developments
Exports in US dollar terms increased by 27.1 per cent while Imports by 36.4 per cent leading to widening of trade deficit to US $ 23.8 billion during 2004-05 (upto February). During 2004-05 (April-December), current account showed a deficit of US $ 7.4 billion as against a surplus of US $ 4.8 billion in the corresponding period of the previous year, Net accretion to foreign exchange reserves, including valuation changes, amounted to US $ 18.2 billion during April-December 2004. Indian foreign exchange market witnessed orderly condition with rupee exhibiting two-way movements.
Global Developments
Though world economy is projected to slow to 4.3 per cent in 2005, expansion is above trend. Oil price appears to have larger permanent component. Risk to growth arises from current account and fiscal imbalances necessitating exchange rate adjustment. The global financial system is stable but risks have increased.
(i)
Provision of appropriate liquidity to meet credit growth and support investment and export demand in the economy while placing equal emphasis on price stability, (ii) Consistent with the above, to pursue an interest rate environment that is conducive to macroeconomic and price stability, and maintaining the momentum of growth, and (iii) To consider measures in a calibrated manner, in response to evolving circumstances with a view to stabilising inflationary expectations.
To raise the ceiling of overseas investment by Indian entities in overseas joint ventures and/or wholly owned subsidiaries from 100 per cent to 200 per cent of their net worth under the automatic route. To accord general permission to Authorised Dealers (ADs) to open foreign currency accounts of the project offices set up in India by foreign companies and operate the accounts flexibly. RBI has set up an Expert Group to formulate strategy for increasing investment in agriculture. Survey to assess customer satisfaction on credit delivery in rural areas by banks-- proposed. It is proposed to increase the limit on loans to farmers through produce marketing scheme from Rs.5 lakh to Rs.10 lakh under priority sector lending. Banks urged to continue their efforts to step up credit to agriculture. RBI has enabled NGOs to access External Commercial Borrowings up to US $ 5 million
The Reserve Bank is reviewing all its existing guidelines on financing small scale sector, debt restructuring, nursing of sick units, etc with a view to rationalising, consolidating and liberalising them.
Under a scheme to be drawn up by the RBI, banks will be encouraged to establish mechanisms between their branches and branches of SIDBI for enhancing credit to small industries. The Reserve Bank will explore modalities to meet the growing financial needs of medium enterprises. RBI is in the process of reviewing the performance of RRBs (Regional rural Banks) and exploring restructuring of RRBs.
To issue guidelines on merger and amalgamation between private sector banks and with NBFCs. The principles underlying these guidelines would also be applicable as appropriate to public sector banks, subject to relevant legislation. Banks are urged to refocus on deposit mobilisation and empower the depositors, by providing wider access and better quality of banking services. RBI will implement policies to encourage banks which provide extensive services while disincentivising those which are not responsive to the banking needs of the community, including the underprivileged.
To set up an independent Banking Codes and Standards Board of India on the model of the mechanism in the UK in order to ensure that comprehensive code of conduct for fair treatment of customers are evolved and adhered to. To issue appropriate guidelines to banks to ensure transparency and disclosure of information by the card issuing banks and customer rights protection including facilitating enforcement of such rights. In order to maintain consistency and harmony with international standards, banks advised to adopt Standardised Approach for credit risk and Basic Indicator Approach for operational risk with effect from March 31, 2007.
The Reserve Bank would enter into bank-wise dialogues relating to ownership and governance in private banks to ensure a time-bound framework for compliance. On the basis of the feedback, the draft guidelines on securitisation of standard assets would be finalised. The guidelines on sale/purchase of non-performing assets would be finalised on the basis of feedback. The Report of the Working Group on Conflicts of Interest in the Indian Financial Services Sector (Chairman: Shri D.M. Satwalekar) would be put in the public domain for wider dissemination before recommending for adoption. The Vision Document for Payment and Settlement Systems indicating action points would be placed in the public domain for wider dissemination. A Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) was constituted as a Committee of the Central Board of RBI
The Reserve Bank proposes to operationalise National Electronic Funds Transfer (NEFT) System and NEFT (Extended). In order to facilitate the technology plans of the financial sector, RBI is preparing a Financial Sector Technology Vision Document which would be put in the public domain. RBI is examining the issue of smooth flow of bank finance to NBFCs. The Standing Committee on Procedures and Performance Audit on Public Services (Chairman: S.S. Tarapore) constituted by RBI has ceased its operations in March 2005. In order to facilitate regular monitoring, Ad hoc Committees in banks have been converted to permanent Standing Committees on Customer Service.
Contd
The conduct of monetary policy today is also influenced by Phelps' work. Central bankers have given up on the idea that interest-rate changes can influence the long-run rate of unemployment. Instead, they concentrate on controlling inflation. One tool: If the unemployment rate is below its long-run level, then the Fed is more likely to raise interest rates.
The US Bureau of Labor Statistics just reported that the unemployment rate was 4.6% in September2006. Joel Prakken, chairman of Macroeconomic Advisers, estimates that the natural rate is around 5.25%, though it could be as much as a half-point higher or lower. Behravesh pegs it somewhat lower, perhaps between 4.5% and 5%.
In either case, unemployment has fallen close to the level that would create an acceleration of wage growth. That would mean the Fed might be more likely to raise rates.