Monetary Policy In 2 Minutes

MONETARY POLICY 2008-09

While aggregate supply capacities expanded and alleviated domestic macro-imbalances in 2007-08 to some extent, available indicators suggest that economic activity in India currently continues to be mainly demand-driven.

The pick-up in inflation during the fourth quarter of 2007-08 has mainly emanated from supply-side pressures such as the one-off increase in domestic petrol and diesel prices to partially offset the global crude oil price increase over the year; continuous hardening of prices of petroleum products that are not administered, rising prices of wheat and oilseeds and the adjustment in steel prices in March 2008 due to the surge in international prices.

The upsurge in inflation in India has occurred at a time when global commodity prices have been volatile at historically elevated levels and central banks in mature and emerging economies alike have been articulating heightened inflation concerns.

The moderation in non-food credit growth has been marked in respect of interest-sensitive sectors which had been recording significantly elevated growth rates in preceding years.

During the fourth quarter of 2007-08, financial markets were impacted by unusual swings and high volatility in foreign exchange flows as well as in cash balances of the government with the Reserve Bank with consequent shifts in liquidity conditions.

There are concerns that demand pressures, which have been reasonably contained so far, are being coupled with supply-side factors which, if not temporary, could impact domestic inflation significantly.

The recent monetary policy responses in the US have also heightened the uncertainties facing EMEs by widening interest rate differentials and increasing the costs of sterilisation, especially in a period when inflationary pressures warrant tightening.

The outlook for the global financial system is overcast by the rising incidence of losses and write-offs in banking systems in the US and Europe amidst dislocations in the securitised credit market. There are also growing uncertainties surrounding the viability of financial guarantors and doubts about their business models as well as the approach of rating agencies with potential systemic implications.

In the overall assessment, there have been significant shifts in both global and domestic developments in relation to initial assessments. The dangers of global recession have increased at the current juncture although consensus expectations do not rule out a soft landing. On the domestic front, the outlook remained positive up to January 2008. Since then, the prospects for growth in the year ahead have been trimmed as risks to inflation and inflation expectations from the upside pressures due to international food, crude and metal prices have become more potent and real than before.

Stance of Monetary Policy for 2008-09

In view of the monetary overhang, it is necessary to moderate monetary expansion and plan for a rate of money supply in the range of 16.5- and 17 per cent in 2008-09 in consonance with the outlook on growth and inflation so as to ensure macroeconomic and financial stability in the period ahead.

Given the unprecedented complexities involved and the heightened uncertainties at this juncture, there are some key factors that govern the setting of the stance of monetary policy for 2008-09. The challenge of escalated and volatile food and energy prices; even as investment demand remains strong, supply elasticities are expected to improve further; recent initiatives in regard to supply-management by the government of India and measures relating to the cash reserve ratio by the Reserve Bank of India; the importance of anchoring expectations relating to both global and domestic developments.

Barring the emergence of any adverse and unexpected developments in various sectors of the economy, assuming that capital flows are effectively managed, and keeping in view the current assessment of the economy including the outlook for growth and inflation, the overall stance of monetary policy in 2008-09 will broadly be to ensure a monetary and interest rate environment that accords high priority to price stability; well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum.

Based on an overall assessment of the sources of funding and the overall credit requirements of the various productive sectors of the economy, the growth of non-food credit including investments in bonds/debentures/shares of public sector undertakings and private corporate sector and commercial paper (CP) is placed at around 20 per cent in 2008-09.

The Reserve Bank will continue with its policy of active demand management of liquidity through appropriate use of the CRR stipulations and open market operations (OMO) including the MSS and the LAF, using all the policy instruments at its disposal flexibly, as and when the situation warrants.

Monetary Measures

Bank Rate kept unchanged at 6 per cent.

Reverse Repo Rate and Repo Rate kept unchanged at 6.00 per cent and 7.75 per cent, respectively.

The Reserve Bank retains the option to conduct overnight repo or longer term repo under the liquidity adjustment facility (LAF) depending on market conditions and other relevant factors. The Reserve Bank will continue to use this flexibility including the right to accept or reject tender(s) under the LAF, wholly or partially, if deemed fit, so as to make efficient use of the LAF in daily liquidity management.

Cash reserve ratio (CRR) of scheduled banks increased to 8.25 per cent with effect from the fortnight beginning May 24, 2008.

External Developments

Developmental and Regulatory Policies

Issuances of Floating Rate Bonds (FRBs) to be considered at an appropriate time taking into account market conditions.

A module of the NDS auction for non-competitive bidding scheme in the auctions of State Development Loans (SDLs) being developed by the CCIL is expected to become functional by September 2008.

Following the enactment of the Payment and Settlement Systems Act, 2007, a clearing and settlement arrangement for OTC rupee derivatives will be put in place in consultation with the CCIL.

Introduction of repo in corporate bonds to be considered once the prerequisites like efficient price discovery through greater public issuances and secondary market trading, and an efficient and safe settlement system, based on Delivery versus Payments (DvP) III and Straight Through Processing (STP), are met.

To permit authorised dealer (AD) banks to write off, in addition to claims settled by the Export Credit Guarantee Corporation of India (ECGC), the outstanding export bills settled by other insurance companies which are regulated by the Insurance Regulatory Development Authority (IRDA).

To enhance the current period for realisation and repatriation to India of the full export value of goods or software exported from six months to 12 months from the date of export, subject to review after one year.

Wider dissemination of the investor-friendly features of the regulations under the Government Securities Act, 2006 through media publicity and the website of the Reserve Bank for better customer service.

The modalities for implementing the recommendations of the Internal Working Group to review the auction procedure for the Government securities are being worked out.

Credit Delivery

With effect from April 2009, the shortfall in lending to weaker sections by the domestic scheduled commercial banks (SCBs) would be taken into account for the purpose of allocating amounts for contribution to RIDF or funds with other financial institutions as specified by the Reserve Bank.

Regional Rural Banks (RRBs) will be allowed to sell loan assets held by them under priority sector categories in excess of the prescribed priority sector lending target of 60 per cent, to enable greater flow of credit to this sector.

For 100 per cent financial inclusion, 277 districts identified and target achieved in 134 districts in 18 States and five Union Territories.

Pending finalisation of action on the recommendations of the Radhakrishna Committee, it is proposed to ask each domestic commercial bank, including RRBs, to select one district for introduction, on a pilot basis, of a simplified cyclical credit product for farmers to enable them to continuously utilise a core component of 20 per cent of the credit limit .

With a view to bringing about greater transparency, the Reserve Bank is in the process of collecting details of various charges levied by banks for public dissemination.

In order to ensure that all bank branches provide better customer services to members of public at bank counters for exchange of notes, it is proposed to introduce a scheme of incentives and penalties for bank branches (including currency chests), based on their performance in rendering such services.

A simplified procedure for crop loans to landless labourers, share croppers, tenant farmers and oral lessees to be introduced whereby banks can accept an affidavit giving details of land tilled/crops grown by such persons for loans up to Rs 50,000 without any need for independent certification. Banks could also encourage the Joint Liability Group (JLG)/SHG mode of lending for such persons.

In collaboration with the Indian Banks' Association (IBA), the Banking Codes and Standards Board of India (BSCBI) is evolving a banking code for small- and micro-enterprises.

A Working Group has been constituted to prepare RRBs to adopt appropriate technology and migrate to core banking solution to submit its report by June 30, 2008.

Banks to be permitted to classify 100 per cent of the credit outstanding under General Credit Card (GCC) from 50 per cent earlier, and overdrafts up to Rs 25,000 against 'no-frills' accounts in rural and semi-urban areas.

Prudential Measures

In case of infrastructure projects to be financed by banks, the date of completion of the project should be clearly spelt out at the time of financial closure of the project and if the date of commencement of commercial production extends beyond a period of two years (as against the current norm of one year) after the date of completion of the project as originally envisaged, the account should be treated as sub-standard. The revised instructions are effective from March 31, 2008.

Banks are required to review their advances to traders in agricultural commodities to ensure that bank finance is not used for hoarding and forward the first such review to the Reserve Bank by May 15, 2008 for carrying out supervisory review of banks' exposure to the commodity sector.

The Reserve Bank has constituted an Internal Technical Group to propose criteria for the applicability of Basel norms to State Cooperative Banks/District Central Cooperative Banks/Regional Rural Banks that is expected to submit its report by June 30, 2008.

The Reserve Bank has undertaken a detailed process of identifying the eligible credit rating agencies whose ratings may be used by banks for assigning risk weights for credit risk consistently for each type of claim, for both risk weighting and risk management purposes.

A Working Group to lay down a roadmap for adoption of a suitable framework for cross-border supervision and supervisory cooperation.

Institutional Developments

Following the enactment of the Payment and Settlement Systems Act, 2007, the Reserve Bank has placed the draft regulations under the Payment and Settlement Systems Act, 2007 on its website inviting public comments latest by May 15, 2008 to finalise regulations in consultation with the Government of India.

The Reserve Bank has extended the waiver of processing charges for ECS / EFT / NEFT up to March 31, 2009.

The Reserve Bank is formulating draft guidelines for mobile payment systems in India to be placed on its website by June 15, 2008.

Effective April 1, 2008, all payment transactions of Rs 1 crore and above in the money, Government securities and foreign exchange markets and the regulated entities (banks, PDs and NBFCs) have been made mandatory to be routed through the electronic payment mechanism.

A Working Group to be constituted comprising representatives of the Reserve Bank, Central/State Governments and the UCB sector to suggest measures, including the appropriate regulatory and supervisory framework, to facilitate emergence of umbrella organisation(s) for the UCB sector in the respective States.

To dispense with the minimum net worth criteria for undertaking insurance business provided other criteria as prescribed from time to time are met.

To increase the extant limit on individual housing loans from Rs 25 lakh to a maximum of Rs 50 lakh in respect of Tier-II UCBs, subject to certain conditions.

In the light of international developments and increasing bank exposure to these systemically important NBFCs, to review the regulations in respect of capital adequacy, liquidity and disclosure norms and issue revised instructions by May 31, 2008.

As part of the progress made by the Committee on Financial Sector Assessment (CFSA), the four Advisory Panels constituted by the Committee have prepared their draft reports. The reports of the CFSA as also those of Advisory Panels are expected to be finalised by end-June 2008 and will be placed thereafter on the Reserve Bank's website.

The advance estimates of the Central Statistical Organisation (CSO) placed real GDP growth at 8.7 per cent for 2007-08, over and above 9.6 per cent in 2006-07.

The average price of the Indian basket of international crude increased by 27.6 per cent from $62.4 per barrel during 2006-07 to $79.7 per barrel in 2007-08.

On a year-on-year basis, the wholesale price index (WPI) inflation stood at 7.4 per cent at end-March 2008 as compared with 5.9 per cent a year ago. During 2007-08, headline inflation declined from 6.4 per cent at the beginning of the financial year to a low of 3.1 per cent in mid-October before firming up from mid-February.