Annual Policy Statement for the Year 2005-06 by Dr. Y. Venugopal Reddy, Governor, Reserve Bank of India
The policy Statements of the Reserve Bank provide
a framework for the monetary, structural and prudential measures that are taken
from time to time against the background of an assessment of macroeconomic and
monetary developments. In order to provide a distinctive focus between monetary
policy and developmental policies, the format of presentation of this Statement
has been modified while broadly following the pattern already set in previous
years.
2. The Statement consists of two parts: Part
I. Annual Statement on Monetary Policy for the Year 2005-06; and Part II. Annual
Statement on Developmental and Regulatory Policies for the Year 2005-06. An
analytical review of macroeconomic and monetary developments was issued, a day
in advance, as a supplement to Part I of the Statement providing the necessary
information and technical analysis with the help of simple charts and tables.
3. There will be a Mid-term Review of the
annual policy Statement in October, as in the past, covering both Part I and
Part II of the Statement. In addition, there will be a First Quarter Review
of Part I of the Statement in July and a Third Quarter Review in January. While
the annual Statement and the Mid-term Review will continue, as in the past,
to be presented in the meeting with bankers, the quarterly reviews will be released
to the Press. The proposed quarterly reviews of monetary policy should provide
the opportunity for structured communication with markets on a more frequent
basis while retaining the flexibility to take specific measures as the evolving
circumstances warrant. Tentatively, for the current financial year, the dates
planned for the First Quarter Review, the Mid-term Review and the Third Quarter
Review are July 26, 2005, October 25, 2005 and January 24, 2006, respectively.
Part I. Annual
Statement on Monetary Policy for the Year 2005-06
The annual Statement on Monetary Policy for
the Year 2005-06 consists of three Sections:
I. Review of Macroeconomic and Monetary Developments during 2004-05;
II. Stance of Monetary Policy for 2005-06; and
III. Monetary Measures.
I. Review of Macroeconomic
and Monetary Developments during 2004-05
Domestic Developments
4. The mid-term Review of the annual policy
Statement released on October 26, 2004 had placed the real GDP growth for 2004-05
in the range of 6.0-6.5 per cent, lower than 6.5-7.0 per cent anticipated earlier
in the annual policy Statement. The downward revision was prompted by the combined
downside risk of high and uncertain oil prices and deficient monsoon rainfall
on GDP growth.
5. The advance estimate of GDP released by
the Central Statistical Organisation (CSO) in February 2005 has placed the GDP
growth at 6.9 per cent during 2004-05, which is higher than the expectations
of the mid-term Review but consistent with the projections of the annual policy
Statement. The GDP growth of 6.9 per cent during 2004-05 is on top of a higher
increase of 8.5 per cent in the previous year. During 2004-05, GDP from agriculture
and allied activities is estimated to have increased by 1.1 per cent, despite
deficient monsoon, as compared with 9.6 per cent in the previous year. GDP growth
from the industrial sector at 8.3 per cent is higher than 6.5 per cent in the
previous year reflecting higher growth in manufacturing. The services sector
has expanded by 8.6 per cent as compared with 8.9 per cent in the previous year.
6. The annual inflation rate as measured
by variations in the wholesale price index (WPI), on a point-to-point basis,
peaked from 4.6 per cent at end-March 2004 to 8.7 per cent by end-August 2004
after which it registered a steady decline. As at end-March 2005, the annual
point-to-point inflation rate stood at 5.0 per cent as compared with 4.6 per
cent a year ago. The inflation rate turned out as projected in the annual policy
Statement, but lower than the mid-term Review projection of 6.5 per cent. It
may, however, be noted that the inflation rate would have been higher but for
successful policy interventions which included fiscal as well as monetary measures,
and, more importantly, the full pass-through of higher oil prices has not taken
place. During 2004-05, the prices of manufactured products (weight: 63.8 per
cent) registered an increase of 4.5 per cent as compared with 6.7 per cent in
the previous year. The prices of primary articles (weight: 22.0 per cent) increased
by 2.5 per cent as compared with 1.6 per cent in the previous year. There was
a higher increase of 9.2 per cent in prices of ‘fuel, power, light and lubricants’
group (weight: 14.2 per cent) as compared with 2.5 per cent in the previous
year.
7. On an average basis, the annual rate of
inflation during 2004-05 was higher at 6.4 per cent as compared with 5.4 per
cent in the previous year. The prices of manufactured products, on an average,
increased by 6.1 per cent as compared with 5.6 per cent in the previous year.
The prices of primary articles increased, on an average, by 3.8 per cent as
compared with 4.2 per cent in the previous year. The prices of ‘fuel, power,
light and lubricants’ group increased, on an average, by 10.0 per cent as compared
with 6.3 per cent in the previous year.
8. The movements in WPI inflation rate during
2004-05 largely reflected the sharp increase in prices of a number of key commodities.
In order to segregate the impact of supply shocks, the mid-term Review of October
2004 had made a contextual analysis of WPI on account of the increase in prices
of four commodities, viz., iron ore, iron & steel, mineral oils and
coal mining (combined weight of 12.6 per cent in WPI). The WPI inflation rate,
excluding these four items, works out lower at 2.0 per cent on a point-to-point
basis, as against 3.3 per cent a year ago. On an average basis, it was 3.1 per
cent as against 3.7 per cent in the previous year. Excluding only mineral oils
(weight: 7.0 per cent), WPI inflation works out to 3.5 per cent as against 4.7
per cent in the previous year. On an average basis, it was 4.8 per cent as against
4.6 per cent in the previous year.
9. During 2004-05, oil prices in the international
markets remained high and volatile. The average price of a basket of major international
crude varieties (Brent, WTI and Dubai Fateh) at around US $ 41.3 per barrel
was about 42.3 per cent higher as compared with the average price of US $ 29.0
per barrel in the previous year. In contrast, the average domestic price of
petrol and diesel increased by only 17.5 per cent over the previous year. Admittedly,
a part of the impact of increase in global oil prices on domestic oil prices
was cushioned by fiscal measures such as cuts in excise and customs duties and
a part was absorbed by domestic oil companies.
10. The point-to-point inflation rate based
on consumer price index (CPI) for industrial workers was 4.2 per cent in February
2005 as compared with 4.1 per cent a year ago. On an average basis, CPI inflation
was 3.8 per cent during 2004-05 (up to February) as compared with 3.9 per cent
a year ago.
11. Monetary and credit aggregates for the
year 2004-05 reflect the impact of conversion of a financial institution into
a bank. During 2004-05, money supply (M3) increased by 12.8 per cent (Rs.2,57,058
crore), net of conversion, as compared with 16.9 per cent (Rs.2,90,569 crore)
in the previous year. The growth in aggregate deposits of scheduled commercial
banks (SCBs) at 14.1 per cent (Rs.2,11,963 crore), net of conversion, was lower
than 17.5 per cent (Rs.2,23,563 crore) in the previous year. The lower deposit
growth could be partly attributed to reduction in non-resident Indian (NRI)
deposits with the banking system. Deposit growth, adjusted for NRI deposits,
was 16.3 per cent (Rs.2,20,509 crore), net of conversion, as against 18.3 per
cent (Rs.2,09,147 crore) in the previous year. The expansion in currency with
the public was also lower at 13.3 per cent (Rs.42,016 crore) as compared with
16.1 per cent (Rs.43,827 crore) in the previous year.
12.As regards the sources of change in M3, the
increase in bank credit to the commercial sector at 21.7 per cent (Rs.2,21,870
crore), net of conversion, was higher than the increase of 13.5 per cent (Rs.1,21,494
crore) in the previous year. On the other hand, net bank credit to government
increased by 0.9 per cent (Rs.6,638 crore) as against an increase of 9.9 per
cent (Rs.67,143 crore) in the preceding year. This is attributable to the substantial
decline in the net RBI credit to the Central Government. Banking sector’s net
foreign exchange assets increased by 23.8 per cent (Rs.1,25,412 crore)primarily
on account of an increase of 26.5 per cent (Rs.1,28,377 crore) in net foreign
exchange assets of RBI.
13. The increase in reserve money during
2004-05 at 12.1 per cent (Rs.52,616 crore) was lower than the increase of 18.3
per cent (Rs.67,451 crore) in the previous year. As regards the components of
reserve money, currency in circulation rose by 12.7 per cent (Rs.41,621 crore)
as compared with 15.8 per cent (Rs.44,555 crore) in the previous year. Among
the sources of reserve money, RBI’s foreign currency assets (adjusted for revaluation)
increased by Rs.1,15,044 crore as compared with an increase of Rs.1,41,428 crore
in the previous year. The expansionary impact of foreign currency assets, however,
was neutralised to a large extent by substantial recourse to the market stabilisation
scheme (MSS) in conjunction with reverse repo operations under the liquidity
adjustment facility (LAF). Consequently, the net RBI credit to the Central Government
declined by Rs.50,646 crore (adjusted for the Government’s deposit balances
under MSS with RBI) as compared with a decline of Rs.76,065 crore in the previous
year. The balances under MSS, to sterilise the impact of forex inflows, stood
at Rs.64,211 crore at end-March 2005. RBI’s credit to banks and commercial sector
declined by Rs.833 crore as compared with a decline of Rs.2,728 crore in the
previous year. The ratio of net foreign exchange assets (NFEA) to currency rose
from 148.1 per cent in March 2004 to 166.2 per cent in March 2005 reflecting
accretion to reserves on a continuous basis. Adjusted for MSS, the ratio of
NFEA to currency was 148.8 per cent in March 2005.
14. Scheduled commercial banks’ credit registered
a strong increase of 26.0 per cent (Rs.2,18,623 crore), net of conversion, during
2004-05 as compared with 15.3 per cent (Rs.1,11,570 crore) in the previous year.
Food credit increased by Rs.5,159 crore as against a decline of Rs.13,518 crore
in the previous year. Non-food credit increased by 26.5 per cent (Rs.2,13,464
crore), net of conversion, as compared with 18.4 per cent (Rs.1,25,088 crore)
in the previous year. The incremental non-food credit-deposit ratio was as high
as 100.7 per cent, net of conversion, as compared with 56.0 per cent in the
previous year. Incremental investment-deposit ratio fell commensurately to 25.1
per cent from 58.2 per cent in the previous year, thereby accommodating the
higher credit demand to a large extent.
15. As observed in the mid-term Review of
October 2004, in the recent years, the impetus to credit growth has emanated
from non-agriculture non-industrial sectors, particularly, housing, small transport
operators and retail loans. While credit flow to these sectors continues to
remain buoyant, more recent indications are that credit to agriculture and industry
has also picked up.
16. During 2004-05 (April-February), agricultural
credit increased by 23.1 per cent as compared with 15.0 per cent in the corresponding
period of the previous year. The flow of credit to industry increased by 12.6
per cent as compared with 3.5 per cent in the corresponding period of the previous
year. The increase in credit flow to the infrastructure industries, viz.,
roads, ports, power and telecommunications was 38.6 per cent as compared with
an increase of 33.2 per cent in the corresponding period of the previous year.
There has also been a discernible increase in credit flow to industries like
food processing, cotton textiles, iron & steel, other metal & metal
products, drugs & pharmaceuticals, gems & jewellery, automobiles, petroleum,
electricity and construction.
17. While there was substantial increase
in credit extended by scheduled commercial banks (SCBs) during 2004-05, their
investments in bonds/ debentures/shares of public sector undertakings and private
corporate sector, commercial paper (CP) etc., declined by 2.9 per cent (Rs.2,573
crore), net of conversion, as compared with a decline of 3.9 per cent (Rs.3,669
crore) in the previous year. The total flow of funds from SCBs to the commercial
sector, including their investments, increased by 23.6 per cent (Rs.2,10,891
crore), net of conversion, as against 15.7 per cent (Rs.1,21,419 crore) in the
previous year. As such, flow of funds to the commercial sector during 2004-05
exceeded the growth of 19.0 per cent anticipated in the mid-term Review of October
2004.
18. During 2004-05, the Central Government’s
net market borrowings at Rs.46,050 crore (gross Rs.1,06,501 crore) were significantly
lower than such borrowings in the previous year. This could be partly attributed
to receipts by the Centre from the States under the debt swap scheme (DSS).
The state governments prepaid Rs.16,943 crore of central government debt through
additional market borrowings over and above the prepayment from their small
savings collection under DSS. Market borrowings by state governments under DSS
were in addition to their normal market borrowings of Rs.15,649 crore (net)
[Rs.20,772 crore (gross)] and Rs.1,387 crore for prepayment of RIDF loans to
NABARD. During 2004-05, the combined market borrowings of the Centre and States
were Rs.80,029 crore (net) [Rs.1,45,603 crore (gross)] with lower RBI support
in the form of devolvement and private placement at Rs.1,197 crore due to comfortable
liquidity conditions.
19. In addition to the normal market borrowings,
the Central Government raised Rs.65,481 crore (face value) under MSS for sterilisation
purposes. Overall, the net resources raised through government securities (Centre,
States and MSS) amounted to Rs.1,45,510 crore during 2004-05 as compared with
Rs.1,35,192 crore (Centre and States) in the previous year.
20. The weighted average cost of Central
Government borrowing through primary issuance of dated securities rose by 40
basis points to 6.11 per cent in 2004-05 from 5.71 per cent in the previous
year. The weighted average maturity of the dated securities issued during 2004-05
was lower at 14.13 years as compared to 14.94 years in the previous year.
21. The persistence of a large government
borrowing programme has implications for efficient monetary and debt management.
With a pick up in credit demand, the banking system reduced its holding of government
securities as a share of its net demand and time liabilities (NDTL) from 41.3
per cent in March 2004 to 38.5 per cent in March 2005. Such holdings of government
securities, however, continue to be in excess of the statutory minimum requirement
of 25 per cent of NDTL. In terms of volume, such holdings above the statutory
liquidity ratio (SLR) amounted to Rs.2,60,582 crore in March 2005.
22. During 2004-05, there was a slippage
in the key deficit indicators for 2004-05 from their budgeted levels. Moreover,
the Union Budget sets a ‘pause’ for deficit indicators in 2005-06 as envisaged
in the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 keeping
in view the impact of implementation of the recommendations of the Twelfth Finance
Commission (TWFC) which implies substantially higher devolution to States. It
is, however, essential to pursue fiscal consolidation with resolve to realise
the long-term potential of the economy. In this context, the parameters set
out in FRBM Act coupled with the recommendations of TWFC provide a basis for
fiscal consolidation within the federal structure.
23. During 2004-05, financial markets remained
generally stable, though interest rates showed some intra-year upward movement.
At the shorter end of the market, the weighted average call money rate increased
by 40 basis points from 4.37 per cent in March 2004 to 4.77 per cent by March
2005. Similarly, the cut-off yields on 91-day and 364-day Treasury Bills also
increased by 95 and 122 basis points from 4.37 per cent and 4.44 per cent to
5.32 per cent and 5.66 per cent, respectively, by March 2005. The yields on
government securities with 1-year residual maturity increased by 97 basis points
from 4.54 per cent to 5.51 per cent by March 2005. The weighted average discount
rate on commercial paper (CP) of 61 to 90-days maturity increased by 73 basis
points from 5.11 per cent to 5.84 per cent by March 2005.
24. An interesting development in the money
market during 2004-05 was the increase in the relative size of the collateralised
segment vis-à-vis the uncollateralised segment. The combined average
daily transactions of market repo and collateralised borrowing and lending obligation
(CBLO) was proportionately higher than those in the uncollateralised call/notice
money market. The spread between call money rates and market repo rates narrowed
from around 60 basis points in April 2004 to around 10 basis points by February
2005. The spread, however, widened to around 40 basis points in March 2005 on
account of increase in market liquidity. Institutional and technological changes
such as operationalisation of Clearing Corporation of India Limited (CCIL),
negotiated dealing system (NDS), real time gross settlement (RTGS), delivery
versus payment (DvP) III mode of settlement in government securities and rollover
of repo have lowered transaction costs, reduced settlement risks, enhanced transparency
and facilitated the ease of transaction. This is reflected in increasing collateralisation
of transactions and better alignment of interest rates in the money market.
25. The yield on government securities with
5-year residual maturity increased by 158 basis points from 4.78 per cent in
March 2004 to 6.36 per cent in March 2005. The yield on securities with 10-year
maturity increased by 150 basis points from 5.15 per cent to 6.65 per cent in
March 2005. Similarly, the yield on securities with 20-year residual maturity
increased by 114 basis points from 5.85 per cent to 6.99 per cent during the
same period.
26. As the longer-term yields exhibited sharper
movements, the tenor spread in the government securities revealed intra-year
variations. The spread between securities with residual maturities of 1-year
and 10-year widened from 61 basis points in March 2004 to 114 basis points in
March 2005. Similarly, the spread between government securities with residual
maturities of 1-year and 20-year widened from 131 basis points in March 2004
to 148 basis points in March 2005.
27. While the yield curve steepened during
2004-05, the interest rate movement was orderly notwithstanding the sharp upward
movement noticed during the third quarter of the financial year. For example,
the average call money rates had peaked to 6.30 per cent and the yield on 10-year
government securities had touched 7.31 per cent in November on account of adverse
expectations emanating from uncertainties on the inflation front but the rates
moderated in the subsequent period. Overall, despite large excess liquidity
in the system, interest rates moved upwards reflecting uncertainties in oil
prices, upward trend in global interest rates and increasing domestic demand
for credit.
28. In line with the trend in yields in the
government securities market, the yields on corporate papers also increased.
The yield on 5-year AAA-rated corporate bond increased from 5.60 per cent in
March 2004 to 7.14 per cent by March 2005. The spread between yields of AAA-rated
corporate bond and government securities for 5-year residual maturity, however,
narrowed from 82 basis points in March 2004 to 76 basis points by March 2005.
29. The term deposit rates offered by the
public sector banks for maturities up to one year moved from a range of 3.75-5.25
per cent in March 2004 to 2.75-6.0 per cent in March 2005. The interest rates
on term deposits over one year moved from a range of 5.00-6.00 per cent to 4.75-7.00
per cent during this period. The spread between typical deposit rates of 15-29
days and over 3-year tenor offered by public sector banks widened to 200 basis
points in March 2005 from 175 basis points a year ago.
30. The benchmark prime lending rates (BPLRs)
of public sector banks moved from a range of 10.25-11.50 per cent in March 2004
to 10.25-11.25 per cent in March 2005. BPLRs of foreign and private sector banks
moved from a range of 11.00-14.85 per cent and 10.50-13.00 per cent in March
2004 to 10.00-14.50 per cent and 11.00-13.50 per cent, respectively, in March
2005.
31. During 2004-05, a substantial part of
banks’ lending was at sub-BPLR rates given the competitive conditions in the
credit market. The share of sub-BPLR lending in total lending of commercial
banks, excluding export credit, increased from about 50 per cent in March 2004
to over 60 per cent by March 2005. As at end-March 2005, public sector banks’
median (representative) lending rate for the demand and term loans (at which
maximum business is contracted), in the range of 9.00-12.50 per cent and 8.35-12.00
per cent, respectively, exhibited moderation as compared with their corresponding
levels of 11.00-12.75 per cent each in March 2004. The movement in lending rates
was in the desired direction keeping in view the concern expressed in the mid-term
Review of November 2003 regarding the observed rigidities in the downward movement
of lending rates.
32. The Reserve Bank has been persistently
drawing the attention of banks to interest rate risks. Accordingly, banks were
advised in January 2002 to build up investment fluctuation reserves (IFR) to
a minimum of 5 per cent of their investment portfolio under the ‘held for trading’
(HFT) and ‘available for sale’ (AFS) categories, by transferring the gains realised
on sale of investments within a period of five years. As at end-February 2005,
banks have built up IFR up to 3.9 per cent. In September 2004, RBI allowed banks
to exceed the ceiling of 25 per cent of investments included under ‘held to
maturity’ (HTM) category by shifting some of their investments in SLR securities
from the HFT/AFS categories to HTM category at the lowest of the acquisition
cost or prevailing market value or book value, subject to a maximum of 25 per
cent of NDTL. Further, in the mid-term Review of October 2004, banks were advised
to prepare themselves to implement the capital charge for market risk as envisaged
under Basel norms in a phased manner by end-March 2006.
33. The equity market during 2004-05 passed
through its peak and trough, moving from a low on May 17 to record its all-time
high in March.A strong macroeconomic outlook, positive investment climate, continued
investment support by foreign institutional investors (FIIs), and encouraging
corporate financial results were the main factors driving the market sentiment
during 2004-05. However, an intra-year rise in inflation, deficient monsoon
rainfall, outlook in the global financial markets and volatility in international
oil prices were the main factors that led to some uncertainties.
Developments in External Sector
34. During 2004-05 (up to February), India’s
exports in US dollar terms increased by 27.1 per cent as compared with 16.4
per cent in the previous year. Imports showed a higher increase of 36.4 per
cent as compared with 25.0 per cent in the previous year. While the increase
in oil imports was even higher at 44.6 per cent as compared with 15.7 per cent
in the previous year, non-oil imports showed an increase of 33.3 per cent as
compared with 28.8 per cent in the previous year. Consequently, the trade deficit
widened to US $ 23.8 billion as compared with US $ 13.7 billion in the previous
year.
35. At a further disaggregated level, non-oil
trade balance registered a deficit of US $ 4.8 billion during 2004-05 (April-January)
as against a surplus of US $ 1.3 billion in the corresponding period of the
previous year. Non-oil imports, excluding gold and silver, increased by 33.8
per cent as compared with an increase of 24.8 per cent in the corresponding
period of the previous year. Import of gold and silver increased by 60.8 per
cent over and above a growth of 50.9 per cent in the corresponding period last
year. Import of capital goods showed an increase of 32.1 per cent as compared
with an increase of 30.1 per cent in the corresponding period of the previous
year, reflecting strength of investment demand. Growth in exports was generally
broad-based with primary products showing an increase of 24.7 per cent and manufactured
goods expanding by 22.2 per cent; particularly, engineering goods, gems &
jewellery and chemicals were the key drivers in manufacturing exports.
36. The current account of the balance of
payments (BoP) had remained in surplus consecutively over the past three years
(2001-04). During 2004-05 (April-December), the 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, reflecting widening of trade deficit. The trade
deficit (on payments basis) of US $ 28.4 billion was partially offset by net
invisible receipts of US $ 21.0 billion. Major items of net invisible receipts
included software services (US $ 12.2 billion) and private transfers (US $ 15.5
billion). However, increase in capital inflows more than offset the current
account deficit. While net invisible receipts remain robust, the current account
for the year as a whole is likely to exhibit a deficit on account of widening
of trade deficit.
37. The net capital inflows at US $ 20.7
billion during April-December 2004 comprised portfolio investment (US $ 5.1
billion), direct investment (US $ 2.2 billion), external commercial borrowings
(US $ 4.1 billion), short-term credit (US $ 2.7 billion) and other capital (US
$ 4.3 billion), while NRI deposits registered net outflows (US $ 1.3 billion).
As a result, net accretion to foreign exchange reserves, including valuation
changes, amounted to US $ 18.2 billion during April-December 2004.
38. During 2004-05, the Indian foreign exchange
market witnessed orderly conditions with Rupee exhibiting two-way movements.
The Rupee came under some pressure during April-July 2004 on account of adverse
developments in the Indian equity market, rising global oil prices and a fall
in capital inflows. The exchange rate of the Rupee which stood at Rs.43.39 per
US dollar at end-March 2004 depreciated by 6.6 per cent to Rs.46.45 per US dollar
by end-July 2004. The Rupee recovered and stood at Rs.43.75 per US dollar at
end-March 2005. During 2004-05, the Rupee depreciated by 0.8 per cent against
the US dollar, 6.2 per cent against Euro, 3.1 per cent against Pound sterling
but appreciated by 1.9 per cent against Japanese yen. India’s foreign exchange
reserves increased by US $ 28.5 billion from US $ 113.0 billion at end-March
2004 to US $ 141.5 billion by end-March 2005.
39. 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
40. The world economy expanded by 5.1 per
cent during 2004 recording its highest growth rate since the mid-1970s. The
International Monetary Fund (IMF) has projected the world economic growth to
slow to 4.3 per cent during 2005 and 4.4 per cent in 2006. Even this pace of
expansion is higher than the average growth recorded in the last two decades.
The buoyancy in the world economy has been aided by productivity gains, cost
cutting by corporates, trade expansion, financial stability, benign inflation
and low interest rates. Global economic expansion has been largely driven by
accelerated growth in the US, some newly industrialized Asian economies, Commonwealth
of Independent States (CIS) and other emerging markets and developing countries,
especially, Russia, China and India. Growth in sub-Saharan Africa has also distinctly
improved.
41. Consumer price inflation in the US has
increased over last two years, but remained low in the Euro area, Japan and
other advanced economies. Inflation in other emerging markets and developing
countries also declined to 5.7 per cent in 2004 from 6.0 per cent in the preceding
year, with perceptible decline in Africa, central and eastern Europe, CIS countries
and Latin America. Inflation in developing Asia, however, increased from 2.6
per cent in 2003 to 4.2 per cent in 2004 with inflation in China edging up from
1.2 per cent to 3.9 per cent. Nevertheless, general inflation has remained low
in spite of sharp increase in commodity prices in 2004 with oil prices rising
by over 30 per cent and non-fuel commodity prices rising by nearly 19 per cent.
Going forward, the risks that inflation may turn out to be higher and growth
lower than currently anticipated has increased.
42. The rise in oil prices appears to have
a large permanent component and this makes it important to factor in the second
round effects in assessing the inflationary impact. As per IMF estimates, a
permanent US $ 5 per barrel increase in oil prices was expected to lower global
GDP growth by up to 0.3 percentage points. However, the adverse impact on growth
was not apparent during 2004 because the oil price increase reflected acceleration
in demand. The large increase in export earnings of oil-exporting countries
have supported strong growth and have resulted in fiscal and current account
surpluses in these countries. While some non-oil producing countries have benefited
from strong growth in oil-producing countries, higher oil prices have the potential
for adverse balance of payments effects and could lead to substantial adjustment
in domestic consumption with attendant adverse impact on growth. If capacity
pressures seen in some industries persist and labour market conditions tighten,
inflationary pressures could emanate both from the demand and supply side. Overhang
of liquidity in some emerging markets, fuelled by large capital flows amidst
global external imbalances could also accentuate inflationary pressures.
43. Risks to growth arise from current account
and fiscal imbalances and excessive leveraging in some advanced economies which
has necessitated current account and exchange rate adjustments. Global expansion
has been largely imbalanced with hesitant recovery amidst structural rigidities
in some advanced economies, leaving the prospects of global growth in near term
somewhat uncertain. Current account deficit of advanced economies has widened
to 1.0 per cent of GDP, with the US running a deficit as high as 5.7 per cent
of GDP. Fiscal gaps in the US, the Euro area and Japan remain large. Unemployment
rates in advanced economies have declined very little in relation to pick up
in economic activity. Currency adjustments are still not over in spite of 20
per cent real effective exchange rate depreciation of the US dollar over last
two years and a 13 per cent appreciation in the Euro. Policy rates have been
raised in the US but are still below the neutral level in major advanced economies,
except the UK. Short-term market interest rates in advanced economies have hardened
by more than 50 basis points in the first quarter of 2005. Though long-term
interest rates have not moved as much, the transmission could follow. While
net private capital flows to emerging markets increased sharply by 32 per cent
in 2004 to nearly US $ 200 billion, the levels may not be sustained in the coming
years. If unanticipated macroeconomic or geopolitical developments occur against
this background, the extent of required adjustment could get amplified.
44. The global financial system today is
far more stable than in the latter half of the 1990s as a result of robust world
economic growth over the past three years and good corporate earnings. The financial
institutions addressed issues arising out of bad loan problems and strengthened
their capital base as well as risk management systems. In the emerging market
economies, improved economic fundamentals coupled with enhanced policy credibility
resulted in a series of upgrades on sovereign credit ratings. This has contributed
to the benign financial market conditions and tightening of spreads. However,
world financial markets are known to be characterised by multiple equilibria
where good state of markets could change into a bad state within a very short
period. Abundant global liquidity and low short-term interest rates over the
past few years have also contributed to asset price rise and leveraging of corporate
and household balance sheets in several parts of the world, covering both the
emerging and the matured markets. Furthermore, considering that economic expansion
may be at a very advanced stage of business cycle in some systemically important
matured markets, it may be difficult to sustain the current high levels of corporate
earnings. There is an even greater need now to keep a vigil on potential bubbles
in the asset markets since real estate market valuations have, in the recent
past, been supported by low-interest consumer debt. Current equity valuations,
which still look good in most markets, could move very quickly if corporate
earnings drop. Currency adjustments have proceeded in an orderly manner over
last two years, but if required adjustments in current account and fiscal gaps
of advanced economies do not take place over the next few years, interest rates
may have to rise to clear the markets. In such an event, the impact on balance
sheets could be much larger than is currently being anticipated. Finally, if
oil prices continue to firm up at a pace seen so far in 2005, financial markets
could see a major reaction as pace of economic activity slackens, corporate
earnings fall and external imbalances sharpen.
45. Over the years, India’s commercial and
financial linkages with the rest of the world has been increasing with trade
liberalisation and openness on the capital account. This is reflected in the
transmission of international impulses to the real sector and domestic financial
markets. Trends in international prices have now significant influence on domestic
prices. Indian corporates and institutions are increasingly accessing international
markets with consequent asset diversification. While this process has provided
important opportunities, it has also brought in new challenges and risks, necessitating
fine-tuning of macro policies in a much broader context.
II. Stance of Monetary
Policy for 2005-06
46. During 2004-05, monetary
policy faced difficult challenges which prompted a change in the stance in the
mid-term Review of October 2004. First, there was a carry forward of excess
liquidity of over Rs.81,000 crore. Second, the headline WPI inflation accelerated
beyond the anticipated level during the first half of the year. Third, the seasonal
decline in food prices did not materialise fully, perhaps stemming from deficient
monsoon. Fourth, international commodity prices remained high and volatile.
Fifth, internationally, monetary policy stance in a number of countries was
transiting from highly accommodative to a neutral level. Sixth, the pass-through
of international commodity price pressures to domestic inflation had implications
for inflationary expectations. Seventh, given the uncertainties, the reaction
of financial markets was adverse. As interest rates were at historically low
levels, the upside risk was high. There was sharp upward movement in interest
rates towards the middle of the year which ensued a selling pressure in government
securities market. Eighth, the equity markets touched a low on May 17 which
had an adverse impact on sentiments very temporarily and markets bounced back
very quickly thereafter. Finally, these developments occurred at a time when
industrial growth was looking up after a prolonged period of sluggishness and
non-food credit was also picking up. In the event, the Reserve Bank had to balance
the considerations of growth while containing inflationary expectations. Given
the role of supply factors in the nature of inflation, the response was in concert
with the Government. In signalling its commitment to price stability, the Reserve
Bank switched its stance from a ‘very close watch on the movements in the price
level’ in the annual policy Statement to ‘equal emphasis on price stability’
in the mid-term Review. Similarly, liquidity management for the purpose was
emphasised with a switch from a provision of ‘adequate liquidity’ to ‘appropriate
liquidity’. The policy measures were also calibrated to evolving circumstances
with a view to stabilising inflationary expectations.
47. During 2004-05, the following
steps were taken in a measured and calibrated manner. First, the Reserve Bank
communicated its assessment of the supply-induced nature of inflation to the
market on several occasions. Second, the market was sensitised to the differential
behaviour of inflation at the producers’ and the consumers’ level, the former
being higher as observed in a number of other oil-importing countries. Third,
the Government responded with fiscal measures, particularly by reducing customs
and excise duties on oil. Fourth, corporates also responded positively by moderating
the exercise of their pricing power. Fifth, in order to enable the Reserve Bank
to address the overhang of liquidity, the Government raised the ceiling of MSS
from Rs.60,000 crore to Rs.80,000 crore. Sixth, for a more flexible management
of liquidity, overnight fixed rate reverse repo under LAF was introduced. Seventh,
CRR was raised by one-half of one percentage point to 5.0 per cent. Eighth,
the remuneration of CRR was delinked from the Bank Rate and was reduced to 3.5
per cent to enhance its effectiveness as a monetary instrument. Ninth, banks
were allowed to transfer their investment into HTM category up to their statutory
minimum SLR requirement after providing for depreciation. While this measure
provided an opportunity to banks to interface with interest rate cycles, at
a macro level, it helped in maintaining financial stability. Finally, the fixed
reverse repo rate under LAF was raised by 25 basis points to 4.75 per cent.
However, the repo rate and the Bank Rate were left unchanged at 6.0 per cent
signalling the short-term nature of upward inflationary pressures. The financial
markets responded positively to the package of measures and, consequently, interest
rates stabilised towards the last quarter of the year, albeit at higher
levels, but lower than their intra-year highs registered during the middle of
the year. Moreover, credit flow to the commercial sector remained uninterrupted
and the government borrowing programme could be completed smoothly.
48. In the conduct of monetary
policy, the Reserve Bank was faced with the challenge of reconciling two dominant
views. As inflation was supply induced, it was argued that direct monetary policy
action may be premature keeping in view the fact that industry was coming out
of a sluggish phase. On the other hand, the deterioration in inflation expectations
on the basis of observed acceleration in headline inflation, accompanied by
sharp movements in market interest rates, tested the resolve of the central
bank on price stability. Since such a deterioration occurred under conditions
of overhang of excess liquidity, strong credit growth, incomplete pass-through
of oil price shock and uncertainties about its second round effects, the other
argument was in favour of monetary policy response to contain inflationary expectations.The
received wisdom, with the hindsight of oil price shocks of the 1970s and the
1980s, is that in the face of a significant supply shock, it is not prudent
for monetary policy to be overly accommodative. Moreover, globally, monetary
policy was transiting in a number of countries from excessive accommodation
towards a neutral position on inflation concerns. On balance of considerations,
the Reserve Bank raised CRR and the reverse repo rate moderately to signal its
strong commitment to price stability. In this context, it is important to note
that higher levels of sustainable growth is feasible only in an enabling environment
of stable prices.
49. Monetary management during
second half of 2004-05 was conducted broadly in conformity with the stance of
the policy set out for the second half of the year. In terms of macroeconomic
outcome during 2004-05, first, the GDP growth rate turned out to be better than
anticipated largely on account of higher than expected growth from agricultural
sector. More importantly, GDP growth was characterised by a pick up in industrial
activity which, if sustained, could lift India to a higher growth trajectory.
Second, the inflationary outcome, though consistent with the anticipation at
the beginning of the year, turned out to be more favourable than the perception
of the mid-term Review due to moderation in prices of primary and manufactured
products as well as cushioning of the oil price impact. Third, while interest
rates in money and government securities markets rose intra-year, they stabilised
during the later part of the year albeit at higher levels. Fourth,
the pick up in non-food credit growth was generally sustained and distribution
of credit became broad-based across sectors during the later part of the year.
More importantly, the expansion of credit did not trigger an increase in lending
rates. Fifth, the term deposit rates showed some increase. Sixth, money supply
growth turned out to be lower than the projections made at the beginning of
the year. Seventh, though the exchange value of the rupee vis-à-vis the
US dollar depreciated at the beginning of the year, it recovered and exhibited
greater two-way movement. Eighth, the trade deficit widened significantly reflecting
a deficit on non-oil trade balance and higher oil imports. Ninth, though net
invisible receipts are buoyant, the current account of balance of payments which
remained in surplus for consecutive three years is turning into a deficit during
2004-05 reflecting adverse trade balance. While invisibles, such as private
remittances have lent support to the current account, the trade account has
particular relevance as it reflects the competitiveness of the underlying industrial
structure and the degree of openness. Tenth, capital flows resumed after a brief
pause resulting in significant increase in foreign exchange reserves during
the year. Finally, corporate results and the domestic business outlook continue
to remain positive.
50. Against the background of
developments during 2004-05, the stance of monetary policy will depend on several
factors, including macroeconomic prospects, global developments and the balance
of risks. First, the outlook for growth in 2005-06, which should be noticeably
better than the previous year, may get moderated by the conditions in oil markets
which remain tight. Second, if the impact of mineral oil prices on WPI is isolated,
the underlying inflationary pressures appear moderate. The supply factors will
continue to dominate the price situation, while demand management seems to invite
close attention. Third, the non-food credit during 2004-05 recorded its second
highest growth in 55 years. There is evidence of increase in credit-elasticity
of GDP and credit penetration. Hence, adequate credit growth needs to be ensured
for productive sectors and the borrowing programme of governments accommodated,
while closely assessing the implications for demand-management to maintain macro
and price stability. In these circumstances, the liquidity management becomes
critical. The interest rate outlook should take into account these domestic
challenges but the increasing integration warrants some attention to global
factors. Fourth, the borrowing programme of the Centre was unusually low in
2004-05. While the borrowing programme for 2005-06 is significantly higher than
the previous year, it is in line with the magnitudes in 2002-03 and 2003-04,
though the credit growth was sluggish in those years. Fifth, the current account,
which was in surplus for three consecutive years, is turning into a deficit.
The capital account continues to be in surplus in a significant way. Current
indications are that these trends will continue in 2005-06 and, consequently,
the external sector will exhibit strength and resilience, though unanticipated,
globally-transmitted shocks cannot be ruled out.
51. The India Meteorological
Department (IMD) in its forecast of South-West monsoon for the current year
has placed the expected rainfall at 98 per cent of its long period average.
With a normal monsoon, the growth in agriculture can be assumed to be around
3 per cent. Further, it is expected that industry and services sectors would
maintain their current growth momentum while absorbing the impact of oil prices.
The real GDP growth during 2005-06, on the basis of above assumptions, could
be placed around 7.0 per cent for the purpose of monetary policy formulation.
52. A factor that complicates
the conduct of monetary policy during certain periods is the difficulty encountered
in precisely assessing the potential inflationary pressures based on the available
data for the current period. First, the liquidity overhang which was reduced
to a significant extent by December 2004, has since increased to levels witnessed
at the beginning of 2004-05. Second, the international oil prices have again
turned volatile with an upward pressure. Third, besides oil, the other primary
commodity prices remain firm in international markets. Fourth, the full pass-through
of international oil prices to domestic price has not taken place and fiscal
manoeuvrability on this front is getting limited. Fifth, credit growth continues
to remain buoyant. Finally, as against these factors, it must be recognised
that there is evidence of increasing productivity in several sectors in the
economy that could moderate pressures on prices. The level of food stocks and
forex reserves provide cushions against some price increases. Further, the contextual
analysis of WPI excluding mineral oils, on a point-to-point basis in 2004-05,
worked out to 3.5 per cent as against 4.7 per cent in the previous year, which
gives some indication of supply shock elements of WPI as distinct from what
may be construed as core components of inflation. In view of these considerations
governing current trends, the inflation rate in 2005-06, on a point-to-point
basis, may be placed in a range of 5.0-5.5 per cent subject to the growing uncertainties
on the oil front both in regard to global prices and their domestic absorption.
53. Consistent with the real
growth of GDP and inflation, the projected expansion of money supply (M3) for
2005-06 is placed at 14.5 per cent. In tune with this order of growth in M3,
increase in aggregate deposits of scheduled commercial banks is set at Rs.2,60,000
crore which is higher by 15.0 per cent over its level in the previous year.
Non-food bank credit including non-SLR investments of banks is projected to
increase by around 19.0 per cent. This magnitude of credit expansion is expected
to meet adequately the credit needs of all the productive sectors of the economy.
54. For the year 2005-06, the
Union Budget has placed the fiscal deficit at 4.3 per cent of GDP and the net
market borrowing programme of the Centre is budgeted at Rs.1,10,291 crore as
compared with Rs.46,050 crore in the previous year. While the borrowing programme
of the Centre is much higher than that in the previous year, taking into account
the normal market borrowing programme of States and the comparable level of
borrowings of Centre and States in the years prior to 2004-05, the Reserve Bank
expects to conduct debt management within the monetary projections for 2005-06
barring unexpected developments. In this regard, there is scope for accommodating
continued growth in credit needs as well as the higher borrowing programme to
the extent it is possible to unwind MSS to provide appropriate liquidity consistent
with macro objectives.
55. Monetary policy would continue
to enhance the integration of various segments of the financial market, improve
credit delivery, nurture credit culture and enhance the quality of financial
services. Given the volatility in the inflation rate during 2004-05, there is
also a need to consolidate the gains obtained in recent years from reining in
inflationary expectations. It is important to appreciate that, while sustained
efforts over time have helped to build confidence in price stability, inflationary
expectations can turn adverse in a relatively short time if noticeable adverse
movements in prices take place. In the world economy, after a prolonged period
of low inflation, there are signs that inflation may be edging up. The global
oil markets continue to remain tight with higher prices and increased volatility.
Credible commitment of policy to fight inflation is critical to stop translation
of higher oil prices into wage-price spirals. In addition, the international
prices of non-oil primary commodities may continue to remain firm. On the domestic
front, the manoeuvrability on oil prices is getting limited and corporates have
a higher probability of gaining their pricing power with a better industrial
outlook. The pricing pressure, if it were to occur from the supply side, could
get complicated by continuing overhang of excess domestic liquidity. While the
economy has the resilience to withstand supply shocks, the upside risks do exist.
As such, the inflationary situation needs to be watched closely and there could
be no room for complacency on this count.
56. In the context of current
inflation scenario, an issue of policy interest for financial management by
banks and other market participants is whether the interest rate cycle has turned
from the low observed during 2003-04. As is well known, the outcome for interest
rates depends mainly on the outlook for inflation, growth prospects and investment
demand and it is not possible to predict short-run movements in interest rates,
either up or down, without taking cognizance of possible movements in all other
macroeconomic variables. These variables are also subject to unanticipated changes
because of unforeseen domestic or external developments. However, the system
has to recognise interest rate cycles and strengthen risk management processes
to cope with eventualities so that financial stability could be maintained and
interest rate movements could be transited in a non-disruptive manner. In this
regard, it is instructive to observe global trends as the Indian economy is
progressively getting linked to the world economy. While there is an overhang
of domestic liquidity, partly mirroring abundant global liquidity, the trends
in global interest rates, inflation expectations and investment demand would
also have some relevance in the evolution of the domestic interest rates. It
will, therefore, be desirable to contain inflationary pressures to stabilise
domestic financing conditions both for the governments and the private sector.
57. 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 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
the policy instruments at its disposal flexibly, as and when the situation warrants.
58. In sum, barring the emergence
of any adverse and unexpected developments in various sectors of the economy
and keeping in view the inflationary situation, the overall stance of monetary
policy for the year 2005-06 will continue to be as set out in the mid-term Review
of October 2004, namely:
• Provision of appropriate
liquidity to meet credit growth and support investment and export demand
in the economy while placing equal emphasis on price stability.
• Consistent with the above,
to pursue an interest rate environment that is conducive to macroeconomic
and price stability, and maintaining the momentum of growth.
• To consider measures in a calibrated manner,
in response to evolving circumstances with a view to stabilising inflationary
expectations.
III. Monetary Measures
(a) Bank Rate
59. In the mid-term Review of
October 2004, the Bank Rate was kept unchanged at 6.0 per cent. On a review
of the macroeconomic developments, it is considered desirable to leave the Bank
Rate stable (at 6.0 per cent) at present.
(b) Reverse Repo Rate
60. In view of the current macroeconomic and
overall monetary conditions, it has been decided:
• To increase
the fixed reverse repo rate by 25 basis points under the liquidity adjustment
facility (LAF) of the Reserve Bank effective from April 29, 2005 to 5.00
per cent from 4.75 per cent.
61. The repo rate will continue
to be linked to the reverse repo rate, as at present. However, the spread between
the reverse repo rate and the repo rate is reduced by 25 basis points from 125
basis points to 100 basis points with effect from April 29, 2005. Accordingly,
the fixed repo rate under LAF will continue to remain at 6.0 per cent.
(c) Cash Reserve Ratio
62. The cash reserve ratio (CRR)
of scheduled banks is currently at 5.00 per cent. While the Reserve Bank continues
to pursue its medium-term objective of reducing the CRR to the statutory minimum
level of 3.0 per cent, on a review of the current liquidity situation, it is
felt desirable to keep the present level of CRR (5.00 per cent) unchanged.
First Quarter Review
63. The First Quarter Review
of this part of the annual policy Statement will be undertaken on July 26, 2005
and will contain such other changes/ measures as may be necessary.
Part
II. Annual Statement on Developmental and Regulatory Policies for the Year 2005-06
64. A stable and efficient financial
sector is essential for sustained economic growth. In this context, the annual
policy Statements as well as mid-term Reviews of RBI have been continuously
focusing on the developmental and regulatory measures to strengthen the financial
system. The policy Statements also discern the links among monetary, credit
and regulatory policies involving the overall structural transformation of the
real and financial sectors. The emphasis has been on safeguarding the financial
stability of the overall system through effective monitoring and assurance of
implementation of regulations. In this direction, the overall approach has been
that of reorienting the role of RBI for improving institutional soundness, strengthening
the regulatory and supervisory processes in alignment with international best
practices and developing the necessary technological and legal infrastructure.
While the approach towards the reforms has been gradual and relevant to the
context, consultative processes and appropriate sequencing of measures have
succeeded in aiding growth, avoiding crises, enhancing efficiency and imparting
resilience to the system. The aim is to move towards a system that is responsive
to the needs of the common person.
65. In order to reinforce stability
of the overall system and to serve the common person, the emphasis of the policy
Statement, at this stage, is on certain key areas. First, it is useful to debate
the current regulations on interest rates and stipulations relating to priority
sector in terms of their contemporary effectiveness in delivering adequate credit
at appropriate prices. Second, to facilitate a balanced development of the financial
system, it is necessary to further develop money, forex and government securities
markets. Third, there is a need to bridge the financing gaps in agriculture
and in small and medium enterprises in order to enhance credit delivery. Fourth,
from a systemic point of view, sound corporate governance practices, better
risk management and adherence to prudential norms within the financial sector
need to be encouraged. Fifth, in order to strengthen the payment and settlement
systems, a roadmap for development and application of technology in the financial
sector in the medium-term becomes important. Finally, as financial institutions
expand and become more complex, it is imperative to ensure availability of quality
services to all sections of the population.
66. In order to have focused
attention on the identified areas for policy purposes, this Annual Statement
on Developmental and Regulatory Policies for the Year 2005-06 consists of five
Sections: I. Interest Rate Prescriptions; II. Financial Markets; III. Credit
Delivery Mechanisms; IV. Prudential Measures; and V. Institutional Developments.
I. Interest Rate Prescriptions
67. The deregulation of financial
markets in the recent years has improved the competitive environment in the
financial system and strengthened the transmission mechanism of monetary policy.
Sequencing of interest rate deregulation has been an important component of
the reform process which has imparted greater efficiency in resource allocation.
The process has been gradual and predicated upon institution of prudential regulation
of the banking system, market behaviour, financial opening and, above all, the
underlying macroeconomic conditions. The interest rates have been largely deregulated
except for (i) savings deposit accounts, (ii) non-resident Indian (NRI) deposits,
(iii) small loans up to Rs.2 lakh and (iv) export credit.
68. The annual policy Statement
of 2002 had weighed the option of deregulation of interest rate on savings accounts
but the time was not considered opportune considering that bulk of such deposits
are held by households in semi-urban and rural areas. It has, however, been
argued that deregulation will facilitate better asset-liability management for
banks and competitive pricing to benefit the holders of savings accounts. As
regards NRI deposits, interest rate ceilings on FCNR(B) deposits are linked
to LIBOR/ SWAP rates of corresponding foreign currencies, while NRE deposit
rates are linked to US dollar LIBOR/SWAP rates. These stipulations have been
put in place taking into account their implications for the banking system and
the management of the capital account.
69. As regards lending rates,
given the limited ability of small borrowers to manage interest rate risk and
for ensuring availability of credit at reasonable rates, interest rate ceiling
on small loans up to Rs. 2 lakh is linked to BPLR. The contrary view is that
given the competitiveness in the credit market, high share of sub-BPLR lending
and increasingly broad-based credit structure, availability of credit to all
segments of the economy at a price consistent with their risk profiles becomes
important. Further, it is argued that lending rate regulation has dampened larger
flow of credit to small borrowers. In addition, the current regulation seems
to have imparted an element of downward rigidity to BPLR. It may be noted that
RRBs and co-operative banks are free to determine their lending rates and there
are no restrictions on lending rates of micro-finance institutions (MFIs).
70. Interest rate regulation
on export credit has been favoured for making available credit to exporters
at internationally competitive rates. The annual policy Statement of April 2002
had indicated that "linking of domestic interest rates on export credit
to PLR has become redundant in the present circumstances as effective interest
rates on export credit in rupee terms is substantially lower than the PLR".
The mid-term Review of October 2002 had mooted deregulation of interest rate
on rupee export credit in phases to encourage greater competition in the interest
of exports. One view is that in the light of competitive lending rates in the
economy, it is important to ensure that regulated interest rates should not
restrict credit flow to all segments of exporters with different risk profiles.
71. While there is merit in
moving forward to impart greater competitiveness and depth to the activities
of the financial system by further deregulating interest rates in some segments
which have hitherto remained regulated for various reasons found relevant at
different stages, it is proposed to continue with status quo as various
issues pertaining to above regulations on interest rates are being debated.
II. Financial Markets
Money Market
Framework for Development of Money Market
72. Money market provides a
focal point for the central bank’s operations in influencing system liquidity
and thereby transmitting the monetary policy impulses. The broad policy objectives
that are being pursued for the development of money market include ensuring
stability in short-term interest rates, minimising default risk and achieving
a balanced development of various segments of the money market. In order to
review the recent developments and current status of money market in the context
of evolving monetary policy framework, fiscal scenario, regulatory regime and
extent of financial integration, both domestic and external, a Technical Group
on Money Market was constituted. The Report of the Group was discussed in the
Technical Advisory Committee on Money, Foreign Exchange and Government Securities
Markets (TAC) and certain recommendations have been accepted for implementation.
Accordingly, the following measures are proposed:
(i) Call/Notice/Term Money Market
• With effect from the fortnight
beginning June 11, 2005, non-bank participants, except PDs, would be allowed
to lend, on average in a reporting fortnight, up to 10 per cent of their
average daily lending in call/notice money market during 2000-01.
• With effect from August 6, 2005, non-bank
participants, except PDs, would be completely phased out from the call/notice
money market.
• With effect from the fortnight
beginning April 30, 2005, the benchmark for fixing prudential limits on
exposures to call/notice money market in the case of scheduled commercial
banks would be linked to their capital funds (sum of Tier I and Tier II
capital).
• From April 30, 2005, all NDS members are
required to report their term money deals on NDS platform.
• A screen-based negotiated quote-driven
system for all dealings in call/notice and term money market transactions
is proposed.
(ii) Market Repo
• An electronic trading
platform for conduct of market repo operations in government securities,
in addition to the existing voice based system, to be facilitated.
• Participation in market repo facility
in government securities for non-scheduled urban co-operative banks (UCBs)
and listed companies having gilt accounts with scheduled commercial banks
will be allowed subject to eligibility criteria and safeguards.
(iii) Certificates of Deposit
• The minimum maturity period of certificates
of deposit (CDs) reduced from 15 days to 7 days with immediate effect.
73. The Report of the Group
is being placed on RBI website for wider dissemination. The recommendations
of the Group on introduction of asset-backed commercial paper (ABCP) to further
deepen the CP market and additional intra-day LAF to stabilise short-term interest
rates would be considered in future in consultation with market participants.
In addition, optionalities in OTC rupee derivatives would be considered, once
legal clarity to OTC derivatives is provided and appropriate accounting standards
are put in place.
Government Securities Market
(a) Central Government Securities Market: Medium-term
Framework
74. In terms of the stipulation
of FRBM Act, RBI will not be participating in primary issuance of government
securities with effect from April 1, 2006. In this context, the mid-term Review
of October 2004 emphasised that open market operations (OMO) would become a
more active policy instrument necessitating review of processes and technological
infrastructure consistent with market advancement. In order to address these
emerging needs and equip RBI as well as the market participants appropriately,
a Technical Group on Central Government Securities Market was constituted. Earlier,
another Group (Chairman: Dr.R.H. Patil) had examined the role of primary dealers
(PDs) in the government securities market. The Reports were discussed in TAC
and certain recommendations have been accepted for implementation. Accordingly,
the following measures are proposed:
• The number of actively
traded securities need to be enlarged to enhance liquidity and improve pricing
in the market. It is proposed to consolidate debt and build up large liquid
securities in consultation with the Government while continuing the programme
of reissuances.
• Post-FRBM, RBI will reorient
government debt management operations while simultaneously strengthening
monetary operations. This will entail functional separation between debt
management and monetary operations within RBI. For this purpose, RBI will
have discussions with market players on the modalities and procedures of
market operations.
• The settlement system for transactions
in government securities will be standardised to T+1 basis.
• The Reserve Bank would continue to resort
to multiple and uniform price methods flexibly in the auction of government
securities.
• Permitted structures of
PD business will be expanded to include banks which fulfil certain minimum
criteria subject to safeguards and in consultation with banks, PDs and the
Government.
75. The recommendations of the
Technical Group on restructuring the underwriting obligations of PDs, allowing
PDs exclusivity in primary auctions, introduction of ‘When Issued Market’ and
limited short selling in government securities would be considered in consultation
with the Government.
(b) Sale of Government Securities: Relaxation
76. At present, sale of government
securities allotted in primary issues can be entered into on the same day only
between entities maintaining SGL account with RBI. In order to facilitate further
deepening of the government securities market, it is proposed:
• To permit sale of government securities
allotted in primary issues with and between CSGL account holders also on
the same day.
(c) Market Borrowings of State Governments
77. The Twelfth Finance Commission
(TWFC) recommended that the Centre should not act as a financial intermediary
for future lending to the States. The Centre would release only the grant portion
of central assistance of state plan to States and allow them to approach the
market directly to raise the loan portion of the funds. In case some fiscally
weak States are unable to raise funds from the market, the Centre could borrow
for on-lending to such States. The Centre has accepted in principle the recommendations
and has proposed to implement it in phases, in consultation with RBI. As the
implementation of the recommendations of TWFC would have major implications
for the market borrowing programmes, RBI would facilitate smooth transition
of the process in consultation with the Central and the state governments. As
a first step, consultations were held with State Finance Secretaries on April
8, 2005.
Foreign Exchange Market
(a) Forex Market Group: Medium-term Framework
78. Since the onset of reforms
in the early 1990s, significant liberalisation of the foreign exchange market
has taken place and the process gained momentum after Sodhani Committee recommendations
were accepted for implementation by RBI. The foreign exchange market is now
deeper and wider as gauged in terms of parameters such as the range of products,
participation, liquidity and turnover. As indicated in the mid-term Review of
October 2004, an internal Group was set up to review comprehensively the initiatives
taken by RBI in the foreign exchange market and identify areas for further improvements.
The Group reviewed forex market liberalisation in select emerging markets and
examined the current regulatory regime in the light of liberalisation in related
sectors to identify areas for further liberalisation. The Report of the Group
was discussed in TAC. As recommended by the Group, the following measures are
proposed:
• Cancellation and rebooking of all eligible
forward contracts booked by residents, irrespective of tenor, to be allowed.
• Banks to be allowed to approve proposals
for commodity hedging in international exchanges from their corporate customers.
• The closing time for inter-bank foreign
exchange market in India to be extended by one hour up to 5.00 p.m.
• Dissemination of additional information
including traded volumes for derivatives such as foreign currency-rupee
options to the market.
79. The other recommendations
of the Group pertaining to writing of covered options by corporates and hedging
of economic risk of corporates in respect of their domestic operations arising
out of changes in the landed cost of the imported substitutes of the commodities
they consume/produce would be considered. The sequencing with regard to implementation
of these measures will take into account the enabling conditions for further
progress towards capital account convertibility, liberalisation in other sectors
of the economy and the trend in overall balance of payments.
(b) Overseas Investment: Liberalisation
80. At present, under the automatic
route, Indian entities are permitted to invest in overseas joint ventures and/or
wholly owned subsidiaries up to 100 per cent of their net worth. With a view
to promoting Indian investments overseas, it is proposed:
• 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.
(c) Foreign Currency Accounts by Foreign Companies
in India: Liberalisation
81. At present, authorised dealers
(ADs) are required to obtain RBI approval for opening of foreign currency accounts
of the project offices set up in India by foreign companies. In order to further
liberalise the procedure, it is proposed:
• To accord general permission
to ADs to open foreign currency accounts of the project offices set up in
India by foreign companies and operate the accounts flexibly.
III. Credit Delivery Mechanisms
(a) Flow of Credit to Agriculture
82. The Union Budget has proposed
to increase the flow of credit to agriculture by 30 per cent during the year
2005-06. It has been the Reserve Bank’s endeavour to enhance credit flow to
agriculture by removing bottlenecks in credit delivery. In this direction, as
indicated in the annual policy Statement of May 2004 and the mid-term Review
of October 2004, most of the recommendations of the Advisory Committee on Flow
of Credit to Agriculture and Related Activities from the Banking System (Chairman:
Prof. V.S. Vyas) have been implemented by RBI and NABARD. Other recommendations
covering the target for direct and indirect lending for agriculture under priority
sector lending, negotiable warehousing receipt system, setting up of agri-risk
fund, computerisation of land records, permitting access to external commercial
borrowing (ECB) and granting autonomy to NABARD are under examination of the
Government. As at end-December 2004, public sector banks have issued 167.9 lakh
Kisan Credit Cards (KCCs) with limits amounting to about Rs.46,000 crore. Cumulative
sanctions and disbursements under various tranches of RIDF (RIDF I to X) amounted
to about Rs.42,000 crore and Rs.24,000 crore, respectively, by February 2005.
With a view to further increasing the flow of credit to agriculture, the following
measures have been initiated:
• RBI has set up an Expert Group to formulate
strategy for increasing investment in agriculture and the report is expected
by end-May 2005.
• In order to make an assessment
of customer satisfaction on credit delivery in rural areas by banks, it
is proposed to conduct a survey with the help of an outside agency.
• Keeping in view the importance
of post-harvest operations, it is proposed to increase the limit on loans
to farmers through the produce marketing scheme from Rs.5 lakh to Rs.10
lakh under priority sector lending.
• There is a realisation
amongst bankers that there are increasing business opportunities in financing
agriculture, banks are, therefore, urged to continue their efforts to step
up credit to agriculture.
(b) Micro-finance
83. The programme of linking
self-help groups (SHGs) with the banking system has emerged as the major micro-finance
programme in the country. Accordingly, the Union Budget has proposed to enhance
the annual target of credit linkage to 2.5 lakh SHGs during 2005-06. As at March
2005, over 14 lakh SHGs were linked to banks and total flow of credit to these
SHGs was over Rs.6,300 crore. NABARD and banks have set a target of linking
additional 5.85 lakh SHGs to banks by end-March 2007. In order to give further
fillip to micro-finance movement, the following measures have been initiated:
• The Reserve Bank has enabled
non-governmental organisations (NGOs) engaged in micro-finance activities
to access ECBs up to US $ 5 million during a financial year for permitted
end-use, under automatic route, as an additional channel of resource mobilisation.
• As a follow-up of the
Budget proposals, modalities for allowing banks to adopt the agency model
by using the infrastructure of civil society organisations, rural kiosks
and village knowledge centres for providing credit support to rural and
farm sectors and appointment of micro-finance institutions (MFIs) as banking
correspondents are being worked out.
(c) Credit Flow to Small Scale Industries
84. The small scale industries
(SSI) sector plays a very important role in the development of the economy.
While large industries have access to various sources of finance, the SSI sector
has to primarily depend on finance from banks and other financial institutions.
With a view to further smoothening the flow of credit, the following measures
have been initiated:
• The Credit Information Bureau of India
Ltd. (CIBIL) is working out a solution that would provide comprehensive
credit reports on SSIs.
• 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. Banks are urged to take the revised guidelines as
indicative minimum requirement and the Boards of the banks are expected
to formulate more liberal schemes as appropriate.
• Under a scheme to be drawn
up by the RBI, banks will be encouraged to establish mechanisms for better
co-ordination between their branches and branches of SIDBI which are located
in 50 clusters that have been identified by the Ministry of Small Scale
Industries, Government of India. Under the scheme of strategic alliance
(i) the existing branches of SIDBI redesignated as "Small Enterprises
Financial Centres" (SEFC) will take up co-financing of term loan requirements
of SSI units along with the bank branches and the working capital requirements
of these units will be met by the banks; (ii) the expertise of the SIDBI
in appraisal of credit requirements of SSI units will be leveraged by the
branches of commercial banks, by payment of a nominal fee; (iii) SIDBI will
provide other expert services to help the banks in simplifying the application
forms, documentation and disbursement procedures, etc.; and (iv) the working
of the scheme may be monitored and modified to suit the local conditions
by the State Level Bankers’ Committee (SLBC) and, depending on the experience,
the coverage of the scheme may be extended to more clusters. The services
of SEFCs will be available for tiny industrial units also.
(d) Credit Flow to Medium Enterprises
85. In view of the fast changing
market conditions and increasing competitiveness, there is an urgent need to
upgrade the technology of small scale industries and their graduation to medium
enterprise sector. The Reserve Bank will explore modalities to meet their growing
financial needs. A simplified debt restructuring and rehabilitation mechanism
is also being considered for the sector.
(e) Restructuring and Development of Regional
Rural Banks
86. The Regional Rural Banks
(RRBs) are conceived as institutions that combine the local feel and familiarity
with rural problems, which the co-operatives possess, and the degree of business
organisation as well as the ability to mobilise deposits, which the commercial
banks possess. In view of their importance as purveyors of rural credit, the
Union Budget 2004-05 emphasised that the sponsor banks would be accountable
for the performance of their RRBs.
87. As indicated in the mid-term
Review of October 2004, sponsor banks are being encouraged to merge the RRBs
sponsored by them state-wise. A few proposals in this regard are at various
stages of consideration. While the sponsor banks were advised that the appointment
of Chairmen of their RRBs should be approved by the Management Committees of
their Boards, the Government was requested to ensure that independent and professionally
qualified persons are nominated to the Boards of RRBs to make them more vibrant
and proactive.
88. In order to reposition RRBs
as an effective instrument of credit delivery in the Indian financial system,
RBI is in the process of reviewing the performance of RRBs, exploring restructuring
of RRBs through merger/ consolidation, changing of sponsor banks, reviewing
minimum capital requirement and suggesting suitable measures for regulation,
supervision and governance of RRBs.
(f) Priority Sector Lending
89. Prescriptions relating to
priority sector lending have been modified from time to time, and generally
the eligibility criteria have been enlarged to include several new areas. In
December 2004, it was decided that only advances will be eligible, thus, beginning
a phased withdrawal of eligibility of investments in bonds. There have been
suggestions for a further review of the eligibility criteria and other related
aspects.
90. One view is that lending
to any infrastructure project should be made eligible for priority sector landing
while making sub-targets fungible within the overall target. There is another
view that enlargement of areas has resulted in loss of focus. It is also held
that credit growth in housing, venture capital and infrastructure has been strong
while it has been sluggish in agriculture and small industries. Further, it
is argued that only sectors that impact large population, weaker sections and
are employment-intensive such as agriculture, tiny and small industry should
be eligible for priority sector. Since there are several issues that need to
be considered in this regard, it is appropriate that these are debated and examined
in depth.
IV. Prudential Measures
91. The Reserve Bank has taken
several steps to strengthen the regulatory and supervisory framework of the
financial sector. Further developments in this area are as under.
(a) Policy on Merger and Amalgamation of Banks
92. In pursuance of the recommendations
of the Joint Parliamentary Committee (JPC), a Working Group was constituted
by RBI to evolve guidelines for voluntary merger of banking companies. Based
on the recommendations of the Group and in consultation with the Government,
it is proposed:
• To issue guidelines on
merger and amalgamation between private sector banks and with NBFCs. The
guidelines would cover: process of merger proposal, determination of swap
ratios, disclosures, norms for buying/selling of shares by promoters before
and during the process of merger and the Board’s involvement in the merger
process. The principles underlying these guidelines would also be applicable
as appropriate to public sector banks, subject to relevant legislation.
(b) Supervision of Financial Conglomerates
93. As indicated in the annual
policy Statement of May 2004, the Working Group on Financial Conglomerates (FC)
has identified 22 FCs. With a view to monitoring intra-group transactions and
exposures, a pilot process was initiated to obtain information from the designated
entities of each FC by the principal regulators. Such information was analysed
and discussed amongst the principal regulators and a system for exchange of
information among them has been put in place. In order to appropriately focus
on monitoring of the process, in consultation with Chairman, SEBI and Chairman,
IRDA, it is proposed:
• To hold a half-yearly
discussion with the CEO of the designated entity, which would be convened
by the lead regulator with other regulators, on the basis of available information
for review and addressing concerns, if any.
(c) Interests of the Depositors
94. Depositors’ interests forms
the focal point of the regulatory framework for banking in India and it has
been appropriately enshrined at several places in the Banking Regulation Act,
1949. In Section 5(ca) of the Act, "Banking Policy" has been defined
as "any policy which is specified from time to time by the Reserve Bank
in the interest of the banking system or in the interest of monetary stability
or sound economic growth, having due regard to the interests of the depositors,
the volume of deposits and other resources of the bank and the need for equitable
allocation and the efficient use of these deposits and resources".
95. Furthermore, as per the
Act, some of the considerations that are required to be taken into account while
granting licence for banking business, in addition to ensuring the capacity
of the bank to pay present and potential depositors in full, is whether the
affairs of the company are not being or are not likely to be detrimental to
the interests of the depositors or prejudicial to public interest. A licence
to do banking business provides the entity the ability to accept deposits and
access to deposit insurance for small depositors. Similarly, regulation and
supervision by RBI enables these entities to access funds from a wider investor
base and the payment and settlement systems provides efficient payments and
funds transfer services. All these services, which are in the nature of public
good, involve significant costs and are being made available only to ensure
availability of banking and payment services to the entire population without
discrimination.
96. Against this background,
while policies relating to credit allocation, credit pricing and credit restructuring
should continue to receive attention, it is inappropriate to ignore the mandate
relating to depositors’ interests. Further, in our country, the socio-economic
profile for a typical depositor who seeks safe avenues for his savings deserves
special attention relative to other stakeholders in the banks.
97. In the observations and
recommendations of the Committee on Procedures and Performance Audit on Public
Services (CPPAPS) (Chairman: S.S. Tarapore), on ‘Banking Operations: Deposit
Accounts and other facilities Relating to Individuals (Non-Business)’, it was
indicated: "The bank’s offerings are generally opaque – what is not charged
is mentioned but what is charged is not mentioned – high hidden costs appear
rampant and unjustified, thus banks enjoy undue enrichment. If a small customer
goes to a bank and has a technical problem, anecdotal evidence suggests that
he runs into enormous difficulties. The Committee notes with some sadness that
there is substance in the widespread impression among the small depositor community
that one needs to know someone higher-up for getting his/her job done. Intense
depositor loyalty is the only plank on which the Indian banking systems is surviving.
The banks have to understand that depositors are at the end of their tether
and banks providing poor customer service will be punished by switching loyalty’’.
The information suggests that in recent years banks are taking increasing recourse
to non-deposit resources to fund their assets. Against this background:
• Banks are urged to refocus on deposit
mobilisation and empower the depositors, by providing wider access and better
quality of banking services.
• RBI will persist with its efforts to ensure
quality of banking services, in particular, to small individual depositors.
(d) Financial Exclusion
98. There has been expansion,
greater competition and diversification of ownership of banks leading to both
enhanced efficiency and systemic resilience in the banking sector. However,
there are legitimate concerns in regard to the banking practices that tend to
exclude rather than attract vast sections of population, in particular pensioners,
self-employed and those employed in unorganised sector. While commercial considerations
are no doubt important, the banks have been bestowed with several privileges,
especially of seeking public deposits on a highly leveraged basis, and consequently
they should be obliged to provide banking services to all segments of the population,
on equitable basis. Against this background:
• 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.
• The nature, scope and
cost of services will be monitored to assess whether there is any denial,
implicit or explicit, of basic banking services to the common person.
• Banks are urged to review their existing
practices to align them with the objective of financial inclusion.
(e) Customer Service
99. Liberalisation and enhanced
competition accord immense benefits, but experience has shown that consumers’
interests are not necessarily accorded full protection and their grievances
are not properly attended to. Several representations are being received in
regard to recent trends of levying unreasonably high service/user charges and
enhancement of user charges without proper and prior intimation. Among the complaints
received are: charges for balance enquiry, cheque status verification, signature
verification, address confirmation, photograph verification, punitive service
charges for non-maintenance of minimum balance in savings accounts, transaction
charges for reorder of cheque book and for cash transactions at the branch beyond
a stipulated number, and diversion of customers to usage of ATMs including payment
for cash transactions.
100. It is instructive in this
regard to note that in Canada, the issue of bank service charges was the subject
of a 1988 investigation conducted by the House of Commons Standing Committee
on Finance. The Committee report set out a number of recommendations, which
have subsequently been reflected in market practice. The Committee recommendations
resulted in improved disclosure of service charges and the designation of Office
of the Superintendent of Financial Institutions (OSFI) to handle and report
on service charge complaints.
101. In the US, organisations such
as Consumers’ Union are fighting to create legislation that will help protect
vulnerable consumers from price gouging on checking accounts. American consumer
groups are against what they call is the "trap of never-ending bank fees
that is impossible to escape". They are demanding ‘lifeline banking’ legislation,
which will give consumers access to basic banking services and protect them
from exorbitant fees and surcharges for providing information such as signature
and photograph verification. Several American states have implemented legislation
for minimum no-frills services. Some states prohibit ATM surcharges.
102. In the UK, there exists an
institutional arrangement whereby a separate board has been set up to oversee
the code drawn up by the banks’ association. The Banking Code of the British
Bankers’ Association (BBA) is a voluntary code, which sets standards of good
banking practices for financial institutions to follow when they are dealing
with personal customers in the UK. It provides valuable protection for customers
on a day-to-day basis as also in the times of financial difficulty. The code
applies to savings deposits and current accounts, card products and services,
loans and overdrafts and payment services including foreign exchange. Taking
account of all these considerations, it has been decided:
• 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.
• To widen the scope of
the Banking Ombudsman inter alia to cover all individual cases/grievances
relating to non-adherence to the fair practices code evolved by IBA and
adopted by individual banks.
(f) New Capital Adequacy Framework in India:
Implementation
103. As indicated in the mid-term
Review of October 2004, draft guidelines for implementation of the New Capital
Adequacy Framework were formulated and placed on the RBI website. In order to
maintain consistency and harmony with international standards, banks were advised
to adopt Standardised Approach for credit risk and Basic Indicator Approach
for operational risk with effect from March 31, 2007. The Reserve Bank may consider
allowing some banks to migrate to Internal Rating Based (IRB) approach after
developing adequate skills both in banks and at supervisory levels. As banks
would be allowed to adopt/migrate to the advanced approaches only with the specific
approval of RBI, as a first step, banks which are aiming at adopting the advanced
approaches should make an objective self-assessment of their fulfillment of
the minimum criteria prescribed under Basel II.
104. As banks have two years lead-time
to prepare themselves for Basel II, they are encouraged to focus on capacity
building and undertake impact analyses. On the basis of the outcome of the impact
studies, banks may put in place appropriate strategies and plans for raising
fresh capital or augment capital through internal resources. Banks may also
redefine their business strategy with a view to altering their profile of risk
exposures or adopt a combination of both these approaches to meet the capital
requirement.
105. Under the New Framework, banks
adopting Standardised Approach would use the ratings assigned only by those
credit rating agencies which are identified by RBI. The New Framework also recognises
the responsibility of bank management in developing an Internal Capital Adequacy
Assessment Process (ICAAP) that is commensurate with banks’ risk profile and
control environment. Banks are, therefore, required to focus on formalising
and operationalising their ICAAP, which will serve as a useful benchmark while
undertaking the parallel run with effect from April 1, 2006.
(g) Ownership and Governance in Private Banks
106. It was indicated in the mid-term
Review of October 2004 that the second draft on the policy framework for ownership
and governance in private sector banks would be put in public domain. Based
on the feedback received on the draft guidelines and in consultation with the
Government, RBI has since issued final guidelines. These guidelines focus on
ensuring ‘fit and proper’ criteria, on a continuous basis in respect of investments,
restructuring and consolidation in the banking sector and provide for observance
of sound corporate governance principles. The Reserve Bank would enter into
bank-wise dialogues to ensure a time-bound framework for compliance.
(h) Guidelines on Securitisation of Standard
Assets
107. In the recent period, the
market for securitisation of standard assets has grown significantly. In order
to ensure orderly development of the market, draft guidelines on securitisation
of standard assets by banks/financial institutions and NBFCs were issued and
placed on the RBI website for comments. On the basis of the feedback, the draft
guidelines would be finalised.
(i) Guidelines on Purchase/Sale of Non-Performing
Assets
108. With a view to further increasing
the options available to banks for effectively addressing the issue of non-performing
assets, draft guidelines were issued on sale/purchase of non-performing assets
and comments thereon were sought from the banks by end-April 2005. The guidelines
broadly cover the areas on procedure for purchase/sale of non-performing financial
assets by banks including valuation and pricing aspects, prudential norms, and
disclosure requirements, and would be finalised on the basis of feedback.
(j) Modification of CDR Mechanism
109. Performance of the corporate
debt restructuring (CDR) mechanism has been reviewed and it has been decided
to make changes in regard to criteria for the minimum exposure and number of
lenders for deciding on CDR package; rationalisation of regulatory concessions;
applicability of the extant instructions relating to asset classification only
for the first restructuring of debt; and flexibility in exit option by allowing
one time settlement (OTS). Draft circular is being put in the public domain
for wider dissemination before taking final decisions.
(k) Working Group on Conflicts of Interest in
the Indian Financial Services Sector
110. As indicated in the mid-term
of Review of October 2004, RBI has constituted a Working Group on Conflicts
of Interest in the Indian Financial Services Sector (Chairman: Shri D.M. Satwalekar).
The Report of the Group is expected by July 2005, which would be put in the
public domain for wider dissemination before recommending for adoption.
V. Institutional Developments
Payment and Settlement Systems
(a) Payment and Settlement Systems: Action
Points
111. As indicated in the mid-term
Review of October 2004, a Vision Document for Payment and Settlement Systems
was prepared by RBI under the guidance of the National Payment Council and was
placed on the RBI website. Based on the feedback, a roadmap for upgradation
of payment systems was drawn up for implementation in the next three years (2005-08).
Some of the key action plans of the Document relate to a new umbrella organisation
for retail payment systems, regulations for various modes of electronic credit
transfers, risk mitigation measures to ensure settlement finality, efficiency
enhancement measures, customer rights and services and rural reach. The Vision
Document indicating action points would be placed in the public domain for wider
dissemination by June 2005.
(b) Board for Regulation and Supervision of
Payment and Settlement Systems
112. In continuation of the steps
initiated by RBI for developing institutional framework for payment and settlement
systems, a Board for Regulation and Supervision of Payment and Settlement Systems
(BPSS) was constituted as a Committee of the Central Board of RBI as notified
in the Gazette of India on February 18, 2005. The BPSS would prescribe policies
relating to the regulation and supervision of all types of payment and settlement
systems, set standards for existing and future systems, authorise the payment
and settlement systems and determine criteria for membership to these systems.
113. In order to assist BPSS in
performing its functions, RBI constituted a new department, the Department of
Payment and Settlement Systems (DPSS). With the constitution of DPSS, the functions
of the Department of Information Technology (DIT) would be to formulate and
to implement information technology policies for RBI as well as for the banking
and financial systems in the country.
(c) Electronic Payment Products: Status and
Proposed Action
114. The coverage of RTGS and ECS
has increased significantly during last year. As on April 25, 2005, RTGS connectivity
was available in 4,776 bank branches at 398 centres of the country. It is expected
that about 10,000 branches would be covered by end-March 2006.
115. The Reserve Bank proposes
operationalisation of National Electronic Funds Transfer (NEFT) System, which
would enable T+0 settlement for all networked branches of banks all over the
country for electronic transfer of funds. In order to facilitate non-networked
branches of banks to transfer funds electronically, the NEFT (Extended) System
would be implemented under which these branches could access NEFT-enabled branches
of banks for transfer of funds.
(d) Reinforcing of Information Security
116. In view of the increasing
dependence of the financial sector on internal and external networks for their
operations, information security has assumed greater importance. In this direction,
RBI has initiated several measures to ensure information security in banks.
As indicated in the mid-term Review of October 2002, banks were encouraged to
use Public Key Infrastructure (PKI) to protect information security. Since then
inter-bank systems like RTGS, PDO/NDS/SSS, SFMS, and CFMS have been made PKI-compliant.
Banks are encouraged to make increasing use of SFMS which is PKI-enabled for
inter/intra bank transactions.
Information Technology
Technology Policy: Vision Document
117. The Reserve Bank has been
guiding banks in implementation of information technology (IT) so as to provide
for seamless integration across various entities in the financial sector. In
order to facilitate the technology plans of the financial sector, RBI is preparing
a Financial Sector Technology Vision Document, covering the medium-term policy
perspectives. The draft of the Vision Document would be put in the public domain
for wider dissemination. Based on the feedback, action points would be finalised.
Urban Co-operative Banks
(a) UCBs: Medium-term Framework
118. As indicated in the mid-term
Review of October 2004, a draft ‘Vision Document for Urban Co-operative Banks’
was prepared keeping in view the heterogeneity of the sector in terms of size,
area of operation, performance and strength and was placed on the RBI website.
Based on the feedback, a medium-term framework for urban co-operative banks
(UCBs) up to 2010 is being drawn up in order to facilitate the development of
this sector into a strong and vibrant system comprising entities conforming
to all prudential requirements. The medium-term framework would be placed in
the public domain for wider dissemination and for implementation as appropriate.
The Standing Advisory Committee for Urban Co-operative Banks is increasingly
being used for continuous dialogue with the various stakeholders of the sector.
(b) Restructuring of Weak Scheduled UCBs
119. Keeping in view the importance
of scheduled UCBs, RBI has begun a consultative process involving officials
of the concerned state governments and banks for revitalising and rehabilitating
the weak scheduled UCBs. The emphasis is on a time-bound programme for restructuring
of UCBs by identifying the contours of their rehabilitation plan and setting
up monitorable milestones. The Reserve Bank would be closely monitoring the
achievements of the banks vis-à-vis the targets, at regular intervals,
and initiating appropriate action with a view to protecting depositors’ interests
and avoiding systemic problems. The issues relating to large depositors, part
conversion of deposits into equity, reduction of non-performing assets, human
resources and technological development as also support from the state government
would be examined. The option of merger/amalgamation could also be explored
wherever necessary.
Non-banking Financial Companies
120. The non-banking financial
companies (NBFCs) play a critical role as an instrument of credit delivery,
particularly, in the small scale and retail sector in the remote areas. The
emphasis has been on developing NBFCs into a financially strong sector with
improved skills and technology. In this context, RBI is examining the issue
of smooth flow of bank finance to NBFCs.
Working Group on Computerisation of State Treasuries
and On-line Connectivity
121. The Reserve Bank has constituted
a Working Group on Computerisation of State Treasuries and On-line Connectivity
to gather information on government receipts and payments with members drawn
from four state governments and RBI to study the existing practices in treasury
functions of various states, system of accounting of receipts and payments,
level of computerisation in treasuries, scope for further computerisation and
issues relating to uniform application software for treasury operations.
Standing Committee on Procedures and Performance
Audit on Public Services
122. As indicated in the mid-term
Review of November 2003, the Standing Committee on Procedures and Performance
Audit on Public Services (Chairman: Shri S.S. Tarapore) constituted by RBI has
submitted 14 Reports. Six Reports submitted by the Committee deal with matters
relating to foreign exchange, government transactions, banking operations, currency
management, regional assessment and benchmarking. Eight special Reports were
submitted dealing with specific references made by RBI. Banks and RBI have implemented
most of the recommendations of the Committee. The Standing Committee 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. A system for monitoring on a regular basis the customer
services rendered by RBI offices is being put in place.
Legal Reforms: Review of Developments
123. The Reserve Bank, in co-ordination
with the Government, has taken initiatives for necessary changes in the legal
structure to strengthen the functioning of the financial system. The Credit
Information Companies (Regulation) Bill, 2004 and Government Securities Bill,
2004 were introduced in the Parliament. As indicated in the Union Budget, 2005-06,
certain amendments to the Banking Regulation Act, 1949 and the Reserve Bank
of India Act, 1934 will be considered by the Government. In addition, the Payment
and Settlement Bill is being finalised by the Board for Regulation and Supervision
of Payment and Settlement Systems.
Mid-term Review
124. A review of the annual policy
Statement will be undertaken on October 25, 2005 and will contain such other
changes/measures as may be necessary in regard to developmental and regulatory
policies for the second half of the year.
Mumbai
April 28, 2005