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April 29, 2002 | 1400 IST
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Jalan's statement on the Monetary Policy


The statement of Bimal Jalan, Governor of the Reserve Bank of India on Monetary and Credit Policy for the year 2002-03, consists of three parts:

  1. Review of Macroeconomic and Monetary Developments during 2001-02;
  2. Stance of Monetary Policy for 2002-03, and
  3. Financial Sector Reforms and Monetary Policy Measures.

Like last year, a technical and analytical review of macroeconomic and monetary developments is being issued as a separate document. This document provides the necessary macroeconomic and other information in somewhat greater detail with the help of simple charts and tables.

Review of Macroeconomic and Monetary Developments: 2001-02

Domestic Developments

RBI Governor Bimal JalanRecently, the Central Statistical Organisation (CSO) released revised figures for national income growth for the year 2000-01.

According to the latest estimates, the growth rate of GDP was substantially lower than earlier estimated, mainly due to downward revision in the growth rate of the services sector.

While the growth rate of the services sector was revised downwards from 7.5 per cent to 5.0 per cent, that of agriculture and allied activities was revised from 0.2 per cent to (-) 0.2 per cent.

On the other hand, industrial sector growth was revised upwards from 5.3 per cent to 6.2 per cent. As a result, overall GDP growth during 2000-01 was placed at 4.0 per cent on a revised basis as against 5.2 per cent estimated earlier.

During 2001-02, according to preliminary estimates by the CSO the growth in agricultural sector is expected to be buoyant at about 5.7 per cent as against a negative growth of 0.2 per cent in the previous year.

However, the overall growth performance of the industrial sector at 3.3 per cent is estimated to be lower than that of 6.2 per cent in the previous year.

Combined with a reasonable performance of the services sector, estimated to grow by 6.2 per cent mainly on account of trade and transport, finance and business services, the CSO in its latest estimates has projected real GDP growth in 2001-02 at 5.4 per cent as compared with 4.0 per cent in 2000-01.

This is consistent with the rate of growth between 5.0 and 6.0 per cent indicated by RBI in the Mid-term Review of October 2001.

The domestic inflationary situation during 2001-02 was highly favourable. The annual rate of inflation, on a point-to-point basis, as measured by variations in the wholesale price index (WPI) (base: 1993-94 = 100) declined from 4.9 per cent in end-March 2001 to 1.4 per cent by end-March 2002.

Inflation on account of manufactured products (weight: 63.7) registered a decline of 0.4 per cent as compared with an increase of 3.8 per cent in the previous year reflecting sluggish conditions in industrial sector. Primary articles (weight: 22.0) showed an increase of 3.8 per cent as against a decline of 0.4 per cent last year.

The moderation in inflation rate has been largely on account of much lower increase of 3.8 per cent in 'fuel, power, light and lubricants' group (weight: 14.2) in contrast to 15.0 per cent increase a year ago.

The base effect of higher oil prices last year is apparent, as annual inflation measured by increase in WPI on an average basis, worked out to 3.6 per cent as against 7.2 per cent a year.

During 2001-02, the annual growth in money supply (M3) was in line with the projected trajectory at 14.0 per cent (Rs 1,83,912 crore) as against 16.8 per cent (Rs 1,89,046 crore) a year ago.

Among the components, the growth in aggregate deposits of scheduled commercial banks at 14.3 per cent was lower than that of 18.4 per cent in the previous year during which deposits were augmented by India Millennium Deposit inflows.

The expansion in currency with the public was higher at 15.2 per cent (Rs 31,890 crore) as against 10.8 per cent (Rs 20,468 crore) in the previous year. This could partly be attributed to higher agricultural activity and larger procurement of foodgrains.

The increase in reserve money during 2001-02 at 11.4 per cent (Rs 34,514 crore) was higher than that of 8.1 per cent (Rs 22,757 crore) in the previous year.

It is interesting to note that the expansion in reserve money was entirely on account of the increase in net foreign exchange assets of RBI which rose by 33.9 per cent (Rs 66,794 crore) as compared with 18.9 per cent (Rs 31,295 crore) in 2000-01.

On the other hand, unlike in the past, net domestic assets of RBI declined on account of both net RBI credit to the Central Government as well as credit to the commercial sector.

Notwithstanding RBI's subscription to fresh government dated securities of Rs 28,892 crore, net RBI credit to the Central Government declined by 0.3 per cent (- Rs 506 crore) due to open market sales of government securities of Rs 30,335 crore. RBI's claims on banks and commercial sector also showed a decline of Rs 9,575 crore reflecting comfortable liquidity available with them.

During 2001-02, non-food credit registered a lower growth of 12.8 per cent (Rs 60,411 crore) as against an increase of 14.9 per cent (Rs 61,176 crore) in the previous year reflecting deceleration in industrial production.

The increase in total flow of funds from scheduled commercial banks to the commercial sector during 2001-02 including banks' investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper, etc. was also lower at 12.0 per cent (Rs 65,862 crore) as against 16.1 per cent (Rs 75,791 crore) in the previous year.

Total flow of resources to the commercial sector, including capital issues, global depository receipts (GDRs) and borrowing from financial institutions was Rs 1,37,429 crore as compared with Rs 1,71,928 crore in the previous year.

The increase in food credit at Rs 13,987 crore during 2001-02 was similar compared with Rs 14,300 crore in the previous year reflecting large scale procurement operations.

The buffer stock of foodgrains rose to 54.5 million tonnes by end-February 2002 from 46.8 million tonnes in end-February 2001.

The carrying costs of holding large buffer stocks beyond an optimal level need to be carefully considered, keeping in view the fact that the outstanding food procurement credit of scheduled commercial banks was as high as Rs 53,978 crore by March 2002.

As per the revised estimates in the Budget 2002-03, the fiscal deficit of the Central Government for 2001-02 was placed at Rs 1,31,721 crore as against the budget estimate of Rs 1,16,314 crore.

During the financial year 2001-02, net market borrowings of the Central Government at Rs 92,302 crore (gross Rs 1,33,801 crore), exceeded the budget estimates by Rs 14,949 crore and was higher by Rs 822 crore over the revised estimate.

The State Governments' net market borrowings have also increased by Rs 4,404 crore from the earlier budgeted level of Rs 12,857 crore.

Although the combined slippage in the borrowings of the Centre and States by as much as Rs 19,353 crore did not exert undue pressure on interest rates because of availability of ample liquidity and depressed credit demand, as emphasised in the Budget speech for 2002-03, there is an urgent need to contain fiscal deficit to improve the task of monetary and debt management from a medium-term perspective.

As emphasised in various policy Statements, the overall monetary management becomes difficult when a large and growing borrowing programme of the Government, year after year, puts pressure on the absorptive capacity of the market.

Already, the banking system holds government securities of more than 36.5 per cent of its net demand and time liabilities as against the statutory minimum requirement of 25.0 per cent.

In terms of volume, such holdings above the statutory liquidity ratio (SLR) amounted to more than Rs 1,40,300 crore, which is higher than the gross borrowings of the government.

Such a large exposure to government securities may inhibit the ability of banks to meet the credit requirements of the productive sectors of the economy, if there is a significant pick-up in demand during the current year.

Further, the sustainability of public debt is now a matter of concern, given the increasing interest payments. The reduction in fiscal deficit would impart flexibility to the interest rate regime.

It was indicated in the annual policy Statement of April 2001, and reiterated in the Mid-term Review of October 2001 that RBI is committed to maintain adequate liquidity in the market with preference for softening of interest rates to the extent the evolving situation warrants.

To this end, despite the high level of government borrowing programme during 2001-02, it was possible to maintain adequate liquidity and a softer interest rate environment without engendering inflationary conditions in the economy.

This is evidenced from the fact that the primary market yields on 91-day and 364-day Treasury Bills came down by as much as 262 basis points and 280 basis points, respectively.

Simultaneously, the call money rate and weighted average discount rate of CP declined by 156 basis points and 153 basis points, respectively, during the course of the year.

There was also a perceptible downward shift in secondary market yields on government securities across the maturity spectrum during the year.

The yield on government securities with 1-year residual maturity moderated from 9.05 per cent in March 2001 to 6.10 per cent by March 2002 indicating a reduction in yield by as much as 295 basis points.

Similarly, the yield on government securities with 10-year residual maturity had declined by 287 basis points to 7.36 per cent by March 2002 from 10.23 per cent in March 2001.

These are among the sharpest reductions in interest rates during the course of a year in the last three decades. However, it needs to be recognised that it may not be possible to reduce the cost of borrowing in the face of higher market borrowings, year after year, particularly when credit demand picks up.

In this context, it may be mentioned that while the yields on government securities have declined sharply, those on non-government bonds have witnessed a lower reduction resulting in widening of the spread between these two categories of fixed income securities.

Illustratively, the spread between the prime-rated CP and 91-day Treasury Bills widened from 82 basis points in end-March 2001 to 202 basis points by end-March 2002.

This could be attributed to greater preference of investors, particularly the banking sector, to seek high quality securities in the face of sluggish growth of industrial sector.

The "flight to quality" has been so strong that the yield rate on 10-year government securities had fallen by 287 basis points to reach 7.36 per cent as at end-March 2002.

On the other hand, the reduction in deposit rates has been less pronounced with the term deposit rates of public sector banks moving down from a range of 4.0-10.5 per cent for various maturities in March 2001 to 4.25-8.75 per cent by March

The term structure of interest rates reveals that the long-term interest rates have declined more sharply than the short-term rates.

For example, in the government securities market, the spread between the yields on 10-year government securities and 91-day Treasury Bills narrowed down from 237 basis points at end-April 2001 to 123 basis points by end-March 2002.

While the tenor spread in the government securities market has narrowed reflecting, inter alia, moderation of inflationary expectations, the term spread between highly rated corporate paper and government securities has widened.

For example, the spread between AAA rated 5-year corporate bonds and the yield on government securities of equal residual maturity widened from about 65 basis points in end-April 2001 to about 177 basis points by end-March 2002 reflecting, inter alia, an increase in investor preference for sovereign paper.

It is necessary to impart greater flexibility to interest rate structure in India consistent with the underlying macroeconomic conditions.

Further progress in this direction could be made if banks move over to a variable interest rate structure on longer term deposits as early as possible.

Since interest rates could vary in both directions, depending on the phase of business cycle and inflationary outlook, a variable interest rate regime on long-term deposits does not necessarily imply lowering of the average interest rate earned by depositors over a period of time (compared with a fixed rate regime, which favours old deposits over new deposits when interest rates are coming down, and vice versa when rates are moving in the opposite direction).

In addition, banks need to reduce their operating costs over time by improving productivity and increasing their volume of lending. This should be possible with proper upgradation of technology in areas which, at present, are contributing to higher costs.

In view of the easy liquidity conditions and softer interest rate environment, the overall monetary conditions are at present reasonably comfortable.

However, experience of recent years once again confirms that monetary management has now become much more complex than was the case even a few years ago.

This is because of several factors, such as the on-going integration of financial markets across the world, the phenomenal increase in financial turnover, liberalisation of the economy, and the rapidity with which unanticipated domestic and international tremors get transmitted to financial markets across the world because of the new technology.

It may be recalled that at the beginning of 2001-02, the Reserve Bank had taken steps to ease monetary policy. However, adverse external developments post-September 11 and their effect on financial markets in India necessitated a quick response to provide assurance and stabilise domestic financial markets without tightening monetary conditions.

Fortunately, these measures succeeded in stabilising financial conditions without calling for a reversal in the monetary stance.

The need for proactive counter-cyclical policy in the light of emerging situation has also been the experience of other monetary authorities, including the US and European central banks.

It is important to emphasise this since, in case the present economic circumstances change, it may again become necessary to take appropriate monetary measures, which may not be in consonance with the present easy liquidity conditions.

Keeping these realities in view, it is particularly important for banks and financial institutions to make adequate provisions for unforeseen contingencies in their business plans, and fully take into account the implications of changes in the monetary and external environment on their operations.

In this context, in January 2002, RBI proposed that banks should build up investment fluctuation reserve (IFR) to a minimum of 5.0 per cent of their investment portfolio by transferring the gains realised on sale of investments within a period of five years.

Banks are, however, free to build up higher percentage of IFR of up to 10.0 per cent of their portfolio depending on the size and composition of their portfolio, with the concurrence of their Board of Directors.

External Developments

While the world economy had slowed down considerably during the first half of the year 2001, the expectation of revival was modest for the second half.

The recessionary trends were compounded by the adverse impact of September 11 events on services and trade. In addition, all segments of the financial market, particularly the equity markets, were badly affected.

The impact was also felt in the financial markets of the emerging market economies, as there was a shift away from risky assets.

These uncertainties prompted the IMF to sharply scale down its growth projection for the global economy to 2.4 per cent, which is almost half of the level of growth recorded in 2000.

Fortunately, in recent weeks, the outlook for a recovery in the world economy, particularly in the US, has become much better. This has now prompted the IMF to upgrade its growth projection for the global economy for 2002 to 2.8 per cent from the earlier projection of 2.4 per cent in December 2001.

International developments, consequent to the events of September 11, had their destabilising impact on Indian financial markets with a sharp decline in the equity prices and net capital outflows of foreign institutional investors.

Foreign exchange market also became volatile with the rupee depreciating vis--vis US dollar and consequent uncertainties also affected the government securities market.

However, RBI promptly announced its intention to provide appropriate liquidity and initiated several measures so as to stabilise domestic financial markets. These actions by RBI restored stability and confidence in financial markets, which were reflected in the quick return of these markets to normal conditions.

Despite adverse external developments, India's foreign exchange reserves continued to record a healthy growth during 2001-02 due to moderation in trade deficit and strong capital and other inflows.

Foreign exchange reserves increased by as much as $11.8 billion from $42.3 billion in end-March 2001 to US $54.1 billion by end-March 2002.

Of these, foreign currency assets increased by $11.5 billion. This is the highest increase recorded in a single year and is an evidence of strong domestic and international confidence in India's management of its balance of payments in the post-1991 period.

Reflecting this confidence, in the last four years since the East Asian crisis of 1997-98, India's foreign exchange reserves have more than doubled despite substantial increase in oil imports during the period and several other unfavourable developments affecting the prospects of developing countries.

India's sustained efforts to build an adequate level of foreign exchange reserves have been vindicated by global uncertainties.

It is now widely agreed that in judging the adequacy of reserves in emerging economies, it is not enough to relate the size of reserves to the quantum of merchandise imports or the size of the current account deficit.

The overall approach to the management of India's foreign exchange reserves in recent years has, therefore, reflected the changing composition of balance of payments. In addition to the likely developments in the current account, the reserve management has also endeavoured to reflect the liquidity risks associated with different types of flows and other requirements.

The policy for reserve management is thus judiciously built upon a host of identifiable factors and other contingencies.

The prevalent national security environment further underscores the need for strong reserves. We must continue to ensure that, leaving aside short-term variations in reserves level, the quantum of reserves in the long-run is in line with the growth of the economy, the size of risk-adjusted capital flows and national security requirements.

This will provide us with greater security against unfavourable or unanticipated developments, which can occur quite suddenly.

India's exports have not done well last year largely on account of global slowdown exacerbated by the September 11 events which affected export of services.

The growth rate of exports in US dollar terms decelerated to 0.05 per cent during 2001-02 (April-February) as compared with 20.6 per cent in the corresponding period of the previous year.

In view of enlargement in domestic refining capacity, increase in oil exports (by 12.7 per cent) have emerged as a significant item of export growth.

Non-oil exports, on the other hand, declined by 0.5 per cent as against an increase of 15.7 per cent in the previous year.

The growth of imports showed an increase of 2.1 per cent as compared with 1.6 per cent in the corresponding period of the previous year reflecting lower oil imports emanating from moderation in international oil prices.

While oil imports registered a decline of 11.9 per cent as against an increase of 55.0 per cent in the previous year, non-oil imports increased by 8.7 per cent.

It was announced in the annual policy Statement of April 2001 that a survey would be conducted through an independent outside agency in order to have a feedback on simplification of procedures by RBI for export credit delivery as also the level of exporters' satisfaction with bank services.

Accordingly, the work of the survey was entrusted to National Council of Applied Economic Research, New Delhi. NCAER has since submitted its report.

The results of the survey reflect positive responses to RBI's initiatives in improving the credit delivery system to exporters.

More than three-fourths of exporters were satisfied with overall bank services relating to export credit delivery. Nearly one-fourth of exporters perceived them as "excellent" and more than half as "good".

The only exception is the eastern region where only 12 per cent perceived them as "excellent" and less than half as "good". The report also made some suggestions for improving the credit delivery to exporters which are being examined.

Reflecting comfortable supply position, the foreign exchange market generally exhibited stable conditions during 2001-02 barring some instances of volatility arising out of occasional uncertainties in market sentiments.

The foreign exchange market witnessed brief periods of uncertainty in May 2001 on account of pressure on oil prices and downgrading of sovereign outlook; deceleration in capital inflows following September 11 events; and again in December 2001 due to terrorist attack on Indian Parliament and border tension.

While the rupee depreciated against the US dollar during the year, it showed a mixed trend against other major currencies such as, Japanese Yen, Euro and Pound Sterling.

In the European Monetary Union, Euro, as a single currency, came into being with effect from January 1, 1999.

As a preparatory measure, RBI, on November 20, 1998 had notified Euro as a permissible transaction currency under FERA and advised banks to accept FCNR (B) deposits in euro and convert existing deposits to euro freely besides balances in Exchange Earners' Foreign Currency (EEFC) and Resident Foreign Currency accounts. Banks were given freedom to use Euribor and Eurolibor as benchmarks for pricing their foreign exchange transactions.

At the instance of RBI, FEDAI conducted a training programme for bankers to familiarise them with the procedure of handling euro notes/coins.

In the wake of smooth transition to euro notes and coins from January 1, 2002, RBI instructed Authorised Dealers (ADs) and full-fledged money changers to make arrangements to display euro exchange rates for travellers' cheques and currency notes and extend facilities to residents for conversion of legacy currencies to euro.

Another major development in this area is that the Government of India has since given the option to RBI to use euro as intervention currency in addition to US dollar.

Furthermore, Hyderabad and Nagpur have been included as new centres for sale and purchase of US dollar and euro.

It may be recalled that in the annual policy Statement of April 1998, soon after the Asian crisis, RBI had highlighted the need for caution in the management of the exchange rate in emerging economies.

It was observed that: "Sll countries, and developing countries in particular, have to be constantly watchful of developments that may adversely affect exchange markets. There can be no room for complacency in this regard."

It was further reiterated in the Mid-term Review of October 1998 that: "RBI will continue to closely monitor developments in the financial markets at home and abroad, and take such monetary and administrative actions as may be considered necessary from time to time."

RBI will not hesitate to use its reserves, when warranted, to meet sharp day-to-day supply-demand imbalances in the market. As before, it will ensure that lumpy and uneven demand, particularly for oil imports and debt servicing obligations of the Government, does not cause any disturbance.

Subsequent international developments have further underscored the need for careful management of the exchange rate in order to maintain orderly conditions in the markets (without, however, targeting a specific level).

An important reason for this conclusion was highlighted in the Mid-term Review of October 2000 which observed that: " in the very short-run, "expectations" about the likely behaviour of a currency next day or over a week or fortnight can play a major role in determining its movement against foreign currencies, particularly the US dollar.

Given the "bandwagon" effect of any adverse movements, and the herd behaviour of market participants, expectations can often become self-fulfilling.

This is particularly true of thin developing country markets, where net volumes are relatively small. The day-to-day movement in currency markets is further complicated by volatility in private capital flows, which are highly sensitive to short-term domestic and international developments as well as future expectations.

Another important reason for a vigil on exchange rate is the likely effect of adverse developments in forex market on the real economy, as has been seen in several East Asian and Latin American countries a couple of years ago, and in Turkey and Argentina recently.

The "contagion" effect is quick, and a sharp change in the currency value can affect the real economy more than proportionately.

Exporters may suffer if there is unanticipated sharp appreciation and debtors or other corporates may be affected badly if there is a sharp depreciation, which can also lead to bank failures and bankruptcies.

Against the above background, India's exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way, has stood the test of time.

Despite several unexpected external and domestic developments, India's external situation continues to remain highly satisfactory.

RBI will continue to follow the same approach of watchfulness, caution and flexibility while dealing with the forex market. It is a matter of satisfaction that the recent international research on viable exchange rate strategies in emerging markets has lent considerable support to the exchange rate policy followed by India.

A number of countries (including those in East Asia) are now following similar policies.

In the past two years, a number of changes have been introduced in various schemes for remittances, investment and maintenance of bank accounts by non-resident Indians.

Continuing with the policy of liberalisation of the capital account, following the announcement made in the Budget 2002-03, the Reserve Bank has implemented the following measures:

1.With a view to providing full convertibility on non-resident deposit schemes, non-resident non-repatriable (NRNR) account and non-resident special rupee (NRSR) account schemes were discontinued with effect from April 1, 2002.

Banks would not accept any deposit, whether by way of renewal of existing deposits or otherwise under these two schemes with effect from April 1, 2002.

Existing accounts under NRNR scheme, however, may be continued up to the date of maturity. On maturity of the existing deposits under the NRNR scheme, the maturity proceeds shall be credited to the account holder's non-resident (external) account (NRE account), after giving notice to the account holder.

Similarly, the existing accounts in the form of term deposits under NRSR scheme may be continued till the date of maturity.

On maturity, the maturity proceeds shall be credited to the account holder's non-resident (ordinary) account (NRO account). Existing NRSR accounts, other than term deposits, would not be continued after September 3.

2.Existing limits for Indian direct investment outside India under automatic route has been raised from $50 million in a financial year to $100 million.

Such Indian investors could now purchase foreign exchange up to 50 per cent of their net worth as on the date of last audited balance sheet as against the existing limit of 25 per cent.

3. Corporate borrowers are allowed to prepay ECBs to the extent of the balances in their EEFC accounts, with the approval of RBI.

Corporates which are export-oriented units and others can credit up to 70 per cent and 50 per cent, respectively, of their foreign exchange earnings to their EEFC accounts.

RBI has since decided to allow the corporates to credit higher than the above percentage of export proceeds to their EEFC accounts on a case-by-case basis to enable them to take advantage of lower interest rates and prepay their ECBs.

4.It has been decided to allow Indian corporates with proven track record to contribute funds from their foreign exchange earnings for setting up Chairs in educational institutions abroad, and for similar such purposes.

Such cases will be considered by RBI on a case-by-case basis.

5.RBI had issued a notification in September 2001 permitting Indian companies to raise the 24 per cent limit on Foreign Institutional Investors' (FIIs) investment to the sectoral cap/statutory ceiling as applicable.

As announced by the Finance Minister in his Budget speech for 2002-03, FII portfolio investments will not be subject to sectoral limits for foreign direct investment except in specified sectors. The details of sectors and the limits applicable will be specified by the Government in due course.

6.NRIs will be able to repatriate their current income in India such as rent, dividend, pension, interest, etc. by submitting a certificate from their chartered accountant certifying that the amount proposed to be remitted is eligible for remittance and that applicable taxes have been paid/provided for.

7.Indian mutual funds will be allowed to invest in rated securities in countries with fully convertible currencies, within the existing limits.

Earlier such investment was only permitted in ADRs/GDRs issued by Indian companies in overseas markets.

8.With a view to further liberalise capital account transactions, it has been decided to put the limit for Foreign Currency Convertible Bond (FCCB) scheme under the automatic route up to US $50 million.

The Reserve Bank, as a part of the consultative process, constituted various working groups on relevant policy subjects with the participation of bankers, market participants and experts.

Working groups were also set up for suggesting road maps for implementation of international best systems and practices in the financial system in general and banking sector in particular.

The reports of the working groups were examined internally and, as necessary, these were also put on the RBI Web site for wider dissemination and comments. The details of the progress made in respect of certain working groups constituted recently are given in the Annexure to this statement.

The overall stance of monetary policy in 2001-02, as outlined in last year's annual policy Statement, was as follows:

  • Provision of adequate liquidity to meet credit growth and support revival of investment demand while continuing a vigil on movements in the price level.
  • Within the overall framework of imparting greater flexibility to the interest rate regime in the medium-term, to continue the present stable interest rate environment with a preference for softening to the extent the evolving situation warrants.

The monetary management in 2001-02 was largely in conformity with the monetary policy stance announced in annual policy statement of April 2001 and reiterated in the Mid-term Review of October 2001.

However, the monetary management in 2001-02 was fraught with several challenges like overhang of liquidity, global slowdown, external developments after September 11 and the tense situation on the borders.

As spelt out in the Mid-term Review of October 2001, RBI has been able to maintain stable interest rate regime throughout the year with a bias towards further softening of the interest rates.

The yields on government securities in the secondary market ruled much lower than the yields at the beginning of the financial year. The large market borrowing programme of the Government could be completed at a lower cost without unduly affecting the general interest rates.

Though there have been substantial lendable resources with banks due to reduction in the Cash Reserve Ratio (CRR) and prevalence of soft interest rate regime, as mentioned earlier, non-food credit off-take has not picked up to a desirable extent due to low level of economic activity in general, which is evident from the decelerated growth in industrial production.

During the last quarter of 2001-02, a pick-up in the non-food credit has been observed which is expected to continue.

Further, benign inflation, good agricultural prospects, and signs of recovery, though incipient, in the US and euro-zone should help the process of recovery in our economy. Agricultural recovery should increase rural demand for both durable and non-durable goods.

The global recovery should also help our exports, specifically in software and knowledge-based industries. As such, it is anticipated that the demand for credit is likely to increase in the current year.

During 2001-02, forex market showed considerable stability without any undue pressure on exchange rate.

As pointed out in the previous Section, India's exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way, has stood the test of time.

Despite several unexpected external and domestic developments, India's external situation has remained highly satisfactory.

RBI will continue to follow the same approach of watchfulness, caution and flexibility in regard to the forex market.

Barring major unforeseen global development, RBI will also continue to ensure that, leaving aside short-term variations in reserve levels, the quantum of reserves in the long-run is in line with the growth rate in the economy, the share of external sector in the economy, and the size of the risk-adjusted capital flows.

The fiscal deficit of the Central Government which was budgeted at 4.7 per cent of GDP for 2001-02 was revised upward to 5.7 per cent. For the year 2002-03, the fiscal deficit was placed at 5.3 per cent of GDP and the market borrowing programme of the Centre at Rs 1,42,867 crore (gross) and Rs 95,859 crore (net).

While the market borrowing programme in respect of some States has come under stress, RBI expects to conduct debt management without serious pressure on overall liquidity and interest rates.

The projection of overall growth rate for the year 2002-03 basically depends on the speed of recovery in the industrial sector and the expected growth in agriculture.

The present indications show that agriculture is likely to grow at a higher rate than last year and there are positive indications of a quicker recovery in the industrial sector with good prospects for export sector.

For the purpose of monetary policy formulation, for the year as a whole, growth rate of real GDP in 2002-03 is placed at 6.0 - 6.5 per cent. The rate of inflation is assumed to be slightly lower than 4.0 per cent.

The projected expansion in broad money (M3) for 2002-03 is 14.0 per cent. Consistent with this order of growth in M3, an increase in aggregate deposits of scheduled commercial banks is set at Rs 1,54,000 crore.

Non-food bank credit adjusted for investments in commercial paper, shares/debentures/bonds of PSUs and private corporate sector is projected to increase by 15.0-15.5 per cent.

Against this background, RBI proposes to continue to ensure that all legitimate requirements for credit are met, consistent with price stability.

Towards this end, RBI will continue its policy of active demand management of liquidity through OMO, including two-way sales/purchase of Treasury Bills and using the policy instruments at its disposal, whenever required.

Unless circumstances change unexpectedly, RBI will continue to maintain current interest rate environment with a bias towards softer interest rate regime in the medium-term.

Further, the long-term objective would be towards realignment of interest rates of all types of debt instruments, both the government and private sector, within a narrow band.

The Monetary Policy framework has also substantially changed during the past few years in moving from direct to indirect instruments and improved the transmission mechanism of monetary policy.

This process is likely to accelerate with the operationalisation of the Real Time Gross Settlement (system. The precursors for RTGS such as operationalisation of Negotiated Dealing System (NDS) and Clearing Corporation of India Ltd. (CCIL) have been put in place.

There have been substantial improvements in the systems of regulation and supervision of banks and the proposal to set up a Credit Information Bureau (CIB) to collect, process and share credit information on the borrowers among banks and FIs within the existing legal framework attains importance in this regard.

The Bank Rate changes combined with CRR and repo rate changes have emerged as signalling devices for interest rate changes and important tools of liquidity and monetary management.

The liquidity adjustment facility (LAF) has evolved as an effective mechanism for absorbing and/or injecting liquidity on a day-to-day basis in a more flexible manner and, in the process, providing a corridor for the call money market.

With most of the procedural and technological constraints removed, RBI's endeavour to make LAF much more efficient will continue.

RBI will also continue its efforts to bring about development and smooth functioning of the financial market and pursue further financial sector reforms towards achieving a greater degree of financial stability.

In sum, under normal conditions and barring emergence of any adverse and unexpected developments in the various sectors of the economy, the overall stance of Monetary Policy for 2002-03 will be:

  • Provision of adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level.
  • In line with the above, to continue the present stance on interest rates including preference for soft interest rates.
  • To impart greater flexibility to the interest rate structure in the medium-term.


The Monetary and Credit Policy 2002-2003
The Rediff Budget Special

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