Executive Summary

India is a democratic country where economy plays a very important role. The economy was characterized by extensive regulation, protectionism, and public ownership, leading to pervasive corruption and slow growth. Since 1991, continuing economic liberalization has moved the economy towards a market based system. The Indian economy has undergone substantial changes since the introduction o! economic re!orms in 1991. They included various measures like deregulating the markets and encouraging private participation" trade liberalization" dismantling the restrictions on domestic and !oreign investments" re!orming the !inancial sector and the tax system, etc. Today, #anking is also an important !actor in Indian $inancial System. The banking system in India has undergone signi!icant changes during last 1% years. There have been new banks, new instruments, new windows, new opportunities and, along with all this, new challenges. &hile deregulation has opened up new vistas !or banks to augment incomes, it has also entailed greater competition and conse'uently greater risks. (entral banking is the responsibility o! the )eserve #ank o! India, which in 19*+ !ormally took over these responsibilities !rom then Imperial #ank o! India, relegating it to commercial banking !unctions. ,!ter India-s independence in 19./, the )eserve #ank was nationalized and given broader powers.

The )eserve #ank o! India has achieved transparency in its operations, especially in terms o! evolving communication policy aimed at addressing a wide range o! audiences. 0otwithstanding the changing challenges o! di!!erent regimes, the )eserve #ank has managed to evolve constructively on a continuous basis to cope with demands !or stable macroeconomic management and !inancial stability, while meeting the ob1ectives o! economic growth and development. ,s the economy becomes increasingly open and global, the role o! the )eserve #ank will undergo !urther change and it will need to e'uip it !or coping with these emerging challenges on a continuous basis.

INDEX
Sr no. 1 Chapter no. I
1.1 1.2 1.*

Tit e Intro!uction
Indian 3conomy #anking 4i!!erent periods o! #anking Sector

'.. no.
1/0 182 *8. +8%

II
2.1 2.2 2.*

In!ian "inancia Sy#tem

$inancial sector 5 its importance 6easures (hanging role o! )#I in !inancial sector

1 / 15
989 1: 8 11 12 8 1+

III
*.1 *.2 *.*

Intro!uction to Centra $an% in In!ia

)eserve #ank o! India $unctions )ole

10 / 22
1% 8 19
n

19 19 8 2:

4 5

IV V
+.1 +.2 +.*

&onetary 'o icy ( it# o)*ective# Techni+ue# o, monetary contro u#e! )y -$I
7pen 6arket 7perations )epo rate and )everse )epo rate #ank rate 2

21 / 20 20 / 33
2/ 8 29 29 8 *:

*1 +.. +.+ +.% (ash )eserve )atio Statutory ;i'uidity )atio Interest )ate *2 8 *. *+ 8 */ *9

VI
%.1 %.2 %.*

E+uitie# in In!ia
Introduction o! Sensex !or 1: years <icture o! =4< )#I> )eview on #ank $inancing o! e'uities

34 / 45
*9 8 .: .: 8 .1 .1 8 .+

VII
/.1 /.2 /.*

Cri#i# ( In!ia
Introduction o! (risis ?arious actions taken by )#I (hallenges !orward to be !aced by )#I

40 / 55
.% 8 ./ ./ 8 +: +1 8 ++

VIII
9.1 9.2 9.*

In, ation in In!ia

Introduction Steps taken by )#I to control it 7bservations 5 Suggestions

50 / 05
+% 8 +/ +9 8 %1 %2 8 %+

4 12

IX X

Conc u#ion 00 $i) io.raphy

C56N7IN7 -89E 8" CENT-69 $6N: IN DEVE98'IN7 EC8N8&; / 6 C6SE ST<D; 8" INDI6

C56'TE- I Intro!uction to In!ian Economy

The economy o! India is the twel!th largest in the world by market exchange rates and the !ourth largest in the world by =4<, measured on a purchasing power parity @<<<A basis. The country was under socialist based policies !or an entire generation !rom the 19+:s until the 199:s. The economy was characterized by extensive regulation, protectionism, and public ownership, leading to pervasive corruption and slow growth. Since 1991, continuing economic liberalization has moved the economy towards a market based system. <reviously a closed economy, India-s trade has grown !ast. ,ccording to the &T7 India currently accounts !or 1.+B o! &orld trade as o! 2::/. ,ccording to the &orld Trade Statistics o! the &T7 in 2::%, India-s total merchandise trade @counting exports and importsA was valued at C29. billion in 2::% and India-s services trade inclusive o! export and import was C1.* billion. Thus, India-s global economic engagement in 2::% covering both merchandise and services trade was o! the order o! C.*/ billion, up by a record /2B !rom a level o! C2+* billion in 2::.. India-s trade has reached a still relatively moderate share 2.B o! =4< in 2::%, up !rom %B in 199+.

The Indian economy has undergone substantial changes since the introduction o! economic re!orms in 1991. These re!orms were a comprehensive e!!ort consisting o! three main components namely, liberalization, privatization and globalization. They included various measures like deregulating the markets and encouraging private participation" trade liberalization" dismantling the restrictions on domestic and !oreign investments" re!orming the !inancial sector and the tax system, etc. ,ll such policy initiatives radically changed the economic set up o! the country and integrated it with the rest o! the world. Thus, India was placed in a globally competitive position so as to !ully utilize its potentials and opportunities !or rapid growth o! the economy.

Intro!uction to $an%in.
#anking in India originated in the last decades o! the 19th century. The oldest bank in existence in India is the State #ank o! India, a government owned that is the largest commercial bank in the country. (entral banking is the responsibility o! the )eserve #ank o! India, which in 19*+ !ormally took over these responsibilities !rom then Imperial #ank o! India, relegating it to commercial banking !unctions. ,!ter India-s independence in 19./, the )eserve #ank was nationalized and given broader powers. In 19%9, the government nationalized the 1. largest commercial banks" the government nationalized the six next largest in 199:. (urrently, India has 99 scheduled commercial banks @S(#sA 2/ public sector banks

@that is with the =overnment o! India holding a stakeA, *1 private banks @these do not have government stake" they may be publicly listed and traded on stock exchangesA and *9 !oreign banks. They have a combined network o! over +*,::: branches and 1/,::: ,T6s. The banking system in India has undergone signi!icant changes during last 1% years. There have been new banks, new instruments, new windows, new opportunities and, along with all this, new challenges. &hile deregulation has opened up new vistas !or banks to augment incomes, it has also entailed greater competition and conse'uently greater risks. India adopted prudential measures aimed at imparting strength to the banking system and ensuring its sa!ety and soundness, through greater transparency, accountability and public credibility. 7ur banking sector re!orm has been uni'ue in the world in that it combines a (omprehensive reorientation o! competition, regulation and ownership in a non disruptive and cost e!!ective manner. Indeed our banking re!orm is a good illustration o! the dynamism o! the public sector in managing the overhang problems and the pragmatism o! public policy in enabling the domestic and !oreign private sectors to compete and expand. There has been no banking crisis in India.

The =overnment took steps to reduce its ownership in nationalized banks and inducted private ownership but without altering their public sector character. The underlying rationale o! this approach is to assure that the salutary !eatures o! public sector banking was not lost in the trans!ormation process. 7n account o! healthy market value o! the banksD shares, the capital in!usion into the banks by the =overnment has turned out to be pro!itable !or the =overnment.

$an%in. Sector )et=een 1441 >1404

4uring the !irst phase the growth was very slow and banks also experienced periodic !ailures between 191* and 19.9. There were approximately 1,1:: banks, mostly small. To streamline the !unctioning and activities o! commercial banks, the =overnment o! India came up with The #anking (ompanies ,ct, 19.9 which was later changed to #anking )egulation ,ct 19.9 as per amending ,ct o! 19%+. )eserve #ank o! India was vested with extensive powers !or the supervision o! banking in India as the (entral #anking ,uthority. 4uring those dayDs public has lesser con!idence in the banks. ,s an a!termath deposit mobilization was slow. ,breast o! it the savings bank !acility provided by the <ostal department was comparatively sa!er. 6oreover, !unds were largely given to traders.

$an%in. Sector )et=een 1404 >1441

=overnment took ma1or steps in this Indian #anking Sector )e!orm a!ter independence. In 19++, it nationalized Imperial #ank o! India with extensive banking !acilities on a large scale especially in rural and semi urban areas. It !ormed State #ank o! India to act as the principal agent o! )#I and to handle banking transactions o! the Enion and State =overnments all over the country Seven banks !orming subsidiary o! State #ank o! India was nationalized in 19%: on 19th Fuly, 19%9, ma1or process o! nationalization was carried out. It was the e!!ort o! the then <rime 6inister o! India, 6rs. Indira =andhi. 1. ma1or commercial banks in the country were nationalized. Second phase o! nationalization Indian #anking Sector )e!orm was carried out in 199: with seven more banks. This step brought 9:B o! the banking segment in India under =overnment ownership. ,!ter the nationalization o! banks, the branches o! the public sector bank India rose to approximately 9::B in deposits and advances took a huge 1ump by 11,:::B. #anking in the sunshine o! =overnment ownership gave the public implicit !aith and immense con!idence about the sustainability o! these institutions.

$an%in. Sector ,rom 1441 on=ar!#

9

This phase has introduced many more products and !acilities in the banking sector in its re!orms measure. In 1991, under the chairmanship o! 6. 0arasimha, a committee was set up by his name which worked !or the liberalization o! banking practices. The country is !looded with !oreign banks and their ,T6 stations. 3!!orts are being put to give a satis!actory service to customers. <hone banking and net banking is introduced. The entire system became more convenient and swi!t. Time is given more importance than money.

The !inancial system o! India has shown a great deal o! resilience. It is sheltered !rom any crisis triggered by any external macroeconomics shock as other 3ast ,sian (ountries su!!ered. This is all due to a !lexible exchange rate regime, the !oreign reserves are high, the capital account is not yet !ully convertible, and banks and their customers have limited !oreign exchange exposure.

The industrial sector has been going through a process o! restructuring and consolidation a!ter liberalization. The industries have responded to the re!orms through mergers and ac'uisitions, adoption o! cost cutting measures, !oreign collaboration, technology up gradation and outward orientation in sectors such as cement, steel, aluminium, pharmaceuticals, and automobiles. Industrial growth increased sharply in the !irst !ive years a!ter the re!orms, but then slowed to an annual rate o! ..+ percent in the next !ive years. $rom low growth rate o! 2./ per cent in 2::1 :2, the industry sector grew at a rate o! /.1 per cent in 2::2 :* and !urther to 9.9 per cent in 2::. :+.There has been steady and continuous rise in supply o! money in the economy since initiation o! re!orms. )eserve 6oney has increased !rom )s.99, +:+ crores in 1991 92 to )s.+/*:%% crores in 2::+ :%. <er!ormance o! the Indian economy on the in!lation !ront, with price stability as one o! the prime ob1ectives o! the re!orm process has been satis!actory, particularly a!ter the mid 199:s. The annual average in!lation rate based on &holesale <rice Index @&<IA was 1:.% per cent between 1991 9%, which !ell down to +.1 per cent in the period 199% 2::1 and then to ../ per cent in 2::1 :%.

1:

C56'TE- II In!ian "inancia Sy#tem Bills o! E"c# ange Certi! icate o! Depo Com sits merc ial re Pape asur rs y Bills Capit al Mark et Mon ey Mark No et nBa Ba nks nk s IR DA Reg ulat ors SE BI R BI

Inst rum ent s

Mar ket s

Indian
Pla yer s

Financial

System

11

"inancia Sector
The Indian !inancial system o! the pre re!orm period, be!ore 1991, essentially catered to the needs o! planned development in a mixed economy !ramework, where the =overnment sector had a predominant role in economic activity. Interest rates on =overnment securities were arti!icially pegged at low levels, which were unrelated to the market conditions. The system o! administered interest rates was characterized by detailed prescriptions on the lending and the deposit side, leading to multiplicity and complexity o! interest rates. (onse'uently, by the end o! the eighties, directed and concessional availability o! bank credit to certain sectors adversely a!!ected the viability and pro!itability o! banks. Thus, the transactions o! the =overnment, the )eserve #ank and the commercial banks were governed by !iscal priorities rather than sound principles o! !inancial management and commercial viability. It was then recognized that this approach, which, conceptually, sought to enhance e!!iciency through a co ordinate approach, actually led to loss o! transparency, accountability and incentive to seek e!!iciency.

Nee! an! importance o, ,inancia #ector

The 0ew 3conomic <olicy @03<A o! structural ad1ustments and stabilization programme was given a big thrust in India in Fune 1991. The !inancial system re!orms have received special attention as a part o! this policy because o! the perceived interdependent relationship between the real and !inancial sectors o! the modern economy. The need !or !inancial re!orms had arisen because the !inancial institution and markets were in a bad shape. The banking sector su!!ered !rom lack o! competition, low capital base, low productivity, and high intermediation costs. The role o! technology was minimal, and the 'uality o! service did not receive ade'uate attention. <roper risk management system was not !ollowed, and prudential norms were weak. ,ll these resulted in poor assets 'uality. 4evelopment !inancial institutions operated in an over 8 protected environment with most o! the !unding coming !rom assured sources. There was little competition in insurance and mutual !unds industries. $inancial markets were characterized by control over pricing o! !inancial assets, barriers to entry, and high transactions costs. The banks were running either at a loss or on very

12

low pro!its, and, conse'uently were unable to provide ade'uately !or loan de!aults, and build their capital. There had been organizational inade'uacies, the weakening o! management and control !unctions, the growth o! restrictive practices, the erosion o! work culture, and !laws in credit management. The strain on the per!ormance o! the banks had emanated partly !rom the all at below market or concessional or subsidized imposition o! high (ash )eserve )atio @())A, Statutory ;i'uidity )atio @S;)A and directed credit programmes !or the priority sectors interest rates. This, apart !rom a!!ecting bank pro!itability adversely, had resulted in the low or repressed or depressed interest rates on deposits and in higher interest rates on loans to the larger borrowers !rom business and industry. $urther, the !unctioning o! the !inancial system, and the credit delivery as well as recovery process had become politicized, which damaged the 'uality o! lending and the culture o! repaying loans. The widespread write o!!s o! the loans had seriously 1eopardized the viability o! banks. ,s the closure o! sick industrial units was discouraged by the government, banks had to continue to !inance non viable sick units, which !urther compromised their own viability. The legal system was not o! much help in recovering loans. There was a lack o! transparency in preparing statements o! accounts by banks. In other words, the re!orms had become imperative on account o! the !acts that despite its impressive 'uantitative growth and achievements, the !inancial health, integrity, autonomy, !lexibility, and vibrancy in the !inancial sector had deteriorated over the past many years. The allocation o! resources had become severely distorted, the port!olio 'uality had deteriorated, and productivity, e!!iciency and pro!itability had been eroded in the system. (ustomer service was poor, work technology remained outdated, and transaction costs were high. The capital base o! the system remained low, the accounting and disclosure practices were !aulty, and the administrative expenses had greatly soared. The system su!!ered also !rom a lack o! delegation o! authority, inade'uate internal controls and poor housekeeping.

1*

&ea#ure#
$or a long time, an alarming increase o! sickness in the Indian !inancial system had re'uired urgent remedial measures or re!orms which were introduced in 1991. &ain an! #u)>o)*ective# o, ,inancia re,orm# intro!uce! in 1441? @iA To develop a market oriented, competitive, world integrated, diversi!ied, autonomous, transparent !inancial system. @iiA To increase the allocative e!!iciency o! available savings and to promote accelerated growth o! the real sector. @iiiA To increase or bring about the e!!ectiveness, accountability, pro!itability, viability, vibrancy, balanced growth, operational economy and !lexibility, pro!essionalism and depoliticisation in the !inancial sector. @ivA To increase the rate o! return on real investment. @vA To promote competition by creating level playing !ields and !acilitating !ree entry and exit !or institutions and market players. @viA To ensure that the rationalization o! interest rates structure occurs, that interest rates are !lexible, market determined or market related, and that the system o!!ers to its users a reasonable level o! positive real interest rates. In other words, the goal has been to dismantle the administered system o! interest rates. @viiA To reduce the levels o! resource pre emptions and to improve the e!!ectiveness o! directed credit programmes. @viiiA To build a !inancial in!rastructure relating to supervision, audit, technology, and legal matters. @ixA To modernize the instruments o! monetary control so as to make them more suitable !or the conduct o! monetary policy in a market economy i.e. to increase the reliance on indirect or market incentives based instruments rather than direct or physical instruments o! monetary control. 1.

The key words describing re!orms have been liberalization, deregulation, marketisation, privatization, and globalization, all o! which convey re!orms ob1ectives in a clear manner. The basic premise underlying the re!orms has been that the state ownership and regulation have harmed the !inancial system, particularly the banks and the investors, and that such regulation is no longer relevant and ade'uate. To use the well known academic terminology, the ob1ective o! !inancial re!orms has been to correct and eliminate !inancial repression" and to trans!orm a !inancially repressed system into a !ree system. $inancial sector re!orms are said to be grounded in the belie! that the competitive e!!iciency in the real sectors o! the economy cannot be realized to its !ull extent unless the allocative e!!iciency o! the private sector was improved. The main thrust o! !inancial sector re!orms was on the creation o! e!!icient and stable !inancial institutions and markets, the removal i! structural bottlenecks, introduction o! new players and instruments, introduction o! !ree pricing o! !inancial assets, relaxation o! 'uantitative restrictions, improvement in trading, clearing and settlement practices, promotion o! institutional in!rastructure, re!inement o! market micro structure, creation o! li'uidity, depth, and the e!!icient price discovery process, and ensuring technological up gradation.

Impact o, "inancia -e,orm#

The re!orm process appears to have yielded some positive results at least in the banking sector as re!lected in the relatively cleaner balance sheets o! banks, reduction in non per!orming assets in relative terms, improvement in operating pro!its, and !airly good progress in attaining capital ade'uacy ratio and other prudential norms. The operating pro!its o! 2/ public sector banks improved !rom )s *1*+ crores in 1992 9* to )s *, %9% crores in 199* 9., )s +, %29 crores in 199. 9+, and )s /, +%9 crores in 199+ 9%, and )s 29, /1+ crores in 2::2 :*. The non per!orming assets o! 0#$(s have increased substantially in the immediate past. ,!ter a brie! period o! great strides, the mutual !und industry has come to be a!!licted by a host o! serious problems. The !unds mobilized by them have declined drastically over the re!orm period. The net asset values o! their various schemes have declined. The volume o! !resh capital raised on the primary stock market has declined signi!icantly. The secondary market re!orms 1+

have not really progressed because o! the recalcitrance o! market operators and S3#IDs lack o! will. The stock markets are plagued by uncommonly high number o! drawbacks, weaknesses, malpractices and so on.

Chan.in. -o e o, -$I in ,inancia #ector

Gaving talked about !inancial sector and the ongoing re!orm process in the sector, let us now turn our attention to what exact role )#I is playing !or the !inancial sector in general and the !inancial re!orm process in particular. ,s all o! us know, )#I is the central bank o! the country. (entral banks are very old institutions. The #ank o! 3ngland was set up way back in 1%9., the #ank o! $rance is more than 2:: years old and the $ederal )eserve #ank was set up in 191*. ,s aptly stated by our =overnor, 4r. #imal Falan, although )#I, set up in 19*+, may appear a Htoddler or at most a young adultD, it is one o! the oldest central banks among the developing world. Traditionally, central banks have per!ormed roles o! currency authority, banker to the =overnment and banks, lender o! last resort, supervisor o! banks and exchange control @now it would be more appropriate to call it exchange managementA authority. =enerally, central banks in developed economies have price or !inancial stability as their prime ob1ective. The )#I has the twin ob1ectives o! maintaining price stability and promoting growth. The ob1ectives are as !ollows> 1. <rovision o! ade'uate li'uidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level. 2. In line with the above to continue the present stance on interest rates including pre!erence !or so!t interest rates. *. To impart greater !lexibility to the interest rate structure in the medium term In developing economies, however, the growth ob1ective assumes greater importance. )ecent experience has shown that during recessionary or de!lationary conditions achievement o! 12 higher growths becomes the dominant ob1ective o! central banks, both in developing and developed economies. ;et us now look at the evolution o! )#I and its changing role and strategy over time. )#I was set up to regulate the issue o! currency and keep reserves with a view to 1%

securing monetary stability in India and generally to operate the currency and credit system o! the country to its advantage @)#I ,ct, 19*.A. &ithin these overall ob1ectives, )#I per!orms a wide range o! promotional !unctions, which are designed to support the countryDs e!!orts to accelerate the pace o! economic development with social 1ustice. In keeping with the overall logic o! re!orms that market based allocation rather than directed allocation o! resources led to greater e!!iciency, the !unctions o! the )#I have undergone a strategic shi!t under the current re!orms. The strategy shi!ted !rom controlling institutions and markets to !acilitation o! e!!icient !unctioning o! markets and strengthening o! the supporting institutional in!rastructure. The preemptions in the !orm o! ()) and S;) have been progressively reduced. The scope o! priority sector has been expanded. The interest rate has been deregulated both on deposits and advances. $rom conservation o! !oreign exchange through control o! transactions, the !ocus has shi!ted to !acilitation o! !oreign exchange transactions. Intervention in the !oreign exchange market has shi!ted !rom !ixing o! exchange rate to merely curbing speculative volatility. Stability issues came to the !ore especially a!ter the crises in South 3ast ,sian countries in late 199:s. The )#I progressively strengthened prudential regulation relating to capital ade'uacy, income recognition, asset classi!ication, provisioning, disclosures and transparency. $urthermore, institutional strengthening was undertaken to ensure the progressive development and integration o! the securities, money and !orex markets. The )#I has made signi!icant improvements in the 'uality o! per!ormance o! regulatory and supervisory !unctions. 7ur standards 1* are comparable to the best in the world. ,ttention is being paid to several contemporary issues such as, relative roles o! onsite and o!! site supervision, !unctional versus institutional regulation, relative stress on internal management, market discipline and regulatory prescriptions, consolidated approach to supervision, etc. Several legislative initiatives have also been taken up with =overnment, covering procedural law, debt recovery systems, (redit In!ormation #ureau, 4eposit Insurance, etc. <rogress in these is critical !or e!!ectiveness o! )#I in the regulatory sphere. , recent important legislative development, which will improve the momentum o! recovery o! dues, is the enactment o! Securitization and )econstruction o! $inancial 1/ ,ssets and 3n!orcement o!

Security Interest @S)$,3SIA ,ct. Ender this ,ct )#I has been entrusted with the role o! stipulating suitable norms !or registration o! securitization or reconstruction companies, prescribing prudential norms, recommending proper and transparent accounting and disclosure standards and !raming appropriate guidelines !or the conduct o! asset reconstruction and securitization. $inancial liberalization has heightened competition among banks, and between banks and other !inancial institutions. #ut competition has engendered certain serious problems. $or example, the distinction between commercial banking, investment banking, development banking, other specialized institutions, and manu!acturing corporate is getting blurred. #anks are entering into para banking and other !inancial services" development !inancial institutions, mutual !unds and insurance companies are entering into banking and each otherDs !ields" and manu!acturing corporate are entering into banking and !inancial activities. $inancial re!orms have given rise to new issues o! !inancial industry structure, systematic or social costs o! oligopoly. The market based exchange rate system has helped to open up the Indian economy, and to integrate it with the rest o! the world. #ut the exchange rate has become !ar more volatile" it has become sub1ect to severe external pressures" its management has become di!!icult" and there has been a partial loss o! autonomy o! domestic monetary policy. The primary impulses !or establishing central banks in many parts o! the world in the twentieth century emanated !rom exigency o! !inancing wars. The necessity to !inance wars also led to nationalization o! many o! the early central banks, which were !unctioning as private entities. (entral banking e!!orts in India a!ter independence were geared towards mobilizing resources !or planned economic development and ensuring price stability. (entral bank mandates in developing countries such as India have gone well beyond typical central banking !unctions to encompass a wide range o! developmental pursuits in order to promote economic growth. (entral banking was initially practiced with a large number o! in!ormal norms, conventions and sel! imposed codes o! conduct. Instituting a medium o! exchange and currency management along with monetary policy had been globally in !ocus till the =reat 4epression. 19

&ith the passage o! time, however, central banks took over a whole range o! !unctions, becoming multi tasking institutions that conduct monetary policy, regulate and supervise the banking system and per!orm a crucial role in the payment system. (risis situations that emerged !rom time to time led to rede!ining o! central bank mandates. The role o! the lender o! last resort evolved over time and enlarged into that o! the regulator and supervisor, as also the custodian o! !inancial stability. This gained credence in the !ace o! danger o! contagion as economies got integrated. The necessity to manage government debt emanated !rom the historic reasons o! !inancing wars. The hazards o! !inancing the persistent government de!icits were, however, well recognized and such !inancing is being increasingly avoided. In the wake o! South 3ast ,sian crisis o! 199/, many central banks in developing countries initiated !inancial re!orms. In this direction, central banks also played a vital role in development o! the !inancial markets to strengthen the monetary policy transmission channels. Institutional development has been one o! the ma1or ob1ectives o! central banks in developing economies in order to spread the umbrella o! organized credit in such economies. The !unctions o! the )eserve #ank o! India have been changing over time as it has responded to the emerging re'uirements o! the macro economy and continuously diversi!ying !inancial system. (entral banks around the world have been vested with a variety o! additional responsibilities such as preparing macroeconomic data bases, data dissemination, putting in place advanced clearing systems, coordinating with the international agencies, undertaking policy oriented research activities and bridging gaps in in!ormation.

19

C56'TE- III -e#erve $an% o, In!ia

The )#I, as the central bank o! the country, is the centre o! the Indian !inancial and monetary system. ,s an institution, it has been guiding, monitoring, regulating, controlling, and promoting the destiny o! the Indian !inancial system. Gowever, it is an oldest among the central banks in the developing countries. It started !unctioning !rom ,pril 1, 19*+ on the terms o! the )eserve #ank o! India ,ct, 19*.. It was a private shareholders institution till Fanuary 19.9, a!ter which it became a State owned institution under the )eserve #ank o! India ,ct, 19.9. The share capital was divided into shares o! )s. 1:: each !ully paid which was entirely owned by private shareholders in the beginning. The =overnment held shares o! nominal value o! )s. 2, 2:,:::.

2:

The #ank is managed by a (entral #oard o! 4irectors, !our ;ocal #oards o! 4irectors, and a committee o! the central board o! directors. The !unctions o! the ;ocal #oards are to advise the (entral #oard on matters re!erred to them. The !inal control o! the #ank vests in the (entral #oard which comprises the =overnor, !our 4eputy =overnors, and !i!teen 4irectors nominated by the (entral government.

21

The internal organizational set up o! the #ank has been modi!ied and expanded !rom time to time in order to cope with the increasing volume and range o! the #ankDs activities. The principle o! the internal organization is !unctional specialization with ade'uate coordination. 4uring the war and post war years, the ma1or preoccupation o! the #ank was !acilitation o! war !inance, repatriation o! sterling debt and planning and administration o! exchange control. The issues relating to regulation and supervision o! banks came to occupy centre stage in the backdrop o! a number o! bank !ailures. The #anking (ompanies ,ct was enacted in 19.9 to empower the )eserve #ank with supervisory control over banks in order to ensure their establishment and operation along sound lines. The )eserve #ank o! India was nationalized on Fanuary 1, 19.9. &ith the launch o! $ive Iear <lans in 19+1, the )eserve #ankDs !unctions became more diversi!ied in terms o! <lan !inancing, establishment o! specialized institutions to promote savings and investment in the Indian economy and to meet credit re'uirements o! the priority sectors. This was a novel !eature !or any central bank at that point o! time. The ,gricultural )e!inance (orporation was set up in 19%* !or extending medium and long term !inance to agriculture. 7ther institutional developments included setting up o! the Industrial $inance (orporation o! India @19.9A, the Industrial 4evelopment #ank o! India @19%.A and Enit Trust o! India @19%.A. The role o! monetary and credit policy in maintaining price stability was explicitly emphasized !or the !irst time in the $irst $ive Iear <lan. <lan !inancing by the )eserve #ank evolved as de!icit !inancing which took the !orm o! system o! issuance o! ad hoc Treasury #ills. This arrangement o! !inancing the =overnment was intended to be temporary but ac'uired a permanent character over time. 4evaluation o! the rupee in Fune 19%% and nationalization o! !ourteen private sector banks in Fuly 19%9 multiplied the responsibilities o! the )eserve #ank. The move helped to bridge the gaps in credit availability in many rural and urban areas and ensured su!!icient !unds availability to the pre!erred sectors. In terms o! the outcome, this phase succeeded in mobilizing private savings through the banks and paved the way !or nationalization o! six more private sector banks in 199:.

22

$or conserving !oreign exchange reserves, the =overnment re examined the provisions o! the $oreign 3xchange )egulation ,ct, @$3),A 19./ and introduced changes in 19/* which incorporated necessary changes !or e!!ective implementation o! =overnment policy and removing di!!iculties in the working o! the existing legislation. In the light o! concerns about capital out!lows, rein!orced by repeated stress on balance o! payments due to drought, war and oil shocks, the emphasis was placed on utilizing domestic savings !or domestic investment, while continuing to preserve !oreign exchange reserves.

"unction# o, -$I
The )#I !unctions within the !ramework o! a mixed economic system. &ith regard to !raming various policies, it is necessary to maintain close and continuous collaboration between the government and the )#I. In the event o! a di!!erence o! opinion or con!lict, the government view or position can always be expected to prevail.

&ain ,unction# o, the -$I

@iA To maintain monetary stability so that the business and economic li!e can deliver wel!are gains o! a property !unctioning mixed economy. @iiA To maintain !inancial stability and ensure sound !inancial institutions so that monetary stability can be sa!ely pursued and economic units can conduct their business with con!idence. @iiiA To maintain stable payments system so that !inancial transactions can be sa!ely and e!!iciently executed. @ivA To promote the development o! !inancial in!rastructure o! markets and systems, and to enable it to operate e!!iciently i.e., to play a leading role in developing a sound !inancial system so that it can discharge its regulatory !unction e!!iciently. @vA To ensure that credit allocation by the !inancial system broadly re!lects the national economic priorities and social concerns.

2*

@viA To regulate the overall volume o! money and credit in the economy with a view to ensure a reasonable degree o! price stability.

-o e# o, -$I
1. Note I##uin. 6uthority The )#I has the sole right or authority or monopoly o! issuing currency notes other than one rupee notes and coins, and coins o! smaller denominations. The issue o! currency notes is one o! its basic !unctions. 2. 7overnment $an%er The )#I is the banker to the (entral and State governments. It provides to the

governments all banking services such as acceptance o! deposits, withdrawal o! !unds by che'ues, making payments as well as receipts and collection o! payments on behal! o! the government, trans!er o! !unds, and management o! public debt. 3.

$an%er@# $an%
The )#I, like all central banks, can be called a bankers bank because it has a very special

relationship with commercial and co operative banks, and the ma1or part o! its business is with these banks. The bank controls the volume o! reserves o! commercial banks and thereby determines the deposits creating ability o! the banks. The banks hold a part or all o! their reserves with the )#I. Similarly, in times o! need, the banks borrow !unds !rom the )#I. It is there!ore, called the bank o! last resort. 4. Supervi#in. 6uthority The )#I has vast powers to supervise and control commercial and co operative banks with a view to developing an ade'uate and sound banking system in the country. Initially, they used to give only orders but now it undertakes inspection o! commercial banks and recommends measures. It has the !ollowing powers> @aA To issue licenses !or the establishment o! new banks and setting up o! bank branches. 2.

@bA

To prescribe minimum re'uirements regarding paid up capital and reserves, trans!er to reserve !und, and maintenance o! cash reserves and others.

@cA

To inspect the working o! banks in India as well as abroad in respect o! their organizational setup, branch expansion, mobilization o! deposits, investments, and credit port!olio management, credit appraisal, region wise per!ormance, pro!it planning, manpower planning, and so on.

5.

Exchan.e Contro
7ne o! the essential !unctions o! the )#I is to maintain the stability o! the external value

o! the rupee. It pursues this ob1ective through its domestic policies and the regulation o! the !oreign exchange market. ,s !ar as the external sector is concerned, the task o! the )#I has the !ollowing dimensions> @aA @bA To administer the !oreign exchange control. To choose the exchange rate system and !ix or manage the exchange rate between the

rupee and other currencies. @cA @dA To manage exchange reserves. To interact with the monetary authorities o! other countries and with international

!inancial institutions such as I6$. 0.

'romoter o, the ,inancia #y#tem

,part !rom per!orming the !unctions already mentioned, the )#I has been rendering

developmental services which have strengthened the countryDs banking and !inancial structure. This has helped in mobilizing savings and directing credit !lows to desired channels, thereby helping to achieve the ob1ective o! economic development with social 1ustice.

C56'TE- IV &onetary 'o icy

2+

6onetary policy is the management o! money supply and interest rates by central banks to in!luence prices and employment. 6onetary policy works through expansion or contraction o! investment and consumption expenditure. 6onetary policy is the process by which the government, central bank, or monetary authority o! a country controls @iA the supply o! money, @iiA availability o! money, and @iiiA cost o! money or rate o! interest, in order to attain a set o! ob1ectives oriented towards the growth and stability o! the economy. 6onetary policy is re!erred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply o! money in the economy, and a contractionary policy decreases the total money supply. 3xpansionary policy is traditionally used to stop unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to stop in!lation. 6onetary policy is contrasted with !iscal policy, which re!ers to government borrowing, spending and taxation. 6onetary policy rests on the relationship between the rates o! interest in an economy, that is the price at which money can be borrowed, and the total supply o! money. 6onetary policy uses a variety o! tools to control one or both o! these, to in!luence outcomes like economic growth, in!lation, exchange rates with other currencies and unemployment. &here currency is under a monopoly o! issuance, or where there is a regulated system o! issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus in!luence the interest rate. The beginning o! monetary policy as such comes !rom the late 19th century, where it was used to maintain the gold standard. , policy is re!erred to as contractionary i! it reduces the size o! the money supply or raises the interest rate. ,n expansionary policy increases the size o! the money supply, or decreases the interest rate. $urthermore, monetary policies are described as !ollows> accommodative, i! the interest rate set by the central monetary authority is intended to create economic growth" neutral, i! it is intended neither to create growth nor combat in!lation" or tight i! intended to reduce in!lation. 7n the external !ront, rupee value has been linked to the market !orces. (urrent account convertibility was achieved in ,ugust 199.. $3), was repealed and replaced by a new legislation $oreign 3xchange 6anagement ,ct @$36,A, in 1999. $urther, the 3xchange 2%

(ontrol 4epartment o! the )eserve #ank was renamed as $oreign 3xchange 4epartment. #esides, a large number o! innovative products and newer players have come to play active role and new hedging instruments have been introduced, viz., !oreign currency rupee options, etc. ,uthorized dealers could use cross currency options, interest rate and currency swaps, capsJcollars and !orward rate agreements @$),sA in the international !orex market. In the context o! monetary policy !ramework, there has been a greater !ocus on li'uidity management engendered by the growing integration o! !inancial markets, domestically and internationally. &ith the near total deregulation o! interest rates, the #ank )ate has been reactivated since ,pril 199/ as a re!erence rate and as a signaling device to re!lect the stance o! monetary policy. $ollowing the recommendations o! the &orking =roup on 6oney Supply> ,nalytics and 6ethodology o! (ompilation @(hairman> I. ?. )eddyA, the )eserve #ank has commenced compilation and publication o! !our monetary aggregates K6: @monetary baseA, 61 @narrow moneyA, 62 and 6* @broad moneyAL" and introduced three new li'uidity aggregates @;1, ;2 and ;*A by incorporating deposits with post o!!ice savings banks, term deposits, term borrowings and certi!icates o! deposits o! term lending and re!inancing institutions and public deposits o! non banking !inancial institutions" broadening o! the de!inition o! credit by including items not re!lected in the conventional bank credit" rede!ining the net !oreign assets o! the banking system to comprise banksD holdings o! !oreign currency assets net o! @aA their holdings o! $(0)@#A deposits and @bA !oreign currency borrowings. &ith the liberalization o! the external sector, the monetary targeting !ramework came under stress due to increasing li'uidity mainly on account o! increased capital in!lows, necessitating a review o! the monetary policy !ramework and the )eserve #ank switched over to a more broad based Mmultiple indicators approachM since 1999 in monetary policy !ormulation. The in!ormal monetary policy strategy meetings review the monetary and li'uidity conditions and the process has been made consultative. The $inancial 6arkets (ommittee @$6(A monitors the developments in !inancial markets on a daily basis. The (ommittee makes 'uick assessment o! the li'uidity conditions and recommends strategies !or intervention in the money and securities markets.

2/

6onetary and credit aggregates have witnessed deceleration since their peak levels in 7ctober 2::9. The li'uidity overhang emanating !rom the earlier surge in capital in!lows has substantially moderated in 2::9 :9. The )eserve #ank is committed to providing ample li'uidity !or all productive activities on a continuous basis. In its mid term review o! monetary policy on 7ctober 2., 2::9, the )eserve #ank had indicated that it would closely and continuously monitor the li'uidity and monetary situation and respond swi!tly and e!!ectively to the impact o! the global developments on Indian !inancial markets. The )eserve #ank had also indicated that the challenge !or the conduct o! monetary policy is to strike an optimal balance among preserving !inancial stability, maintaining price stability and sustaining the growth momentum. In response to emerging global developments, the )eserve #ank has taken a number o! measures since mid September 2::9. The aim o! these measures was to augment domestic and !orex li'uidity and to enable banks to continue to lend !or productive purpose while maintaining credit 'uality so as to sustain the growth momentum. 7n a !urther review o! the evolving developments, the )eserve #ank has taken the !ollowing measures>

Enhancin. -upee 9i+ui!ity

The special term repo !acility, introduced !or the purpose o! meeting the li'uidity re'uirements o! mutual !unds and non banking !inance companies would continue till end march 2::9. #anks can avail o! this !acility either on incremental or on rollover basis within their entitlement o! up to 1.+ per cent o! net demand and time liabilities. ,s the upside risks to in!lation have declined, monetary policy has been responding to slackening economic growth in the context o! signi!icant global stress. ,ccordingly, !or policy purposes, money supply @6*A growth !or 2::9 1: is placed at 1/.: per cent. (onsistent with this, aggregate deposits o! scheduled commercial banks are pro1ected to grow by 19.: per cent. The growth in ad1usted non !ood credit, including investment in bondsJdebenturesJshares o! public sector undertakings and private corporate sector and (<s, is placed at 2:.: per cent. =iven the

29

wide dispersion in credit growth noticed across bank groups during 2::9 :9, banks with strong deposit base should endeavour to expand credit beyond 2:.: per cent.

8)*ective# o, monetary po icy

The ob1ectives o! monetary policy have undergone a change in emphasis over the years. In the planned economy, they per!orce were very much similar to the ob1ectives o! economic planning. ,ccordingly, the ob1ectives o! monetary policy in India were @aA to accelerate economic development in an environment o! reasonable price stability, and @bA to develop appropriate institutional set up to aid this process. The key note o! monetary policy may be said to be controlled expansion o! bank credit and money supply, with special attention to seasonal re'uirements !or credit. The #ank has been directing its attention to ensure that credit expansion takes place in the light o! price variations without a!!ecting the output, particularly the industrial output adversely. In other words, the ob1ective has been one o! disin!lation without de!lation. The authorities have come to hold that monetary policy is able to make more e!!ective contribution to price stability than other ob1ectives. $urther, it has come to be believed that by achieving reasonable price stability, it is possible to @aA ,void waste o! resources because in!lation results in such a waste by increasing uncertainty about the !uture. @bA (reate an environment in which e!!icient decisions are taken and greater employment, poverty alleviation, and balanced growth. In India, while the basic ob1ectives o! monetary policy, namely, price stability and ade'uate credit !low to the productive sectors o! the economy, have remained the same, the operating environment has changed signi!icantly. ,s pointed out in the )#IDs )eport on (urrency and $inance 2::* :., there is an increasing !ocus on the maintenance o! !inancial stability in the context o! better linkages between various segments o! the !inancial markets including money, =overnment securities and !orex markets. 6anaging the capital !lows has emerged as an important concern o! monetary policy. The phasing out o! adhoc treasury bills and their automatic monetization in 199/ imparted a lot o! !lexibility to the )#I in monetary management. Simultaneously, however, reserve !lows through the balance o! payments 6* in

29

2::. :+ is pro1ected to expand by 1..: per cent. 0on !ood credit ad1usted !or investment in commercial paper, sharesJ debenturesJbonds o! public sector undertakings @<SEsA and private corporate sector was pro1ected to increase by 1%.: to 1%.+ per cent in the annual policy statement o! 6ay 2::.. This magnitude o! credit expansion was expected to ade'uately meet the credit needs o! all the productive sectors o! the economy. (ontrary to the assumptions underlying the annual policy statement !or 2::. :+, the south west monsoon turned out to be de!icient by 1* per cent in the current year. There was a surge in in!lation !ollowing the rise in international oil and metal prices. The carry !orward o! li'uidity compounded matters. &ith a view to addressing these issues, the )#I increased the ()) by +: basis points, in two stages, to +.: per cent, thus bringing down the li'uidity in the banking system by about )s. 9,::: crores. The interest rate on eligible ()) balances was de linked !rom the #ank )ate and was reduced to *.+ per cent per annum. The =overnment o! India raised the ceiling o! 6SS !rom )s. %:,::: crores to )s. 9:,::: crores on ,ugust 2%, 2::. to enable the )#I to e!!ectively deal with the problem o! overhang o! li'uidity. ,s the in!lation was supply induced, the =overnment also reduced the duty rates on petroleum products twice in the year 2::. :+. Taking the above developments into account, the )#I in its mid term review o! the annual policy statement !or 2::. :+ @7ctober 2%, 2::.A, revised its =4< growth pro1ection in 2::. :+ !rom a range o! %.+ to /.: per cent to %.: to %.+ per cent. In!lation pro1ection on a point to point basis was raised upwards to %.+ per cent !rom around +.: per cent pro1ected earlier. )#I has not a!!ected any change in its earlier pro1ection o! 6* and aggregate deposit target o! commercial banks. (onsidering credit growth in the !irst hal!, the pro1ection o! ad1usted non !ood bank credit has been revised to 19.: per cent !rom 1%.: to 1%.+ per cent pro1ected earlier. The mid term review increased the !ixed reverse repo rate by 2+ basis points under the ;,$ to ../+ per cent. ,nd increase in the prices o! crude petroleum in the international markets has posed new challenges !or monetary policy. ,s indicated earlier, in the current year, the two ma1or constraints !acing monetary management were carry !orward o! excess li'uidity o! over )s. 91,::: crores !rom the previous year and rise in in!lation !ollowing the rising international prices o! petroleum crude. The annual policy statement !or 2::. :+ had placed the growth o! =4< in 2::. :+ in the range o! %.+ to /.: per cent, on the assumption o! sustained growth in industrial sector, normal monsoon and good per!ormance o! exports. 7n the assumption o! no signi!icant *:

supply shocks and appropriate management o! li'uidity, in!lation rate in 2::. :+, on a point to point basis, was placed at around +.: per cent. The mid term review also proposed a switch over to the international usage o! the terms repo and reverse repo e!!ective 7ctober 29, 2::.. In the mid term review, )#I proposed reduction in the spread between the reverse repo rate and repo rate by 2+ basis points !rom 1+: basis points to 12+ basis points. ,ccordingly, the !ixed repo rate under ;,$ will continue to remain at %.: per cent. The )#I has continued with its policy o! active demand management o! li'uidity through 767s, including the ;,$, 6SS and ()), and using the policy instruments at its disposal !lexibly, as and when the situation warrants consistent with the ob1ective o! price stability. ,t the same time, )#I has also been ensuring ade'uate li'uidity in the system so that all legitimate re'uirements o! credit to maintain the growth momentum are met. The other important policy initiatives announced in the mid term review relate to raising the ceiling on 0)3 interest rates, reduction o! tenure o! domestic term deposits, dispensing with the restrictive provisions o! service area approach !or delivery o! agricultural credit, and measures !or improving credit delivery to agriculture and small scale industry @SSIA sectors.

C56'TE- V
*1

Techni+ue# o, &onetary Contro

6any techni'ues o! monetary control some old and well known have been used in India. ,mong these are> @aA 7pen 6arket 7perations @767A, @bA #ank )ate, @cA (ash )eserve )atio @())A, @dA Statutory ;i'uidity )atio @S;)A, @eA Interest )ates. Some o! the important !eatures and evolution o! these techni'ues are given below>

8pen &ar%et 8peration#

7pen market operations are the means o! implementing monetary policy by which a central bank controls its national money supply by buying and selling government securities, or other !inancial instruments. 6onetary targets, such as interest rates or exchange rates, are used to guide this implementation. Since most money is now in the !orm o! electronic records, rather than paper records such as banknotes, open market operations are conducted simply by electronically increasing or decreasing @-crediting- or -debiting-A the amount o! money that a bank has, e.g., in its reserve account at the central bank, in exchange !or a bank selling or buying a !inancial instrument. 0ewly created money is used by the central bank to buy in the open market a !inancial asset, such as government bonds, !oreign currency, or gold. I! the central bank sells these assets in the open market, the amount o! money that the purchasing bank holds decreases, e!!ectively destroying money. Ender 767, )#I buys or sells government bonds in secondary market. #y absorbing bonds, it drives up bond yields and in1ects money into market. &hen it sells, it does so to stuck money out o! the system. 767 is an actively used techni'ue o! monetary control in the ES, the EN and many other countries. Through the open market sales and purchases o! government securities, the )#I can a!!ect the reserves position o! banks, yields on government securities, and volume and cost o! bank credit. Gowever, it is the techni'ue least used by the #ank, though it has wide powers to use it. There is no restriction the 'uantity or maturity o! government securities which it can buy or sell or hold. Technically, the #ank can conduct 767s in treasury bills, state government securities, and central government securities" but in practice they are conducted only in central government securities o! all maturities.

*2

The open market operations, repo and reverse repo operations have emerged as important li'uidity management tools. $urther, ;i'uidity ,d1ustment $acility @;,$A, which was introduced in Fune 2:::, has emerged as the principal operating instrument o! monetary policy, enabling the )eserve #ank to modulate short term li'uidity under varied !inancial market conditions. In order to !ine tune the management o! li'uidity and in response to suggestions !rom market participants, the )eserve #ank has introduced a Second ;i'uidity ,d1ustment $acility @S;,$A !rom 0ovember 29, 2::+. $urther, to address the dilemma o! keeping a balance between the twin ob1ectives o! containing exchange rate volatility and maintenance o! domestic price stability in the !ace o! surging capital in!lows, the 6arket Stabilization Scheme @6SSA was introduced in ,pril 2::. to provide the )eserve #ank with an additional instrument o! li'uidity management. Ender the 6SS, the cost o! sterilization is borne by the =overnment. Ender this program, the )#I in1ected more than )s. %:, ::: crores in one weekDs time to counter balance the $<I activity, when the !inancial melt down in ,merican 3conomy happened. ,s part o! management o! the demand !or currency, it has been the endeavour o! the )eserve #ank to contain the volume o! notes in circulation by coinciding the lower denomination notes and conscious shi!t towards higher denomination notes in circulation. 6a1or developments in this regard include !ollowing a Hclean note policyD, mechanization o! note counting operations by the commercial banks, outsourcing o! coin distribution to the private operators to ease pressure on distribution channels, regular reviews o! security !eatures o! bank notes and mechanization o! destruction o! soiled notes, etc. These operations are aimed at ensuring the optimal level o! customer service through ade'uate supply o! good 'uality and secure notes and coins in the country.

8&8? 7oa # an! 8)*ective#

The 767s have both monetary policy and !iscal policy goals. Their multiple ob1ectives include> @aA To control the amount o! and changes in bank credit and monetary supply through controlling the reserve base o! banks, @bA To make bank rate policy more e!!ective, @cA To maintain stability in government securities market, @dA To support government borrowing programme, and @eA To smoothen the seasonal !low o! !unds in the bank credit market.

**

In India, 767s have mostly been used !or the purpose o! debt management and this has undermined their e!!ectiveness as a tool o! monetary policy. The !act that government securities market in India is not well organized, broad based and deep, and also that interest rates on government securities, like other interest rates, were administered have reduced the e!!icacy o! 767s so !ar. Gowever, the authorities are now determined to make 767s a ma1or tool o! monetary policy. Similarly, the coupon rates o! government securities have been raised and made market related and competitive, and a large number o! measures have been taken to develop and activise the government securities market in India. This does not mean that 767s did not contribute anything at all to monetary management in the past. They have indirectly helped in the regulation o! supply o! bank credit to the private sector in two ways. $irst, the bank has o!ten conducted 767s !or switching operations, i.e., the sale o! long term scrips in exchange !or short term ones. This has helped to lengthen the maturity structure o! government securities, which in turn, has been !avorable !or the working o! monetary policy. Second, the volume o! the #ankDs net sales o! government securities has increased over the years.

-epo rate
)epo is a repurchase agreement i.e. Selling a security under an agreement to repurchase at a pre determined date and rate. )epo is money market instrument which enables short term borrowing and lending through saleJpurchase operation. It introduced in 4ecember 1992. &henever the banks have any shortage o! !unds they can borrow it !rom )#I. )epo rate is the rate at which our banks borrow rupees !rom )#I. , reduction in the repo rate will help banks to get money at a cheaper rate. &hen the repo rate increases borrowing !rom )#I becomes more expensive. The repo rate is the rate at which )#I lends private and public sector banks while reverse repo is the opposite. ,!ter cut, repo rate now stands at ../+ pc while the reserve repo stands at *.2+ pc. )epo rate is the discounted interest rate at which a central bank repurchases government securities. The central bank makes this transaction with commercial banks to reduce some o! the

*.

short term li'uidity in the system. The repo rate is dependent on the level o! money supply that the central bank chooses to set as part o! its monetary policy. The central bank has the power to lower the repo rates while expanding the money supply in the country. This enables the banks to exchange their government security holdings !or cash. In contrast, when the central bank decides to reduce the money supply, it implements a rise in the repo rates. &hen the central bank o! the nation makes a decision regarding the money supply level the repo or repurchase rate is determined by the market in response to the rules o! supply and demand. The securities that are being evaluated and sold are transacted at the current market price plus any interest that has accrued. &hen the sale is concluded, the securities are subse'uently resold at a predetermined price. This price is comprised o! the original market price and interest, and the pre agreed interest rate, which is the repo rate.

-ever#e repo rate

)everse )epo rate is the rate at which )eserve #ank o! India @)#IA borrows money !rom banks. It introduced by )#I during 199. 8 9+. #anks are always happy to lend money to )#I since their money is in sa!e hands with a good interest. ,n increase in )everse repo rate can cause the banks to trans!er more !unds to )#I due to these attractive interest rates. It can cause the money to be drawn out o! the banking system. The reverse repo rate or reverse repurchase rate is applicable when a country-s reserve borrows money !rom banks. I! reverse repo rates raise, it means that banks will provide more !unds to the reserve. This is a sa!e proposition as lending money to most reserves is an extremely sa!e !inancial transaction. In cases o! reserves borrowing money !rom banks, excess money le!t with the particular bank is channeled into the reserve. This causes money to be taken out o! the economic system. )everse repo rates come into play when there is a !und shortage being !aced by the reserve. OThe repo rate in India is currently /./+B. The reverse repo rate is %.::B.P

$an% -ate
*+

#ank rate, also re!erred to as the discount rate, is the rate o! interest which a central bank charges on the loans and advances that it extends to commercial banks and other !inancial intermediaries. (hanges in the bank rate are o!ten used by central banks to control the money supply. The term bank rate is commonly used by consumers to re!er to the current rate o! interest given on a savings certi!icate o! 4eposit. The term bank rate is most commonly used by consumers who are interested in either obtaining a purchase money mortgage, or a re!inance loan, when re!erring to the current mortgage rate. The )#I provides !inancial accommodation in the !orm o! rediscounting o! bills o! exchange and promissory notes, and loans and advances to scheduled commercial and co operative banks and other approved !inancial institutions !or !inancing bona!ide internal and external commercial, trade and production transactions. The #ank )ate is the basic cost o! re!inance and discounting !acilities. Section .9 o! the )#I ,ct, 19*. de!ines it as the standard rate at which the #ank is prepared to buy or rediscount bills o! exchange or other eligible commercial paper. In the early years, !inancial accommodation !rom the #ank was largely provided at the #ank rate. Subse'uently, owing to di!!erential rates prescribed !or various sector speci!ic re!inance !acilities as also due to the absence o! a genuine bill market, the #ank rate application was con!ined to @aA the ways and means advances to the state governments, @bA advances to primary co operative banks !or SSI, and @cA state !inancial corporations besides penal rates on short!alls in reserve re'uirements.

Ca#h -e#erve -atio

*%

The present banking system is called a O!ractional reserve banking systemP, because the banks need to keep only a !raction o! their deposit liabilities in the !orm o! li'uid cash. The authorities earlier used to change this !raction mainly !or the purpose o! ensuring the sa!ety and li'uidity o! deposits. 7ver the years, however, it has become an important and e!!ective tool !or directly regulating the lending capacity o! banks. The )#I has been using two ratios the (ash )eserve )atio @())A and the Statutory ;i'uidity )atio @S;)A 8 as instruments o! credit control. ()) was introduced in 19+: primarily as a measure to ensure sa!ety and li'uidity o! bank deposits, however over the years it has become an important and e!!ective tool !or directly regulating the lending capacity o! banks and controlling the money supply in the economy. &hen the )#I !eels that the money supply is increasing and causing an upward pressure on in!lation, the )#I has the option o! increasing the ()) thereby reducing the deposits available with banks to make loans and hence reducing the money supply and in!lation. (ash )eserve )atio is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satis!y withdrawal demands, and would normally be in the !orm o! !iat currency stored in a central bank. The reserve ratio is sometimes used as a tool in monetary policy, in!luencing the countryDs economy, borrowing, and interest rates. &estern central banks rarely alter the reserve re'uirements because it would cause immediate li'uidity problems !or banks with low excess reserves" they pre!er to use open market operations to implement their monetary policy. The <eopleDs #ank o! (hina does use changes in reserve re'uirements as an in!lation !ighting tool, and raised the reserve re'uirement nine times in 2::/. ,s o! 2::% the re'uired reserve ratio in the Enited States was 1:B on transaction deposits @component o! money supply O61QA, and zero on time deposits and all other deposits. ,n institution that holds reserves in excess o! the re'uired amount is said to hold excess reserves. (ash reserve )atio @())A in India is the amount o! !unds that the banks have to keep with )#I. I! )#I decides to increase the percent o! this, the available amount with the banks comes down. )#I is using this method, to drain out the excessive money !rom the banks. In terms o! Section .2@1A o! the )#I ,ct 19*., Scheduled (ommercial #anks are re'uired to maintain with )#I an average cash balance, the amount o! which shall not be less */

than three percent o! the total o! the 0et 4emand and Time ;iabilities @04T;A in India, on a !ortnightly basis and )#I is empowered to increase the said rate o! ()) to such higher rate not exceeding twenty percent o! the 0et 4emand and Time ;iabilities @04T;A under the )#I ,ct, 19*.. In Fune 1., 2::*, the rate o! ()) is ..+: per cent o! the 04T;. In terms o! Section .2@1,A o! )#I ,ct, 19*., the Scheduled (ommercial #anks are re'uired to maintain, in addition to the balances prescribed under Section .2@1A o! the ,ct, an additional average daily balance, the amount o! which shall not be less than the rate speci!ied by the )#I in the noti!ication published in the =azette o! India, such additional balance being calculated with re!erence to the excess o! the total o! the 04T; o! the bank as shown in the return re!erred to in section .2@2A o! the )#I ,ct, 19*. over the total o! its 04T; at the close o! the business on the date speci!ied in the noti!ication. ,t present no incremental ()) is re'uired to be maintained by the Scheduled (ommercial #anks. The ()) re!ers to the cash which banks have to maintain with the )#I as a certain percentage o! their demand and time liabilities. Till 19%2, a separate ()) was !ixed in respect o! demand liabilities @+ percentA and time liabilities @2 percentA. The #ank had powers to vary these ratios up to a maximum o! 2: percent and 9 percent respectively. Sub1ect to these ceilings, the )#I could ask banks to maintain with itsel! additional reserves as a speci!ied percentage o! additional demand and time liabilities a!ter certain speci!ied date. This marginal ()) cannot exceed 1:: percent. In 19%2, the separate ())s were merged and one ()) came to be !ixed as a certain percentage o! both demand and time liabilities with the maximum o! 1+ percent. The rules regarding the marginal ()) were not changed. The actual minimum ()) !ixed in 19%2 was * per cent. The ()) is applicable to all scheduled banks including scheduled cooperative banks and the )egional )ural #anks @))#sA, and non scheduled banks. Gowever, co operative banks, ))#s, and non scheduled banks have to maintain the ()) o! merely * per cent, and so !ar it has not been changed by the )#I. The ()) is applicable to various 0)I deposit accounts also but the level o! ()) in their case di!!ers !rom the ()) !or domestic deposits, and also among themselves.

*9

The )#I has powers to impose penal interest rates on banks in respect o! their short!all in the prescribed ()). The penal interest rate is normally * percent above the #ank rate !or the !irst week o! de!ault and + percent !or the subse'uent weeks till the de!ault are made good. In addition, the #ank can disallow !resh access to its re!inance !acility to de!aulting banks and charge additional interest over and above the basic re!inance rate on any accommodation availed o!, and which is e'ual to the short!all in ()). In addition, !rom Fanuary 199+, de!ault in ()) results in graduated penalty by way o! loss o! interest on the de!aulting bankDs cash balances. The )#I pays, since 19/*, at its discretion, interest on that portion o! cash reserves which is the di!!erence between the prescribed ()) and the minimum ()) o! * percent, provided the bank has not de!aulted in respect o! maintaining the prescribed ()). Interest is not paid on excess reserves. &ith a view to providing !lexibility to banks in choosing an optimum strategy o! holding reserves depending upon their intra period cash !lows, all Scheduled (ommercial #anks, are re'uired to maintain minimum ()) balances upto /: per cent o! the total ()) re'uirement on all days o! the !ortnight. I! any Scheduled (ommercial #ank !ails to observe the minimum level o! ()) on any days during the relevant 9 !ortnight, the bank will not be paid interest to the extent o! one !ourteenth o! the eligible amount o! interest, even i! there is no short!all in the ()) on average basis.

Statutory 9i+ui!ity -atio

*9

In addition to the ()), the )#I has made active use o! another ratio, namely the S;). &hile the ()) enables the #ank to impose primary reserve re'uirements the S;) enables it to impose secondary and supplementary reserve re'uirements, on the banking system. There are three ob1ectives behind the use o! S;)> @aA to restrict expansion o! bank credit @bA to increase banks investment in government securities, and @cA to ensure solvency o! banks. Through variations in the S;), the #ank is in a position to insulate a part o! the government debt !rom the open market impact because banks are then prevented !rom disinvesting government securities in !avour o! commercial credit. Statutory ;i'uidity )atio @S;)A is a term used in the regulation o! banking in India. It is the amount which a bank has to maintain in the !orm>
$% &%

(ash =old valued at a price not exceeding the current market price Enencumbered approved securities @=overnment securities or =ilts come under thisA valued at a price as speci!ied by the )#I !rom time to time.

*.

The 'uantum is speci!ied as some percentage o! the total demand and time liabilities @i.e. the liabilities o! the bank which are payable on demand anytime, and those liabilities which are accruing in one monthDs time due to maturityA o! a bank. This percentage is !ixed by the )eserve #ank o! India. The maximum and minimum limits !or the S;) are .:B and 2+B respectively. $ollowing the amendment o! the #anking regulation ,ct @19.9A in Fanuary 2::/, the !loor rate o! 2+B !or S;) was removed. <resently, the S;) is 2.B with e!!ect !rom 9 0ovember, 2::9. The S;) is the ratio o! cash in hand @exclusive o! cash balances maintained by banks to meet the re'uired ()), but not the excess reservesA" balances in current account with the S#I, its subsidiaries, other nationalized banks and the )#I" gold and unencumbered, approved securities, i.e. central and state government securities, securities o! local bodies and government guaranteed securities to total 4T; o! banks. #etween years 19.9 to 19%2, while calculating S;), no distinction was made between cash on hand and balances held with the )#I to meet ()) re'uirements. The S;), like ()), is applicable to co operative banks, non scheduled banks, and the ))#s, but it is maintained at a constant level o! 2+ percent. &hile the S;) de!aults do .:

not invite penal interest payment and the loss o! interest on cash reserves, they do result in restrictions on the access to re!inance !rom the )#I and in the higher cost o! re!inance. The )#I is empowered to increase the S;) !or scheduled commercial banks up to .: percent. The S;) remained at the level o! 2: percent between years 19.9 to 19%2 in terms o! the de!inition then prevailing. Therea!ter, it has been raised !re'uently and substantially. In 199:, S;) has been increased !rom 2: percent to *9.+ percent. The signi!icant increase in the S;) does not mean that the monetary policy became 'uite restrictive during 19%* to 199:. ,n increase in the S;) does not restrain total expenditure in the economy" it may restrict only the private sector expenditure while helping to increase the government expenditure. In a sense, there!ore, the S;) is not a techni'ue o! monetary control" it only distributes bank resources in !avour o! the government sector. It is there!ore, not correct to indicate, as it o!ten done, the extent o! immobilization o! bank resources in terms o! the combined level o! the ()) and S;). ,s in the case o! ()), the post 1991 period is characterized by a declining phase !or S;) also" its level was reduced and it came to be much criticized during this phase. ,!ter 1992, banks were re'uired to maintain S;) based on multiple prescriptions. $or example, in 7ctober 1992, the S;) was !ixed at *9.2+ percent, *9 percent and */.2+ percent o! net 4T; as on * ,pril 1992 with e!!ect !rom !ortnights beginning 9 Fanuary 199*, % $ebruary 199*, and % 6arch 199* respectively. The 7ctober 199/ credit policy rationalized this system o! multiple rates o! S;) by collapsing them into a single prescription o! 2+ percent o! banks. S;) has remained unchanged at 2+ percent since 199/ till today. The S;) is commonly used to contain in!lation and !uel growth, by increasing or decreasing it respectively. This counter acts by decreasing or increasing the money supply in the system respectively. Indian banksD holdings o! government securities @=overnment securitiesA are now close to the statutory minimum that banks are re'uired to hold to comply with existing regulation. &hen measured in rupees, such holdings decreased !or the !irst time in a little less than .: years @since the nationalization o! banks in 19%9A in 2::+ :%. Statutory ;i'uidity )atio re!ers to the amount that the commercial banks re'uire to maintain in the !orm o! cash, or gold or government approved securities be!ore providing credit to the customers. Statutory ;i'uidity )atio is determined and maintained by the )eserve #ank o! .1

India in order to control the expansion o! bank credit. Statutory ;i'uidity )atio re!ers to the amount that all banks re'uire maintaining in cash or in the !orm o! =old or approved securities. Gere by approved securities we mean, bond and shares o! di!!erent companies. This Statutory ;i'uidity )atio is determined as percentage o! total demand and percentage o! time liabilities. Time ;iabilities re!er to the liabilities, which the commercial banks are liable to pay to the customers on there anytime demand. The liabilities that the banks are liable to pay within one month-s time, due to completion o! maturity period, are also considered as time liabilities. In India, )eserve #ank o! India always determines the percentage o! Statutory ;i'uidity )atio. There are some statutory re'uirements !or temporarily placing the money in =overnment #onds. $ollowing this re'uirement, )eserve #ank o! India !ixes the level o! Statutory ;i'uidity )atio. ,t present, the minimum limit o! Statutory ;i'uidity )atio that can be set by the )eserve #ank is 2+B.

.2

Intere#t rate#
The )#I has been !ollowing a policy stance o! imparting !lexibility to the interest rate structure. (oncerned over the downward rigidity o! lending rates, even while deposit rates were coming down, )#I advised banks to announce their benchmark prime lending rates @#<;)sA based on their actual cost o! !unds, operating expenses and a minimum margin to cover regulatory re'uirement. In response to this policy directive, all banks put in place a system o! #<;)s in 2::* :.. The #<;)s o! !ive ma1or banks are lower by 2+ to +: basis points in 4ecember, 2::. compared to the rates prevailing a year ago. 4uring the current year, there has been a marginal !irming up o! deposit rates by 2+ basis points. Interest rates on housing loans have !irmed up marginally in the current year !or banks. (all money rates !irmed up !rom the second hal! o! the year, re!lecting lower li'uidity on account o! large increase in bank credit. The #ank )ate remained unchanged at %.: per cent in the current year. The repo rate @reverse repo rate since 7ctober 29, 2::.A under ;,$ was raised by 2+ basis points to ../+ per cent !rom 7ctober 2/, 2::.. The spread between reverse repo and repo was narrowed by 2+ basis points to 12+ basis points. Towards this end, steps have been initiated to deregulate interest rates, to ease operational constraints in the credit delivery system, to introduce new money market instruments, and so on. The monetary policy is now geared towards @aA reducing the rigidities, @bA introducing !lexibility, @cA encouraging diversi!ication, @dA promoting more competitive environment, and @eA imparting greater discipline and prudence in the operations o! the !inancial system.

.*

C56'TE- VI The Cri#i# an! In!ia

;ike all emerging economies, India too has been impacted by the crisis, and much more than was expected earlier. =4< growth has moderated re!lecting lower industrial production, negative exports, deceleration in services activities, dented corporate margins and diminished business con!idence. There are some com!orting !actors R well !unctioning !inancial markets, robust rural demand, lower headline in!lation and com!ortable !oreign exchange reserves R which bu!!ered us !rom the worst impact o! the crisis. The !iscal stimulus packages o! the =overnment and monetary easing and regulatory action o! the )eserve #ank have helped to arrest the moderation in growth and keep our !inancial markets !unctioning normally.

In order to provide li'uidity support to the housing sector, and particularly to housing !inance companies @G$(sA which have been adversely a!!ected by the recent !inancial market developments, it has been decided to provide a re!inance !acility o! an amount o! )s .,::: crore to the 0ational Gousing #ank @0G#A under the provisions o! Section 1/@.44A o! the )eserve #ank o! India ,ct, 19*.. This re!inance will be available against the 0G#-s loans and advances to G$(s. The !acility will be available at the prevailing repo rate under the ;,$ !or a period o! 9: days. 4uring this 9: day period, the amount can be !lexibly drawn and repaid. ,t the end o! the 9: day period, the withdrawal can also be rolled over. This re!inance !acility will be available up to 6arch *1, 2:1:. The utilization o! !unds will be governed by the policy approved by the #oard o! the 0G#. &ith a view to mitigating the pressures on account o! the recent developments on loan disbursements to Indian exporting companies and !or honoring disbursements under export lines o! credit extended at the behest o! the =overnment o! India to overseas !inancial institutions, sovereign governments and other entities !or !inancing imports !rom India, it has been decided to provide a re!inance !acility to the 3SI6 #ank under the provisions o! Section 1/@.FA o! the ..

)eserve #ank o! India ,ct, 19*.. The re!inance !acility will be o! an amount o! )s +,::: crores. It will be available at the prevailing repo rate under the ;,$ !or a period o! 9: days. 4uring this 9: day period, the amount can be !lexibly drawn and repaid. ,t the end o! the 9: day period, the withdrawal can also be rolled over. This re!inance !acility will be available up to 6arch *1, 2:1:. The utilization o! !unds will be governed by the policy approved by the #oard o! the 3SI6 #ank.

The )eserve #ank will continue to closely monitor the developments in the global and domestic !inancial markets and will take swi!t and e!!ective action as appropriate. The )eserve #ank will endeavour to minimize the stress on various sectors o! the economy on account o! the international !inancial crisis and the global slowdown. The policy ob1ective is to ensure ade'uate availability o! li'uidity in the system and to maintain conditions conducive !or !low o! credit !or all productive purposes, particularly to the housing, export and small and medium industry sectors. The )eserve #ank o! India @)#IA announced it will develop a regulatory and oversight !ramework !or mobile banking, and made clear its concern over the sa!ety o! transactions through mobile phones. OThe large scale spread o! mobile telephony has opened up new vistas !or banking in the !orm o! mobile banking and the potential in this new sphere is enormous" ade'uate steps to ensure sa!ety and security in a mobile based computing J communicating environment have to, however, be made.P )eserve #ank has decided to take up the !ollowing actions which measure the current assessment o! macroeconomic and monetary conditions.

&onetary 'o icy action

It )educe the repo rate under the ;,$ by 2+ basis points !rom +.:B to ../+B with immediate e!!ect. )educe the reverse repo rate under the ;,$ by 2+ basis points !rom *.+B to *.2+B with immediate e!!ect. Neep the ()) unchanged at +.:B o! net demand and time liabilities @04T;A.

.+

-e#erve $an%@# 'o icy thru#t

The thrust o! the )eserve #ank-s policy stance since mid September 2::9 has been aimed at providing ample rupee li'uidity, ensuring com!ortable dollar li'uidity and maintaining continued credit !low to productive sectors. Taken together, the policy measures o! the )eserve #ank have ensured that the Indian !inancial markets continue to !unction in an orderly manner. These measures have added actualJpotential li'uidity in the !inancial system by over )s. .,2:,::: crores. This should assure !inancial markets that the )eserve #ank will continue to maintain com!ortable li'uidity.

Intere#t -ate -e#pon#e ,rom $an%#

&ithin the policy rate ad1ustment already e!!ected by the )eserve #ank, there is scope !or banks to !urther reduce lending rates so as to ensure credit !low !or all productive economic activity. They hope and expect that banks will play their part in the economic ad1ustment process by passing on the bene!its o! lower interest rates to their customers.

7overnment $orro=in.
=overnment borrowing increased substantially in 2::9 :9. 0et borrowing by the (entral =overnment in 2::9 :9 was increased nearly by three times than that in 2::/ :9. ,s per estimates in the interim budget, net borrowing in the current year, 2::9 1:, will also be at this elevated level. 3ven as the increase in borrowing was large and abrupt in the !ourth 'uarter o! 2::9 :9, they managed that in a non disruptive manner through a combination o! measures such as unwinding o! the 6SS securities, open market operations and monetary easing. ,dmittedly, yields had increased. #ut !or the o!!setting li'uidity easing done by the )eserve #ank, yields would have increased even more. =overnment will manage the borrowing in 2::9 1: in a similarly non disruptive manner. ,n e!!ort in this regard is the planned 767 purchases and 6SS unwinding in the !irst hal! o! 2::9J1: that will add primary li'uidity o! about )s.1, 2:,::: crore, the monetary impact o! which is e'uivalent to ()) reduction by * percentage points.

7ro=th 8ut oo%

In the Fanuary 2::9 policy review, they pro1ected growth !or 2::9 :9 o! /.: per cent with a downward bias. The downside risks have since materialized, and =4< growth !or 2::9 :9 is now pro1ected to turn out to be in the range o! %.+ %./ per cent. =oing !orward, the !iscal and .%

monetary stimulus measures initiated during 2::9 :9 coupled with lower commodity prices will cushion the downturn by stabilizing domestic economic activity. 7n balance, with the assumption o! a normal monsoon, !or policy purpose real =4< growth !or 2::9 1: is placed at around %.: per cent.

In, ation 8ut oo%

7n the price stability !ront, India-s per!ormance has been !airly good. Since independence, the in!lation rate, in terms o! the wholesale price index @&<IA, on an average basis, was above 1+ per cent in only !ive out o! !i!ty years. In thirty six out o! !i!ty years, in!lation was in single digit and on most occasions high in!lation was due to shocks 8 !ood or oil. The tolerance level to in!lation has been low, relative to many developing countries, especially on account o! the democratic pressures in the country. The in!lation rate accelerated steadily !rom an annual average o! 1./ per cent during the 19+:s to %.. percent during the 19%:s and !urther to 9.: per cent in the 19/:s be!ore easing marginally to 9.: per cent in the 199:s. Gowever, the in!lation rate declined !rom an average o! 11.: per cent during 199: 9+ to +.* per cent during the second hal! o! the 199:s @199+ 2:::A and !urther to ..9 per cent during 2::* :/. 6ore recently during 2::% :/, &<I based in!lation rate increased !rom ..1 per cent at the end o! 6arch 2::% to an intra year peak o! %./ per cent at end Fanuary 2::/ and remained !irm in the range o! %.1 %.% per cent in the succeeding weeks be!ore moderating to +.9 per cent by the end o! the !inancial year @i.e., as on 6arch *1, 2::/A. Since then, the in!lation has !urther moderated and as on Fune 1%, 2::/, the &<I in!lation rate was ..: per cent. In recent period, there has been considerable improvement in the !iscal position. The average gross !iscal de!icit o! the central government as per cent to =4< during the + decade o! 199:s was %.9 per cent as against *.9 per cent in the 19/:s. The =overnment o! India is pursuing the path o! rule based !iscal consolidation !rom the year 2::. :+ under the $iscal )esponsibility and #udget 6anagement ,ct, 2::* where under time speci!ic targets have been mandated. The underlying purpose o! the targets is to reduce the ratio o! gross !iscal de!icit @=$4A to gross domestic product @=4<A to three per cent by 2::9 :9. $urthermore, the revenue de!icit @)4A to =4< ratio has been targeted to touch :.: per cent by 2::9 :9 so that borrowed resources can be used to meet only capital expenditures. The progress o! targeted !iscal consolidation has been satis!actory so !ar and =$4J=4< and )4J=4< ratios are budgeted to reduce to *.* per cent

./

and 1.+ per cent, respectively, in 2::/ :9. The ob1ective is to meet the targets under the $iscal )esponsibility ,ct by 2::9 :9. The average current account de!icit since 19+: +1 has been around one per cent o! the =4<. 4uring this period, except !or 11 years when there was marginal surplus in the current account, they had modest de!icit during the rest o! the years. In the a!termath o! the balance o! payment crisis in the early 199:s, several stabilization and structural re!orm measures were undertaken. Neeping in view the global trend in commodity prices and domestic demand supply balance, it pro1ect &<I in!lation at around ..: per cent by end 6arch 2:1:. Geadline &<I in!lation decelerated sharply a!ter ,ugust 2::9 re!lecting the !all in global commodity prices. (<I in!lation continues to be at near double digit level but is expected to moderate in the coming months. &<I in!lation, however, is expected to be in the negative territory in the early part o! 2::9 1: which is only o! statistical signi!icance and is not a re!lection o! demand contraction as is the case in advanced economies.

.9

&oney Supp y
6oney supply @6*A growth !or 2::9 1: is placed at 1/.: per cent. (onsistent with this, the aggregate deposits o! commercial banks are pro1ected to grow by 19.: per cent. The growth in ad1usted non !ood credit, including investment in bondsJdebenturesJ shares o! public sector undertakings and private corporate sector and (<s, is placed at 2:.: per cent. ,s always, these numbers are indicative pro1ections and not targets.

Cha en.e# on the =ay ,or=ar!

There are several immediate challenges !acing the economy. These include> @aA supporting the drivers o! aggregate demand to enable the economy to return to its high growth path" @bA boosting the !low o! credit to all productive sectors o! the economy" @cA managing the large government borrowing programme in 2::9 2:1: in a non disruptive manner" @dA restoring the !iscal consolidation process" @eA ensuring an orderly withdrawal o! the large li'uidity in1ected in the system since September 2::9 by the )eserve #ank to support the economy-s productive re'uirements" and @!A the continued challenge o! preserving the stability o! our !inancial system drawing !rom the lesson o! the global crisis. Gere in India, there are several immediate challenges !acing the economy which would need to be addressed going !orward. $irst, a!ter !ive years o! high growth, the Indian economy was headed !or a moderation in the !irst hal! o! 2::9 :9. Gowever, the growth slowdown accentuated in the third 'uarter o! 2::9 :9 on account o! spillover e!!ects o! international developments. &hile the moderation in growth seems to have continued through the !ourth 'uarter o! 2::9 :9, it has been cushioned by 'uick and aggressive policy responses both by the )eserve #ank and the =overnment. 0otwithstanding the contraction o! global demand, growth prospects in India continue to remain !avorable compared to most other countries. &hile public investment can play a critical role in the short term during a downturn, private investment has to increase as the recovery process sets in. , ma1or macroeconomic challenge at this 1uncture is to support the drivers o! aggregate demand to enable the economy to return to its high growth path. The second challenge going !orward is meeting the credit needs o! the non !ood sector. ,lthough, !or the year 2::9 :9 as a whole, credit by the banking sector expanded, the pace o! .9

credit !low decelerated rapidly !rom its peak in 7ctober 2::9. This deceleration has occurred alongside a signi!icant decline in the !low o! resources !rom non bank domestic and external sources. The deceleration in total resource !low partly re!lects slowdown in demand, drawdown o! inventories by the corporate and decline in commodity prices. The expansion in credit, however, has been uneven across sectors. There is, there!ore, an urgent need to boost the !low o! credit to all productive sectors o! the economy, particularly to 6S63s, to aid the process o! economic recovery. The )eserve #ank continues to maintain and will maintain ample li'uidity in the system. It should be the endeavour o! commercial banks to ensure that every creditworthy borrower is !inanced at a reasonable cost while, at the same time, ensuring that credit 'uality is maintained. It may be noted that bank credit had accelerated during 2::. :/. This, combined with signi!icant slowdown o! the economy in 2::9 :9, may result in some increase in 0<,s. &hile it is not unusual !or 0<,s to increase during periods o! high credit growth and downturn in the economy, the challenge is to maintain asset 'uality through early actions. This calls !or a !ocused approach, due diligence and balanced 1udgment by banks. Third, the )eserve #ank was able to manage the large borrowing programme o! the (entral and State =overnments in 2::9 :9 in an orderly manner. The market borrowings o! the (entral and State =overnments are expected to be higher in 2::9 1:. Thus, a ma1or challenge is to manage the large government borrowing programme in 2::9 1: in a non disruptive manner. ;arge borrowings also militate against the low interest rate environment that the )eserve #ank is trying to maintain to spur investment demand in keeping with the stance o! monetary policy. The )eserve #ank, there!ore, would continue to use a combination o! monetary and debt management tools to manage government borrowing programme to ensure success!ul completion o! government borrowings in a smooth manner. The )eserve #ank has already announced an 767 calendar to support government market borrowing programme through secondary market purchase o! government securities. 4uring the !irst hal! o! 2::9 1:, planned 767 purchases and 6SS unwinding will add primary li'uidity o! about )s.1,2:,::: crores which, by way o! monetary impact, is e'uivalent to ()) reduction o! *.: percentage points. This should leave ade'uate resources with banks to expand credit. +:

$ourth, another challenge !acing the Indian economy is to restore the !iscal consolidation process. The !iscal stimulus packages by the =overnment and some other measures have led to sharp increase in the revenue and !iscal de!icits which, in the !ace o! slowing private investment, have cushioned the pace o! economic activity. Gowever, it would be a challenge to unwind !iscal stimulus in an orderly manner and return to a path o! credible !iscal consolidation. In this context, close monitoring o! the per!ormance o! the economy and the proper se'uencing o! the unwinding process would have to be ensured. $i!th, a continued challenge is to preserve our !inancial stability. The )eserve #ank would continue to maintain conditions which are conducive !or !inancial stability in the !ace o! global crisis. , sound banking sector, well !unctioning !inancial markets and robust payment and settlement in!rastructure are the pre re'uisites !or !inancial stability. The banking sector in India is sound, ade'uately capitalized and well regulated. #y all counts, Indian !inancial and economic conditions are much better than in many other countries o! the world. The single !actor stress tests carried out as part o! the report o! the (ommittee on $inancial Sector ,ssessment @($S,A have revealed that the banking system in India can withstand signi!icant shocks arising !rom large potential changes in credit 'uality, interest rate and li'uidity conditions. These stress tests !or credit, market and li'uidity risk show that Indian banks are generally resilient.

Sixth, the )eserve #ank has in1ected large li'uidity in the system since mid September 2::9. It has reduced the ()) signi!icantly and instituted some sector speci!ic !acilities to improve the !low o! credit to certain sectors. The tenure o! some o! these !acilities has been extended to provide com!ort to the market. &hile the )eserve #ank will continue to support all the productive re'uirements o! the economy, it will have to ensure that as economic growth gathers momentum, the large li'uidity in1ected in the system is withdrawn in an orderly manner. It is worth noting that even as the monetary easing by the )eserve #ank has potentially made available a large amount o! li'uidity to the system, at the aggregate level this has not been out o! line with our monetary aggregates unlike in many advanced countries. ,s such, the challenge o! unwinding will be less daunting !or India than !or other countries.

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$inally, we will have to address the key challenge o! ensuring an interest rate environment that supports revival o! investment demand. Since 7ctober 2::9, as the in!lation rate has decelerated and the policy rates have been reduced, market interest rates have also come down. Gowever, the reduction in interest rates across the term structure and across markets has not been uni!orm. =iven the cost plus pricing structure, banks have been slow in reducing their lending rates citing high cost o! deposits. In this context, it may be noted that the current deposit and lending rates are higher than in 2::. :/, although the policy rates are now lower. )eduction in deposit rates a!!ects the cost only at the margin since existing term deposits continue at the originally contracted cost. So lending rates take longer to ad1ust. Fudging !rom the experience o! 2::. :/, there is room !or downward ad1ustment o! deposit rates. &ith &<I in!lation !alling to near zero, possibly likely to get into a negative territory, albeit !or a short period, and (<I in!lation expected to moderate, in!lationary risks have clearly abated. The )eserve #ankDs current assessment is that &<I in!lation could be around ..: per cent by end 6arch 2:1:. #anks have indicated that small savings rate acts as a !loor to banksD deposit interest rate. It may, however, be noted that small savings and bank deposits are not per!ect substitutes. #anks should not, there!ore, be overly apprehensive about reducing deposit interest rates !or !ear o! competition !rom small savings, especially as the overall systemic li'uidity remains highly com!ortable. There is scope !or the overall interest rate structure to move down within the policy rate easing already e!!ected by the )eserve #ank. $urther action on policy rates is now being taken to rein!orce this process. The )eserve #ank has been constantly monitoring global developments along with the domestic economic situation. 7n the positive side, in!lationary pressures have eased signi!icantly. In!lation as measured by year on year variations in the wholesale price index @&<IA has declined to *.*% per cent as on $ebruary 1., 2::9, down by about three !ourths !rom the high o! 12.91 per cent as on ,ugust 2, 2::9. Gowever, consumer price in!lation, as re!lected in various consumer price indices, is in the range o! 9.9+ 11.%2 per cent as o! 4ecember 2::9 Fanuary 2::9, has yet to show moderation. (onsumer price in!lation has remained at elevated level due to increase in primary articles prices. &ith &<I in!lation having moderated signi!icantly, consumer price in!lation may also be expected to decline, though with a lag. +2

,t the same time, there is evidence o! !urther slowing down o! economic activity. 3xports registered negative growth !or the !our recent consecutive months, 7ctober 2::9 Fanuary 2::9. 7verall exports growth during 2::9 :9 @,pril FanuaryA at 1*.2 per cent was signi!icantly lower than 2..2 per cent during the same period o! the last year. The index o! industrial production @II<A registered a negative growth o! 2.: per cent during 4ecember 2::9, with the manu!acturing sector returning a negative growth o! 2.+ per cent. II< growth during ,pril 4ecember 2::9 at *.2 per cent was about one third o! 9.: per cent during the corresponding period o! the previous year due to slowdown in all the ma1or sectors. )eal =4< growth in the third 'uarter o! 2::9 :9 @September 4ecember 2::9A has been placed at +.* per cent by the (entral Statistical 7rganization @(S7A. The services sector, which has been the main engine o! growth during the last several years, has also been slowing down. #usiness con!idence has been dented signi!icantly and investment demand has decelerated.

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C56'TE- VII In, ation in In!ia

In!lation is the supply o! excess money and credit relative to the goods and services produced, resulting in increased prices. ,s the layman understands it, in!lation results in the increase in the price o! some set o! goods and services in a given economy over a period o! time. It is measured as the percentage rate o! change o! a price index. In!lation in India is also a grave issue o! concern, given the vast disparity between the rich and the poor on the one hand or the )ural and the Erban on the other. Skyrocketing in!lation robs the poor, and hurts others, though much less grievously. The !ruits o! the much talked about economic growth have not reached large sections, especially in the rural areas. Ender extant conditions, the bene!it o! high prices paid by consumers does not !low back to primary producers, but is siphoned away by middlemen and speculators who en1oy a !ree run in an economy o! shortages. I! attention to agriculture has been limited to rendering lip service, ine!!iciencies in the physical market remain unattended. &ith production trailing demand in recent years, shortages o! essential commodities have widened. Imports have become expensive because o! high global market prices. It may be instructive to remember that in!lation is not an overnight phenomenon. It is benign to the extent that it allows us time to cover our sel!. In India, the onus to control and take control o! the situation o! in!lation is upon the )eserve #ank o! India @)#IA. The )eserve #ank o! India @,mendmentA ,ct, 2::% gives discretion to the )eserve #ank to decide the percentage o! scheduled banks- demand and time liabilities to be maintained as (ash )eserve )atio @())A without any ceiling or !loor. (onse'uent to the amendment, no interest will be paid on ()) balances so as to enhance the e!!icacy o! the ()), as payment o! interest attenuates its e!!ectiveness as an instrument o! monetary policy.

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The )eserve #ank o! India @)#IA !ollows a multiple indicator approach to arrive at its goals o! growth, price stability and !inancial stability, rather than targeting in!lation alone. This, o! course, leads to criticism !rom mainstream economists. In its e!!ort to balance many ob1ectives, which o!ten con!lict with each other, )#I looks con!used, ine!!ective and in many cases a cause o! the problems it seeks to address. The )#I has certain weapons which it wields every time and in all situations to counter any !orm o! in!lationary situation in the economy. These weapons are generally the mechanisms and the policies through which the (entral #ank seeks to control the amount o! credit !lowing in the market. The general stance adopted by the )#I to !ight in!lation is discussed in brie! the mechanism used by the )#I needs to take up a holistic approach to the same. Then it would deal with very brie!ly suggestions that may shed some light on what could be the possible steps )#I could take to control rising prices. It is interesting to note that the )eserve #ank o! India =overnor. 4r I. ?. )eddy started his stint with the aim o! cutting down the (ash )eserve )atio to * per cent @!rom the then ..+ per centA but rising commodities in!lation has !orced him to raise it now to %.+ per cent. #ut even this %.+ per cent is way below what would truly contain in!lation and it is almost certain that he will be chasing the in!lation curve !or the next !ew years or so.

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Step# 7enera y Ta%en $y the -$I To Tac% e In, ation

,ccording to the ,nnual Statement on 6onetary <olicy !or the Iear 2::/ :9, a care!ul assessment o! the manner in which in!lation is evolving in India reveals that primary !ood articles have contributed signi!icantly to in!lation during 2::% :/. ,t the same time, prices o! manu!actured products account !or well above +: per cent o! headline in!lation. The recent hardening o! international crude prices has heightened the uncertainty surrounding the in!lation outlook. The steps generally taken by the )#I to tackle in!lation include a rise in repo rates @the rates at which banks borrow !rom the )#IA, a rise in (ash )eserve )atio and a reduction in rate o! interest on cash deposited by banks with )#I. The signals are intended to spur banks to raise lending rates and to reduce the amount o! credit disbursed. The )#I-s measures are expected to suck out a substantial sum !rom the banks. In e!!ect, while the economy is booming and the credit needs grow, the central bank is tightening the availability o! credit. The )#I also buys dollars !rom banks and exporters, partly to prevent the dollars !rom !looding the market and depressing the dollar R indirectly raising the rupee. In other words, the central bank-s interactions have a desirable ob1ective R to keep the rupee devalued R which will make India-s exports more competitive, but they increase li'uidity. To combat this, the )#I does what it calls MsterilizationM R it sucks out the rupees it pays out !or dollars through sale o! sterilization bonds. It then sells these bonds to banks. 3conomists point out that there has not been much success in such sterilization attempts in India. The central bank-s attempt to o!!load =overnment bonds on banks has not been too success!ul in as much as the banks sell the bonds and get rupees instead. 3conomists also contrast this with the success!ul experience o! (hina, where the state owned banks strictly abide by the central bank-s dictates and absorb the sterilization bonds. That discipline is lacking in India. The net e!!ect is that the )#I has to resort to indirect methods o! sterilization, such as raising interest rates and raising ()) to contract li'uidity. This makes India +%

more attractive !or !oreign capital !lows that seek better returns and a vicious cycle !ollows. )#I has to buy more !oreign currency and sterilize.

Con#e+uence# o, -$I 'o icy

The economy was growing at a stupendous 9 per cent, second only to (hina worldwide, however the brakes have been !irmly pressed by the )#I due to their anti 8 in!lationary policy. I! the ()) and )3<7 rate are hiked !re'uently, the economy may take a E turn, as most commercial banks religiously increase their lending rates, without actually studying the impact. The last time that the )#I had imposed its policy, the markets had signaled their resounding reaction by a sharp !all in the Sensex by nearly +:: points. The impact on economic growth is also likely to be sharp, 1udging by e!!ects o! similar therapy applied with disastrous e!!ect in the mid 199:s. This would reduce the level o! investment activity in the economy, particularly in the in!rastructure sector. #ig corporate may ask !or, and get, access to external commercial borrowing, but not so !avored are the bulk o! small and medium entrepreneurs @S63A. Gousing activity will su!!er an impact because most loanees are on !loating rates and will !ace increased e'uated installments. These measures generally taken by the )#I do not e!!ectively tackle in!lation but on the other hand e!!ectively stunts the growth pattern o! the economy. The )#I seems to believe that by merely reducing the credit !low and money !low in the economy, in!lation can be curtailed. In!lation is a conse'uence o! increasing demand ?is 8 a 8 ?is the supply in the economy. The demand must be e!!ectively curtailed or pushed down, which the present ()) policy is not managing to do e!!ectively. The )#I, in an ideal world, would have also looked towards a mechanism to bolster the supply !orces to meet the re'uirements o! the consumers and thereby combat in!lation. 3conomists admit that while )#IDs e!!orts to contain in!lation will reduce borrowings, prices would continue to rise. In!lation, according to #imal Falan, a !ormer governor o! the central bank himsel! and now a member o! IndiaDs upper house o! parliament, is yet to peak.

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OIn!lation is a !unction o! rising expectations and going by that, we have some amount o! in!lationary steam le!t in the economy.P &hile the central bankDs e!!orts may have achieved part o! their ob1ective, o! slowing down credit growth, it clearly may not have done enough to curb in!lation. (hetan ,hya, an economist at 6organ Stanley, estimates that growth in bank credit will slow to between 2:B and 22B by the end o! 2::/ !rom the earlier level o! *:B.

There are t=o ma*or !ra=)ac%# in the C-- / -E'8 po icy a!opte! )y the -$I to com)at in, ation.
$irstly, monetary tools have proved more e!!ective in economies with greater !inancial inclusion. They are less e!!ective in economies such as India-s, where the ma1ority o! the population still has no access to banks, and those with access barely have the resources to open bank accounts. The increasing cost o! !unds and rising interest rates are o! little conse'uence in the economic li!e o! a !inancially excluded population. The impact will be critical on smaller segments and will take a while to yield results !or the economy. 6uch more remains to be achieved on the !inancial inclusion !ront. To cite 6r ?. ;eeladhar, 4eputy =overnor o! the )#I, !rom a recent speech> M(ompared to the developed world, the coverage o! our !inancial services is 'uite low. ,s per a recent survey commissioned by the #ritish #ankers- ,ssociation, 92 9. per cent o! the population o! the EN has either a current or a savings bank account.M This contrasts poorly with India, where the ratio o! deposit accounts to total adult population is only +9 percent. #ut even this !igure is suspect, as the average urban middle class income earner o!ten has more than one bank account. This is bound to reduce !urther the percentage o! people with bank accounts. 6ost account holders are urban centric, leaving large segments o! the rural population with no access to banks or the means to save or borrow.

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Their huge numbers are attested to by the )#I !igures, which reveal that the 9+ commercial banks, with a predominant presence in urban India, account !or /9 per cent o! the country-s !inancial assets. The *,::: cooperative banks and )egional )ural #anks, with greater presence in semi urban and rural pockets, contribute a meager nine per cent and three per cent respectively. Secondly, in spite o! its being an indirect weapon o! credit control, ()) does impact the level o! money supply in the economy and plays some role in the !ight against in!lation. #ut the impact o! the ()) hike will not distinguish as between productive credit and credit meant !or consumption. This will hurt growth and the creation o! assets in the economy. $armers today keep several acres o! land uncultivated as the !inancial returns are not commensurate with the expenses incurred !or cultivation. Irrespective o! the increasing cost o! !unds, large segments o! the borrowing public, especially the small, medium and large !armers, have no option but to approach the commercial and cooperative banks, or the multitude o! unregulated moneylenders at the beginning o! every crop cycle. ,s a result, lendable resources o! the system will be reduced to that extent and bank credit will be dearer. This hike will result in increase o! the lending rates, whether !or production or consumption. The )#I can address only the demand side through such an approach. The need o! the hour is to curb only consumption credit and not production. 7n the other hand, there is urgent need to increase supplies o! !ood products and manu!actured goods, !or which credit !low to the !arm sector and industry must increase. The combined e!!ect o! the ()) hike and the )3<7 rate hike will tell upon expansion o! productive credit as well and this is not desirable at this stage. The monetary measures are meant to increase the cost o! !unds !or banks, make loans dearer and temper the demand !or credit. &hile there is a greater possibility o! banks passing on the increased costs to the consumer, it is debatable whether this will choke the demand !or !unds in some speci!ic in!lation impacting sectors.

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Su..e#tion#

#ased on the data and opinions mentioned above, this paper comes to the conclusion that, the ()) 8 )3<7 mechanism adopted by the )#I has overshot its utility. 0o doubt, the )#I is the only authority which is empowered as well as capable to handle the situation. It is also not disputed that the monetary policy is important to !ight in!lation. )ight now, the )#I seems to be concentrating only on the 4emand end o! in!lation, as a result the entire perspective o! supply is completely ignored. In!lation may also be curtailed i! the supply is bolstered to meet the demands o! the people. &ith the increase in supply, prices would inevitably come down and thus in!lation may be controlled. =ranted, the supply side would not be strengthened so easily, as it would re'uire in!rastructure development, planning, large scale investments etc. Gowever, this is where the )#I could play an extremely important role. The )#I already regularly issues master circulars, through which they direct various aspects o! banking and certain corporate matters. The )#I also regulates and governs matters regarding in!low o! !oreign !unds, !oreign institutional investment @$IIA into India, Etilization o! 3xternal (ommercial #orrowings etc. The )#I does so !or various reasons, especially because not all sectors and industries are at the same level. Some would bene!it !rom external input while some would be best le!t alone. $or the purpose o! bolstering agricultural growth, development o! in!rastructure and all other avenues which the )#I may deem !it" it may lay down regulations to direct money either directly or indirectly with special importance to these sectors. To direct !oreign capital in these !ields and thus bolster in!rastructure would not be a di!!icult task, as the )#I already does this !unction. 7nly this time it shall do it with the purpose o! meeting the ever 8 rising demand. This would serve a twin purpose. &ith the )#I increasing the ()) and other interest rates, it becomes di!!icult !or the !armers to get their loans be!ore their pro1ects. It also becomes di!!icult !or S63 to obtain loans to !ul!ill their targets as well. Through this care!ully routed %:

capital, there may be an access to the re'uired !inance !or these groups o! people notwithstanding the high interest rate. Secondly and most importantly this would also enable the government to lay down measures to utilize this money to develop the in!rastructure which would bolster supply and thus would be a huge boost in the !ight against in!lation in the long run. The government would also have to play an important role in controlling in!lation without harming the economic growth by ensuring greater transparency in the )#I-s sterilization operations. The =overnments at the (entre and the States should take urgent action to make available ade'uate credit at competitive interest rates and o!!er other incentives. In!lation can be contained only i! supply side and demand issues are e!!ectively addressed, apart !rom initiating appropriate !iscal and monetary measures. The practice adopted by the (entral bank right now seems to be an ostrich approach. It is su!!iciently clear that the reason that we have in!lation is because the economic status and mindsets o! the people o! India are advancing. The Indian consumer is no longer a!raid to spend tomorrowDs money today. The average Indian consumer has reached a com!ortable economic position where he now starts to demand products and services which were earlier not available to him. This is an indicator o! an improved standard o! living. &hy should this be considered a disadvantageT The problem here is that the countryDs in!rastructure is not capable o! meeting these re'uirements. #ut, surprisingly, instead o! giving any attention to the supply !actors, by simply lowering money and credit in the market, the )#I is arti!icially pushing demand down. It is sti!ling the needs and re'uirements o! the consumers and is attempting to create an illusion that there is no demand.

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The evolution o! central banking, not only in India but also globally, indicates that the central banks have continued to adapt to the changing economic environment. In the interaction between the !inancial intermediaries and the central bank, the !ocus has been the wel!are o! the general public. The central banks care!ully watch the market trends and monitor numerous variables, both 'uantity and rates, in the domestic and global economy. The in!ormation contained in these indicators and the direct !eedback !rom the market participants helps in calibrating and cra!ting an appropriate monetary policy to ensure !inancial stability. In the last hundred years, a period o! time when most central banks were established, the markets, the ob1ectives and instruments o! monetary policy have changed. 4espite these changes, the central banks have established themselves as necessary and permanent part o! the !inancial system. The )eserve #ank o! India had a !air degree o! success in achieving the twin ob1ectives o! growth with stability, especially in the post re!orm period. The well calibrated strategies o! the )eserve #ank in re!ining monetary policy operating procedures, managing the capital !lows, ensuring evolution o! competitive markets and sustaining a healthy !inancial system, while also per!orming the developmental role have yielded visible results. &hile success!ully !acing the challenges o! globalization, the )eserve #ank has earned international credibility in terms o! e!!icacy o! its policies. The )eserve #ank o! India has achieved transparency in its operations, especially in terms o! evolving communication policy aimed at addressing a wide range o! audiences. 0otwithstanding the changing challenges o! di!!erent regimes, the )eserve #ank has managed to evolve constructively on a continuous basis to cope with demands !or stable macroeconomic management and !inancial stability, while meeting the ob1ectives o! economic growth and development. ,s the economy becomes increasingly open and global, the role o! the )eserve #ank will undergo !urther change and it will need to e'uip it !or coping with these emerging challenges on a continuous basis.

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In sum, the changing role o! !inancial regulation and supervision o! the )eserve #ank !ocuses on prudential supervision, while emphasizing the creation o! an environment in which the banks think !reely and innovate. 6ore importance is being given to HprinciplesD and greater attention to Hrisk assessment and risk containmentD. In !uture, the regulatory and supervisory role would not only be H!riendlyD and H!rankD, but also HpromptD and H!irmD. The changing !ace o! regulation and supervision would accord importance to intensi!ied use o! technology in supervisory processes and substantially enhance the skills and capacities o! the supervisors. &hile !ully meeting the socio economic ob1ectives, it would continue to maintain stable and orderly conditions in the !inancial system.

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Conc u#ion
To conclude, the role o! )#I has been rede!ined through gradual evolution and adaptation, along with some statutory changes, and not through any radical restructuring. $urther, while assessing the autonomy o! the )#I, one should recognize that )#I is not a pure monetary authority but is responsible !or several other !unctions also, as a central bank. The developments in the recent past lead one to the conclusion that, de !acto, there has been enhancement o! the autonomy o! the )#I. ,s regards monetary policy !ramework, the ob1ectives remained the same but the !ramework has been changed !rom time to time in a gradual !ashion in response to the evolving circumstances. (ontextually, there are three important issues in the conduct o! monetary policy viz., the assessment o! potential output, the measurement o! unemployment and appropriate measure o! in!lation. &hile the policy tries to cope with these issues, a combination o! instruments is necessarily used in a !lexible manner to meet these complexities. 3very e!!ort has been made to improve the transmission channels especially through the !inancial markets, and through regulatory and institutional re!orms. In addition, there are some constraints in the conduct o! monetary policy, in particular, the !iscal impact, predominant public ownership, prevalence o! administered interest rate, etc. &hile these challenges and dilemmas persist in the Indian context, every e!!ort is made by the )#I to meet the broader ob1ectives set !orth, !rom time to time. The endeavour o! the )#I is to create conditions !or the common person to pay =overnment dues at hisJher bank branch o! choice, while ensuring instantaneous credit to the =overnment account with )eserve #ank. This can be achieved with a high degree o! computerization with appropriate connectivity J net working, encompassing agency banks, =overnment 4epartments and (entral #ank !or expeditious, cost e!!ective and seamless !inancial !lows, in a paperless environment. This arrangement will be analogous to the (ash and 4ebt 6anagement =roup in which =overnment o! India and the )#I are involved.

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$i) io.raphy
Ae)#ite#
www.wikipedia.com www.'uestia.com www.bis.org www.ecb.int www.bos.!rb.org www.ic!ai.org www.nyi!.com www.rbi.org.in www.google.com

$oo%#
$inancial Institutions and 6arkets Indian $inancial System

Ne=#paper
The 3conomic Times

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