PART TWO: THE WORKING AND OPERATIONS OF
THE RESERVE BANK OF INDIA
III MONETARY POLICY OPERATIONS
In balancing the twin objectives of price stability and growth, the conduct of monetary policy was conditioned by the
shift in policy challenge from “management of recovery” to “management of inflation”. During the first half of
2010-11, policy was geared towards non-disruptive normalisation of the monetary policy stance, which supported
consolidation of growth. Inflation stayed elevated, but the sources of inflationary pressures warranted cautious
calibration of the normalisation process. The anti-inflation accent of monetary policy became stronger during the
second half of the year, as the inflation process became generalised and sticky in an environment of strong growth.
Furthering transparency about the monetary policy process, minutes of the meetings of the Technical Advisory
Committee on Monetary Policy are now being released in the public domain. The operating framework for monetary
policy was modified in May 2011, with the switchover to repo rate as the single policy rate for better signalling the
stance of monetary policy.
III.1 The monetary policy stance in 2010-11
changed course during the year, from calibrated
normalisation to tightening driven by inflation
concerns. Liquidity conditions remained consistent
with the shift in monetary policy stance, though some
of the key determinants of liquidity remained volatile.
The cumulative effect of transient factors (such as
advance tax collections), frictional factors (large
government surplus balances) and structural factors
(i.e., high increase in currency in circulation and higher
credit growth relative to deposit growth) culminated
in large deficit liquidity conditions, which were
managed by the Reserve Bank through an
appropriate mix of SLR, OMO and LAF.
III.2 A number of steps were taken during 2010-11
to enhance the communication of monetary policy.
The Reserve Bank introduced mid-quarter reviews
during the year. Another notable development during
2010-11 was the introduction of the Base Rate system
which replaced the Benchmark Prime Lending Rate
(BPLR) with effect from July 2010. This helped in
improving the assessment of the transmission of
monetary policy (Box III.1).
Role of communication in monetary policy
III.3 Monetary policy acts on its ultimate objectives
of price stability and growth with long and variable
lags. Given these lags in monetary transmission,
effective communication of monetary policy
objectives, rationale for policy actions and expected
outcomes is critical. Effective communication along
with appropriate monetary actions can help anchor
inflation expectations. Like other central banks, the
Reserve Bank has also placed a lot of emphasis on
effective communication of its policy objectives. The
stance of monetary policy and the rationale are
communicated to the public in a variety of ways –
periodic monetary policy statements, other
publications, speeches by the top management and
press releases. In order to further enhance the efficacy
of the communication process, a number of steps
have been taken in the recent period. From
September 2010, the Reserve Bank introduced Mid-
Quarter Reviews (MQRs) to combine the rigour and
comprehensiveness of the quarterly process with the
need for flexibility to respond in a fast evolving global
and domestic macroeconomic situation.
Box III.1
Monetary Policy Transmission after the Switchover to Base Rate
The Benchmark Prime Lending Rate (BPLR), introduced in
2003, was expected to serve as the benchmark rate for
pricing of loan products by reflecting the actual cost of funds
for banks. The BPLR system, however, fell short of its original
objective of bringing transparency to lending rates. This was
mainly because banks could lend below the BPLR under
the system. The share of sub-BPLR lending (excluding export
credit and small loans) of SCBs was as high as 77 per cent
in September 2008, before dropping to 70 per cent, which
was still very high, during the quarter ended June 2010. As
a result, it was difficult to assess the transmission of policy
rates of the Reserve Bank to lending rates of banks.
In order to address these concerns, the Reserve Bank
announced the constitution of a Working Group (Chairman:
Shri Deepak Mohanty) in the Annual Policy Statement of
2009-10 to review the BPLR system and suggest changes
to make credit pricing more transparent. The Working Group
submitted its Report in October 2009 and based on the
recommendations of the Group and the suggestions from
various stakeholders, the Reserve Bank issued guidelines
on the Base Rate system in April 2010. The system of Base
Rate, that came into effect on July 1, 2010, replaced the
BPLR system.
Under the new system, the actual lending rate charged to
borrowers is the Base Rate plus borrower-specific charges.
The Base Rate is the minimum rate for all loans and banks
are not permitted to resort to any lending below the Base
Rate except some specified categories such as:
(a) Differential Rate of Interest (DRI) advances, (b) loans to
banks’ own employees, (c) loans to banks’ depositors against
their own deposits, (d) interest rate subvention given by
government to agricultural loans and rupee export credit,
and (e) some specific cases of restructured loans. The
interest rates on small loans up to `2 lakh and rupee export
credit have been deregulated to increase the flow of credit
to small borrowers and exporters at reasonable rates. With
these measures, the Reserve Bank achieved complete
deregulation of interest rates relating to rupee lending by
commercial banks. The Base Rate system was expected to
facilitate better pricing of loans, enhance transparency in
lending rates and improve the assessment of the
transmission of monetary policy. Though the experience so
far is limited, it suggests that these objectives have been
largely met.
The Reserve Bank has increased the repo rate by 325 basis
points (bps) since mid-March 2010. The effective tightening
of the policy rate has, however, been of the order of 475 bps
as the system migrated from surplus mode to deficit mode.
In response, Base Rates have been raised by 75-375 bps between July 2010 and August 11, 2011 (Table 1). The range
of increase was, however, much narrower, i.e., 175-375 bps
for 49 major banks.
Table 1: Variation in Policy Rate of the Reserve Bank and
Deposit/Lending
Rates of SCBs |
(bps) |
Period |
Increase in
Repo
Rate |
Increase in Deposit Rates |
Increase in
Lending Rate |
Base Rate |
BPLR |
Mid-March 2010 to
May 2010 |
50 |
25-160 |
Not
Applicable |
No Change |
June 2010 to
August 11, 2011 |
275 |
25-550 |
75-375 |
100-375 |
It has been observed that there is greater convergence
amongst banks in fixing the Base Rate over time vis-a-vis
under the BPLR system. As a result, the Base Rate system
is found to be more transparent and more responsive to hikes
in policy rates by the Reserve Bank compared to the BPLR
system. This is reflected in the average increase in the Base
Rate by public and private sector banks since July 2010. It
is seen that the pace of increase in Base Rate in response
to increase in policy rate was initially slower but picked up
momentum during December 2010-February 2011. Also, the
number of days taken by these banks to raise their Base
Rates went down during this period (Table 2). However,
following gradual moderation in the growth of non-food credit,
the pace of increase in Base Rate relative to that of the repo
rate slowed down from February 2011 onwards, while the
number of days taken to raise the Base Rate also increased.
Table 2: Extent of Increase in Base Rate and Time
Taken by
Public/Private Sector Banks |
Period
(Month over
Month) |
Increase
in Repo
Rate (bps) |
Average
increase in
Base Rate
(bps) |
Average
no. of days
taken to raise
Base Rate |
Dec.10/July 10 |
75 |
58 |
140 |
Feb.11/Dec.10 |
25 |
65 |
74 |
May 11/Feb.11 |
75 |
64 |
88 |
August 11, 11/May 11 |
125 |
69 |
87 |
Thus, not only has there been a larger degree of convergence
of the Base Rates across banks, they have also become
more responsive to increase in policy rates of the Reserve
Bank. As a result, the assessment of the transmission of
monetary policy has strengthened under the new system,
from that under the BPLR system.
III.4 Steps taken to strengthen the existing two-way
communication process include webcasting of the
Governor’s press conference and interaction with
researchers/analysts on monetary policy after the quarterly reviews. Audio recordings and transcripts
of the press conference and the teleconference with
researchers/analysts are also put on the Reserve
Bank’s website.
III.5 As a part of its communication policy and
given the objective of more transparency, the
Reserve Bank is endeavouring to put in public
domain all data/inputs that go into the formulation
of monetary policy. Accordingly, the main points of
discussion in the meetings of the Technical Advisory
Committee (TAC) on Monetary Policy are being
placed on the website, roughly four weeks after the
meeting of the Committee. The first such release
was in February 2011 of the TAC meeting in January
2011.
Introduction of mid-quarter reviews
III.6 Most major central banks make frequent
monetary policy announcements ranging from 8 to
12 announcements a year. Monetary and credit policy
was traditionally reviewed by the Reserve Bank twice
a year. Over time, a need was felt to increase the
frequency of the policy communication and the Annual
Policy Statement of 2005-06 announced the
introduction of more frequent reviews of monetary
policy, at quarterly intervals. The proposed quarterly
reviews of monetary policy were intended to provide
the opportunity for structured communication with
markets on a more frequent basis, while retaining the
flexibility to take specific measures warranted by
evolving circumstances.
III.7 The gap of a quarter between policy reviews
was felt too long in a rapidly evolving macroeconomic
situation. There were several occasions (April, June
and September-December 2008; January and March
2009; March and July 2010) when the Reserve Bank
had to take policy actions in response to
macroeconomic developments. While these
instances questioned the discipline of the quarterly
schedule, they also underscored the need for
flexibility.
III.8 Accordingly, the First Quarter Review of
Monetary Policy for July 2010 announced the
introduction of MQRs. By instituting MQRs, the
Reserve Bank intended to take the surprise element
out of the off-cycle actions. The Reserve Bank,
however, reserves the flexibility to take swift and preemptive
policy actions, as and when warranted by the evolving macroeconomic developments. It was
decided to announce the MQRs in June, September,
December and March by way of a press release,
providing a rationale for either action or maintenance
of the status quo. The first MQR was announced in
September 2010.
III.9 Unlike the Quarterly Reviews, the MQRs were
intended to be a less intensive process. In the run up
to the MQRs, there are no pre-policy consultations
with the stakeholders from the financial market and
the industry. However, there is a process of consulting
the members of the TAC. In order to take the advice
of the TAC members in the run up to the MQRs, the
Reserve Bank has instituted a mechanism to obtain
the views of the members through a structured
feedback format.
MONETARY POLICY OPERATIONS:
CONTEXT AND RATIONALE
III.10 The monetary policy stance in 2010-11
evolved in line with changing domestic growth-inflation
dynamics. In the first half of 2010-11, the thrust of
monetary policy was on avoiding policy impediments
to the recovery amidst global uncertainties, while also
containing inflationary pressures. Headline inflation,
which touched double digits in the first quarter of 2010-
11, showed moderation in the second quarter of the
year, but remained above the comfort zone of the
Reserve Bank. Food inflation remained high on
account of structural demand-supply imbalances
despite normal monsoons. Though non-food
manufactured products inflation declined from the
elevated levels seen at the start of the year, it
remained sticky and above its medium term trend.
Considering global uncertainties and associated
implications for domestic growth and the fact that
inflation was largely driven by supply side factors, the
Reserve Bank followed calibrated normalisation of
policy (Table III.1).
III.11 In the second half of 2010-11, while growth
continued to consolidate, the moderating path of
inflation reversed beginning December 2010 due to
a series of supply side shocks, both domestic and global. Food prices registered sharp increases in
December 2010 and January 2011 following
unseasonal increase in vegetable prices. The sharp
increase in global prices of raw cotton and rubber, metals and minerals were transmitted quickly to the
domestic markets during the second half of the year.
Even as mineral oil price inflation showed an uptick,
it was less than the extent of the global crude price
inflation as the administered mineral oil prices
remained unchanged. Robust demand conditions saw
input price pressures being increasingly transmitted
to final output prices and rising core inflation. It was,
therefore, crucial to ensure that the elevated
inflationary expectations did not get entrenched.
Hence, towards the end of 2010-11, monetary policy
stance underwent a shift as the Reserve Bank
deviated from the calibrated approach and took
stronger monetary policy measures. This was
warranted to ensure that the long-term growth
prospects were not harmed, even if it meant sacrificing
some growth in the short-term (Table III.2).
Table III.1: Movements in Key Policy Rates and
Reserve Requirements in India |
(Per cent) |
Effective since |
Reverse Repo Rate |
Repo Rate |
Cash Reserve Ratio |
Marginal Standing Facility Rate |
1 |
2 |
3 |
4 |
5 |
February 13, 2010 |
3.25 |
4.75 |
5.50 (+0.50) |
- |
February 27, 2010 |
3.25 |
4.75 |
5.75 (+0.25) |
- |
March 19, 2010 |
3.50 (+0.25) |
5.00 (+0.25) |
5.75 |
- |
April 20, 2010 |
3.75 (+0.25) |
5.25 (+0.25) |
5.75 |
- |
April 24, 2010 |
3.75 |
5.25 |
6.00 (+0.25) |
- |
July 2, 2010 |
4.00 (+0.25) |
5.50 (+0.25) |
6.00 |
- |
July 27, 2010 |
4.50 (+0.50) |
5.75 (+0.25) |
6.00 |
- |
September 16, 2010 |
5.00 (+0.50) |
6.00 (+0.25) |
6.00 |
- |
November 2, 2010 |
5.25 (+0.25) |
6.25 (+0.25) |
6.00 |
- |
January 25, 2011 |
5.50 (+0.25) |
6.50 (+0.25) |
6.00 |
- |
March 17, 2011 |
5.75 (+0.25) |
6.75 (+0.25) |
6.00 |
- |
May 3, 2011 |
6.25 (+0.50) |
7.25 (+0.50) |
6.00 |
8.25* |
June 16, 2011 |
6.50 (+0.25) |
7.50 (+0.25) |
6.00 |
8.50 (+0.25) |
July 26, 2011 |
7.00 (+0.50) |
8.00 (+0.50) |
6.00 |
9.00 (+0.50) |
Note: 1. Reverse repo indicates absorption of liquidity and repo indicates
injection of liquidity.
2. Figures in parentheses indicate change in policy rates in per cent.
* : Marginal Standing Facility is with effect from May 9, 2011. |
III.12 Based on the Report of the Working Group to
Review the Operating Procedures of Monetary Policy
in India (Chairman: Shri Deepak Mohanty) and in the
light of the feedback received, changes relating to
operating procedures of monetary policy were
announced in the Monetary Policy Statement for 2011-
12 (Box III.2).
Table III.2: Monetary Policy Reviews
Monetary Policy Statement 2010-11
Backdrop:
- Broad-based recovery taking firm hold with rising domestic
and external demand.
- Inflation pressures, initially driven by food prices, becoming
more generalized.
- Corporates regaining pricing power in many sectors.
- Inflation expectations of the households at elevated level.
Baseline Projection/Indicative Trajectory:
- 8.0 per cent real GDP growth (with an upside bias) during
2010-11.
- 5.5 per cent WPI inflation for March 2011.
- 17.0 per cent, 18.0 per cent and 20.0 per cent growth in M3,
aggregate deposits and non-food credit, respectively, during
2010-11.
Measures:
- Increase in repo rate, reverse repo rate and CRR by 25 basis
points each.
Expected Outcome:
- Contain inflation and anchor inflationary expectations.
- Sustain the recovery process.
- Meet government borrowing requirements and the private
credit demand.
- Align policy instruments in a manner consistent with the
evolving state of the economy.
Mid-Cycle Policy Measure: July 2, 2010
Backdrop:
- Double-digit headline inflation levels.
- Petrol prices were decontrolled and prices of remaining
administered fuel such as diesel, LPG and kerosene were
increased in end-June 2010.
Measures:
- Increase in repo rate and reverse repo rate by 25 basis points
each (with the LAF window having moved to deficit mode
from end-May 2010, effective tightening of 175 basis points).
First Quarter Review of Monetary Policy 2010-11
Backdrop:
- Growth process registered further momentum during Q1 of
2010-11.
- Overall food inflation at elevated level.
- Rise in administered prices of iron ore and electricity.
- Non-food manufactured products inflation much higher than
the medium-term trend.
Baseline Projection/Indicative Trajectory:
- 8.5 per cent real GDP growth during 2010-11.
- 6.0 per cent WPI inflation for March 2011.
Measures:
- Increase in repo rate and reverse repo rate by 25 basis points
and 50 basis points, respectively.
Mid Quarter Review: September 2010
- Inflation continued to be the dominant concern for policy.
- Increase in repo rate and reverse repo rate by 25 basis points
and 50 basis points, respectively.
Second Quarter Review of Monetary Policy 2010-11
Backdrop:
- Normal monsoons raised the prospects of good Kharif
cultivation.
- Quarterly industrial outlook survey showed improvement in
the overall business conditions.
- Moderation in food inflation not commensurate with a normal
monsoon, due to continued elevated prices of protein-rich
food items.
- Non-food primary articles, specifically fibres registered
significant inflation.
Baseline Projection/Indicative Trajectory:
- 8.5 per cent real GDP growth during 2010-11.
- 5.5 per cent WPI inflation (under the new base) for March
2011, equivalent to 6.0 per cent inflation under the old base.
Measures:
- Increase in repo rate and reverse repo rate by 25 basis points
each.
Expected Outcome:
- Sustain the anti-inflationary thrust of the recent monetary
actions and outcomes in the face of persistent inflation risk.
- Rein in rising inflationary expectations that could be
aggravated by the structural nature of food price increases,
while not disrupting growth.
Mid Quarter Review: December 2010
-
Management of liquidity came to the forefront of policy
concerns, following the excessive tightness in money markets.
-
The SLR of SCBs was reduced from 25 per cent of their NDTL
to 24 per cent with effect from December 18, 2010.
-
Staggered OMO auctions for purchase of government
securities for an aggregate amount of `48,000 crore
announced.
-
These measures were expected to release sizeable primary
liquidity into the system, bringing down the liquidity deficit in
the system close to the comfort zone of the Reserve Bank
while stabilising interest rates in the overnight inter-bank
market closer to the operative policy rate of the Reserve Bank.
Third Quarter Review of Monetary Policy 2010-11
Backdrop:
- Real GDP increased by 8.9 per cent during the first half of
2010-11, reflecting strong domestic demand, especially
private consumption and investment, and improving external
demand.
- Series of commodity price shocks – vegetable prices, crude
oil prices.
Baseline Projection/Indicative Trajectory:
- 8.5 per cent real GDP growth (with an upside bias) during
2010-11.
- 7.0 per cent WPI inflation for March 2011.
Measures:
- Increase in repo rate and reverse repo rate by 25 basis
points each.
Mid Quarter Review: March 2011
- Inflation pressures accentuated further after January 2011.
- Inflation estimated at around 8 per cent for March 2011.
- Increase in repo rate and reverse repo rate by 25 basis points
each.
Monetary Policy Statement 2011-12
Backdrop:
- Very sharp rise in inflation and elevated inflationary
expectations.
- Rise in inputs costs quickly passed on to domestic
manufactured goods.
- Signs of moderation in growth particularly investment
spending.
- Rise in administered coal prices in end-February 2011.
Baseline Projection/Indicative Trajectory:
- 8.0 per cent real GDP growth during 2011-12.
- 6.0 per cent WPI inflation (with an upward bias) for March
2012.
- 16.0 per cent, 17.0 per cent and 19.0 per cent growth in M3, aggregate deposits and non-food credit of SCBs, respectively.
Measures:
- Repo rate increased by 50 basis points to 7.25 per cent.
- Reverse repo rate, determined with a spread of 100 basis
points below the repo rate, automatically adjusted to 6.25
per cent.
- Marginal Standing Facility (MSF) rate, determined with a
spread of 100 basis points above the repo rate, fixed at 8.25
per cent.
- Interest rate on savings bank deposit rate increased from 3.5
per cent to 4.0 per cent.
Expected Outcome:
- Contain inflation by reining in demand-side pressures.
- Anchor inflationary expectations and sustain the growth in
the medium-term by containing inflation.
Mid Quarter Review: June 2011
- The monetary policy stance remains anti-inflationary.
- Repo rate increased by 25 basis points.
First Quarter Review of Monetary Policy 2011-12
Backdrop:
- Some moderation underway in industrial production.
- Prospects of agriculture not clear.
- Continued high level of inflation.
- Rise in administered fuel prices in June 2011.
Baseline Projection/Indicative Trajectory:
- 8.0 per cent real GDP growth during 2011-12.
- 7.0 per cent WPI inflation for March 2012.
- 15.5 per cent and 18.0 per cent growth in M3 and non-food
credit of SCBs, respectively.
Measures:
- Repo rate increased by 50 basis points to 8.0 per cent.
- Reverse repo rate, determined with a spread of 100 basis
points below the repo rate, automatically adjusted to 7.0 per
cent.
- MSF rate, determined with a spread of 100 basis points above
the repo rate, fixed at 9.0 per cent.
Box III.2
Changes in Operating Procedure of Monetary Policy
Background
The operating procedure of monetary policy in India has
witnessed significant changes since the beginning of the
1990s with developments in money market and changes in
liquidity conditions brought about by financial sector reforms.
In this process, the LAF, introduced in June 2000, emerged
as the principal operating procedure of monetary policy, with
the repo and the reverse repo rates as the key instruments
for signalling the monetary policy stance. LAF, supported by
instruments such as the CRR, OMO and MSS, had served
the Indian monetary and financial system well. Large volatility
in capital flows and sharp fluctuations in government cash
balances, however, posed several challenges to liquidity
management by the Reserve Bank.
Thus, the first Quarter Review of Monetary Policy for 2010-
11 proposed the need for revisiting the operating procedures
of monetary policy in India. Accordingly, on October 1, 2010,
a Working Group (Chairman: Shri Deepak Mohanty) was
constituted with members drawn from the Reserve Bank,
financial market participants and the academia.
Changes in the Extant Operating Procedures of Monetary
Policy
Based on the Group’s recommendations and the feedback
received, the following changes in the extant operating
procedures of monetary policy were effected as announced
in the Monetary Policy Statement for 2011-12:
- The weighted average overnight call money rate is now
the operating target of monetary policy.
- The repo rate has acquired the status of being the only
one independently varying policy rate.
- A new MSF has been instituted from which SCBs can
borrow overnight up to 1.0 per cent of their respective
NDTL at 100 basis points above the repo rate.
The revised corridor has a fixed width of 200 basis points.
The repo rate has been placed in the middle of the corridor,
with the reverse repo rate 100 basis points below it and the
MSF rate 100 basis points above it. However, the Reserve
Bank will have the flexibility to change the width of the corridor,
should monetary conditions so warrant.
Asset price implications for monetary policy
III.13 In general, wealth impact is not observed to
be very significant in India. Only a small portion of
savings, i.e., about 12 per cent of total savings of the
household sector in financial assets, is invested in
the equity market. In many advanced economies, the
share of such investment in total financial savings is
much bigger. Therefore, cooling down of the equity
market should not have any significant impact on the
aggregate demand. As regards, the real estate
market, home owners in India, unlike advanced
economies, do not borrow against the houses already
purchased when their valuations go up. As such,
cooling of real estate prices should also not have any
significant impact on consumption and hence
aggregate demand. Thus, asset prices do not seem
to influence the inflation path and conduct of monetary
policy may refrain from responding directly to asset
price cycles. The Reserve Bank has used both micro
and macro prudential measures to limit the risks to
financial stability from asset price cycles. Monetary
policy, as a macroeconomic policy tool, enables an
environment in which prudential regulation works
more effectively.
Overall Assessment
III.14 During the major part of 2010-11, the stance
of the monetary policy was for calibrated
normalisation. The moderation in inflation in Q2 and
Q3 of 2010-11 justified such a calibrated approach.
As the LAF window of the Reserve Bank transited
from a surplus to a deficit mode, consistent with the
Reserve Bank’s anti-inflationary stance and its
calibrated approach to absorb surplus liquidity,
liquidity management also became a central focus in
2010-11. It had to be ensured that the primary liquidity
needs of an expanding economy were met in a
manner consistent with the anti-inflationary monetary
policy stance. Inflation pressures, however, intensified
in Q4 of 2010-11 even as the growth process showed
some signs of moderation. The proximate cause of
the intensification of inflationary pressure was a series
of supply side shocks, both domestic and global,
which rapidly fed into a broad spectrum of
manufactured products. The inflation pressures and
elevated inflation expectations emerged as a source
of risk to future growth. Accordingly, the stance of
monetary policy for 2011-12 gave foremost priority to
containing inflation and anchoring inflation expectations even at the cost of some growth in the
short-run.
Management of liquidity – evolving factors driving
Reserve Bank’s operations
III.15 During 2010-11, the centre’s cash balance
with the Reserve Bank and currency in circulation
were key drivers of autonomous liquidity. With the
consolidation of economic growth, credit growth
accelerated faster than deposit mobilisation, leading
to structural squeeze on liquidity for an extended
period. The deficit liquidity conditions were reflected
in large recourse to the LAF repo window (Chart III.1).
The Reserve Bank actively managed liquidity so that
neither a surplus diluted monetary transmission, nor
a deficit choked fund flows. While the overall liquidity
in the system remained in deficit, consistent with the
policy stance, the extent of deficit went beyond the
Reserve Bank’s comfort zone of (+)/(-) one per cent
of NDTL of banks, requiring appropriate policy
measures (Table III.3).
III.16 The liquidity conditions changed significantly
during Q1 of 2010-11. With the recovery of the
economy firmly in place, the Reserve Bank moved in
a calibrated manner in the direction of normalising its
policy instruments. Accordingly, there was gradual moderation in the volume of surplus liquidity in the
system from February 2010. The liquidity conditions
switched to deficit mode from end-May 2010, due to
large increase in government balances with the
Reserve Bank generated from 3G/BWA spectrum
auctions and the first instalment of quarterly advance
tax payments in June 2010.
![1](http://rbi.org.in/scripts/images/8IIIMPO230811_1.gif) |
III.17 During Q2 2010-11, the liquidity conditions
continued to remain in deficit mode till end-July 2010
and eased thereafter mainly on account of large scale
public debt redemptions. After a brief period of surplus
liquidity (from end-August to early-September 2010),
it again switched to deficit mode as liquidity migrated
to government balances with the Reserve Bank on
account of the second quarterly advance tax
payments.
III.18 The liquidity conditions tightened significantly
during Q3 2010-11 mainly due to autonomous factors,
i.e., increase in the government’s surplus balance with
the Reserve Bank and currency in circulation
compounded by the structural liquidity mismatch
faced by banks. The government’s surplus balance
peaked in December 2010 reflecting advance tax
collections. The net injection under the LAF peaked
at `1,70,485 crore during the third week of December
2010 (Chart III.2).
![2](http://rbi.org.in/scripts/images/8IIIMPO230811_2.gif) |
Table III.3: Liquidity Management Measures taken by the Reserve Bank in 2010-11 |
Time Period/Event |
Measures |
1 |
2 |
End-May 2010 : Larger than
anticipated collection from 3G/BWA
spectrum auctions in addition to
advance tax outflows resulted in
migration of liquidity to central
government’s cash balance account
with the Reserve Bank |
For the period May 28, 2010-July 2, 2010, SCBs were :
(i) Allowed to avail additional liquidity support under the LAF to the extent of up to
0.5 per cent of their NDTL (for any shortfall in maintenance of SLR arising out of
availment of this facility, banks were allowed to seek waiver of penal interest).
(ii) Given access to second LAF (SLAF) on a daily basis. With the persistence of
deficit liquidity conditions, measure (i) was extended up to July 16, 2010 and
measure (ii) up to July 30, 2010. |
End-October 2010 : Frictional liquidity
pressure due to autonomous factors |
(i) The Reserve Bank conducted special SLAF on October 29 and November 1,
2010, a special two-day repo auction under the LAF on October 30, 2010, and
allowed waiver of penal interest on shortfall in maintenance of SLR (on October
30-31, 2010) to the extent of 1.0 per cent of NDTL for availing additional liquidity
support under the LAF.
(ii) The Reserve Bank extended these liquidity easing measures further and
conducted SLAF on all days during November 1-4, 2010 and extended the
period of waiver of penal interest on shortfall in maintenance of SLR (to the
extent of 1.0 per cent of NDTL) for availing additional liquidity support under the
LAF till November 7, 2010.
(iii) The Reserve Bank purchased government securities under OMO from November
4, 2010.
(iv) On November 9, 2010, the Reserve Bank reintroduced daily SLAF and extended
the period of waiver of penal interest on shortfall in maintenance of SLR to the
extent of 1.0 per cent of NDTL for availing additional liquidity support under the
LAF till December 16, 2010.
(v) On November 29, 2010, the Reserve Bank extended the daily SLAF and allowed
additional liquidity support to the SCBs under the LAF to the extent of up to 2.0
per cent of their NDTL till January 28, 2011. |
Mid-December 2010 : Continued build
up in government balances on
account of third quarterly advance tax
collections |
In the MQR, the Reserve Bank:
(i) Reduced the SLR of SCBs from 25 per cent of NDTL to 24 per cent with effect
from December 18, 2010. Given the permanent reduction in the SLR, additional
liquidity support of 1.0 per cent of NDTL was made available from December
18, 2010 to January 28, 2011.
(ii) Announced conduct of OMO auctions for purchase of government securities
for an aggregate amount of `48,000 crore over the next one month (staggered
as purchases of `12,000 crore per week). |
End-January 2011: Frictional and
structural liquidity pressure |
In the Third Quarter Review of January 2011, the Reserve Bank extended the daily
SLAF and additional liquidity support to SCBs of 1.0 per cent of NDTL under the LAF
till April 8, 2011.
Subsequently, both the measures were extended till May 6, 2011. |
III.19 At the start of Q4 2010-11, injections under
the LAF declined marginally due to the cumulative
impact of decline in surplus balances of the Centre
and staggered OMO carried out by the Reserve Bank
in December 2010-January 2011. During 2010-11, the
Reserve Bank purchased government securities for
an aggregate amount of about `67,000 crore under OMO auctions. The liquidity conditions improved
further in February 2011 with the decline in the surplus
balances of the Centre. Notwithstanding the quarterly
advance tax outflows during mid-March 2011, the
liquidity deficit remained controlled on account of
higher government expenditure during the month.
Thus, the quantum of liquidity deficit declined in Q4 as compared with Q3, mainly on account of
the Reserve Bank’s OMO purchases and the
decline in government cash balances with the
Reserve Bank.
III.20 The current financial year began with liquidity
remaining in absorption mode in the first week of
April 2011 on account of high government
expenditure and the absence of normal government
securities auctions. The liquidity conditions again
shifted to injection mode from the second week of
April 2011. The average daily net liquidity injection
declined significantly to about `19,000 crore during
April 2011 from about `81,000 crore in March 2011.
While the negative government balance with the
Reserve Bank added liquidity into the system, the
increasing currency with the public acted in the
opposite direction during the month. The liquidity
conditions tightened further in May 2011 as the gap
between pace of credit growth and deposit
mobilisation by banks, which had been narrowing
from end-December 2010, reversed trend and
increased in May 2011. There was also a decline in
WMA/OD availed by the government.
III.21 The liquidity conditions remained in deficit
mode in June 2011 due to quarterly advance tax
outflows. The average daily net liquidity injection
increased further to around `74,000 crore. The
liquidity conditions improved at the beginning of July
2011 partly on account of redemption of a security
with outstanding stock of `37,000 crore. The liquidity
deficit, however, increased subsequently and the
average daily net liquidity injection was around
`44,000 crore during July 2011. The average daily
net liquidity injection under the LAF was around
`37,000 crore during August 1-16, 2011. Up to
mid-August 2011, availment of funds under the MSF,
which came into operation in May 2011, has happened
only twice.
III.22 As the main drivers of liquidity conditions
varied from quarter to quarter as discussed above,
the Reserve Bank had to manage liquidity actively
while avoiding any possible conflict with the monetary
policy stance. Persistence of inflation at elevated level
was a key challenge for monetary policy, despite
evidence of strengthening monetary policy
transmission.
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