RESEARCH ON RESERVE BANK OF INDIA

Reserve Bank of India

Reserve Bank of India

Seal of RBI

The RBI headquarters in Mumbai

Headquarters Mumbai, Maharashtra 18.93337N Coordinates 72.836201ECoordinates: 18.93337N 72.836201E Established 1 April 1935 Governor Duvvuri Subbarao Central bank of India Currency Indian Rupee ISO 4217 Code INR Reserves US$300.21 billion (2010) Base borrowing 8.00% rate Base deposit 7.00% rate Website rbi.org.in

TOPICS COVERED

ABOUT RBI
*FUNCTIONS OF RBI
NOTES ISSUE BANKER TO THE GOVERNMENT LENDER AT LAST RESORT CUSTODIAN OF FOREIGN EXCHANGE SUPERVISORY FUNCTIONS PROMOTION FUNCTIONS

*CLASSIFICATION OF FUNCTIONS *MONETARY POLICY

Third Quarter Review of Monetary Policy 2009-10

*CONTROL MEASURES
RESERVE REQUIREMENTS OPEN MARKET OPERATIONS REPO BANK RATE AND DISCOUNT RATE

*BOARD OF DIRECTORS

History
o o o o o o o

1.1 19351950 1.2 19501960 1.3 19601969 1.4 19691985 1.5 19851991 1.6 19912000 1.7 Since 2000

*ORGANSATION STRUCTURE

Reserve Bank of India (RBI). The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the beginning. The Government held shares of nominal value of Rs. 2, 20,000. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks. The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage.

Functions of Reserve Bank of India

To maintain monetary stability so that the business and economic life can deliver welfare gains of a properly functioning mixed economy. To maintain financial stability and ensure sound financial institution so that monetary stability can be safely pursued and economic units can conduct their business with confidence. To maintain stable payments system so that financial transactions can be safely and efficiently executed. To promote the development of financial infrastructure of markets and systems, and to enable it to operate efficiently i.e., to play a leading role in developing a sound financial system so that it can discharge its regulatory function efficiently. To ensure that credit allocation by the financial system broadly reflects the national economic priorities and societal concerns. Role of RBI The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the Reserve Bank of India.

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the Issue Department are kept separate from those of the Banking Department. Originally, the assets of the Issue Department were to consist of not less than two-fifths of gold coin, gold bullion or sterling securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of exchange and promissory notes payable in India. Due to the exigencies of the Second World War and the post-was period, these provisions were considerably modified. Since 1957, the Reserve Bank of India is required to maintain gold and foreign exchange reserves of Ra. 200 crores, of which at least Rs. 115 crores should be

in gold. The system as it exists today is known as the minimum reserve system. Banker to Government The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to float new loans and to manage public debt. The Bank makes ways and means advances to the Governments for 90 days. It makes loans and advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters.

Bankers' Bank and Lender of the Last Resort The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking Companies Act

of 1949, every scheduled bank was required to maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 per cent of its time liabilities in India. By an amendment of 1962, the distinction between demand and time liabilities was abolished and banks have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can be changed by the Reserve Bank of India. The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last resort.

Controller of Credit The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. According to the Banking Regulation Act of 1949, the Reserve Bank of India

can ask any particular bank or the whole banking system not to lend to particular groups or persons on the basis of certain types of securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank. The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get a licence from the Reserve Bank of India to do banking business within India, the licence can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank to call for information is also intended to give it effective control of the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial bank. As supereme banking authority in the country, the Reserve Bank of India, therefore, has the following powers: (a) It holds the cash reserves of all the scheduled banks. (b) It controls the credit operations of banks through quantitative and qualitative controls. (c) It controls the banking system through the system of licensing, inspection and calling for information. (d) It acts as the lender of the last resort by providing

rediscount

facilities

to

scheduled

banks.

Custodian of Foreign Reserves The Reserve Bank of India has the responsibility to maintain the official rate of exchange. According to the Reserve Bank of India Act of 1934, the Bank was required to buy and sell at fixed rates any amount of sterling in lots of not less than Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since 1935 the Bank was able to maintain the exchange rate fixed at lsh.6d. though there were periods of extreme pressure in favour of or against the rupee. After India became a member of the International Monetary Fund in 1946, the Reserve Bank has the responsibility of maintaining fixed exchange rates with all other member countries of the I.M.F. Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies. The vast sterling balances were acquired and managed by the Bank. Further, the RBI has the responsibility of administering the exchange controls of the country. Supervisory functions In addition to its traditional central banking functions, the Reserve bank has certain non-monetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the

Banking Regulation Act, 1949 have given the RBI wide powers of supervision and control over commercial and cooperative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation. The RBI is authorised to carry out periodical inspections of the banks and to call for returns and necessary information from them. The nationalisation of 14 major Indian scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the growth of banking and credit policies towards more rapid development of the economy and realisation of certain desired social objectives. The supervisory functions of the RBI have helped a great deal in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation.

Promotional functions With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's functions has steadily widened. The Bank now performs a varietyof developmental and promotional functions, which, at one time, were regarded as outside the normal scope of central banking. The Reserve Bank was asked to promote banking

habit, extend banking facilities to rural and semi-urban areas, and establish and promote new specialised financing agencies. Accordingly, the Reserve Bank has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962, the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964, the Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in 1972. These institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to mobilise savings, and to provide industrial finance as well as agricultural finance. As far back as 1935, the Reserve Bank of India set up the Agricultural Credit Department to provide agricultural credit. But only since 1951 the Bank's role in this field has become extremely important. The Bank has developed the co-operative credit movement to encourage saving, to eliminate moneylenders from the villages and to route its short term credit to agriculture. The RBI has set up the Agricultural Refinance and Development Corporation to provide long-term finance to farmers. Classification of RBIs functions The monetary functions also known as the central banking functions of the RBI are related to control and regulation of money and credit, i.e., issue of currency, control of bank credit, control of foreign exchange operations, banker to the Government and to the money market. Monetary functions of the RBI are significant as they control and regulate the

volume

of

money

and

credit

in

the

country.

Equally important, however, are the non-monetary functions of the RBI in the context of India's economic backwardness. The supervisory function of the RBI may be regarded as a non-monetary function (though many consider this a monetary function). The promotion of sound banking in India is an important goal of the RBI, the RBI has been given wide and drastic powers, under the Banking Regulation Act of 1949 - these powers relate to licencing of banks, branch expansion, liquidity of their assets, management and methods of working, inspection, amalgamation, reconstruction and liquidation. Under the RBI's supervision and inspection, the working of banks has greatly improved. Commercial banks have developed into financially and operationally sound and viable units. The RBI's powers of supervision have now been extended to non-banking financial intermediaries. Since independence, particularly after its nationalisation 1949, the RBI has followed the promotional functions vigorously and has been responsible for strong financial support to industrial and agricultural development in the country. Monetary policy of RBI Goals of Monetary Policy Reserve Bank of India focuses on the following main six basic goals of monetary policy: igh employment H Economic growth Price stability

Interest-rate stability Stability of financial markets Stability in foreign exchange markets

Monetary and Credit policy has direct impact on prices of commodities, inflation and prevailing interest rates, hence, the growth of overall Indian economy. After the economic reforms started in early nineties, although the interest rate determination is market based, credit policy of RBI determines the direction of movement of interest rates. Thus help RBI control the inflation. Apart from this it also

contains norms for the banking and financial sector and the institutions which are governed by RBI like Banks, financial institutions, non-banking financial institutions, primary dealers (money markets) and dealers in the foreign exchange (forex) market. It also contains an economic overview and presents future forecasts. The objective of the policy is to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. Stability for the national currency and growth in employment and income are also considered.

Third Quarter Review of Monetary Policy 2009-10 CO NT E NT S Page No. I. The State of the Economy.......................................1 Global Economy..................................................1 Domestic Economy.............. ........................................2

II. Outlook and Projections................................. 4 Global Outlook.......................................................... 4 Domestic Outlook....................................................... 5 Risk Factors................................................................. 7 III. The Policy Stance................................................ 9 IV.Monetary Measures

Dr. D. Subbarao Governor January 29, 2010 Mumbai

This Policy Review statement should be read and understood together with the detailed review in Macroeconomic and Monetary Developments released yesterday by the Reserve Bank. The statement is organised in four sections. Section I provides an overview of global and domestic macroeconomic developments; Section II sets out the outlook and projections for growth, inflation, money and credit aggregates. Section III explains the stance

of monetary policy and Section IV specifies the monetary measures. I. The State of the Economy Global Economy 2.The global economy is showing increasing signs of stabilisation. The growth outlook in virtually all economies is being revised upwards steadily, with the Asian region experiencing a relatively stronger rebound. Global trade is gradually picking up, but other indicators of economic activity, particularly capital flows and asset and commodity prices are more buoyant. However, even as most of the forecasts on recovery are generally optimistic, significant risks remain. The recovery in many economies is driven largely by government spending, with the private sector yet to begin playing a significant part. There are signs that high levels of global liquidity are contributing to rising asset prices as well as rising commodity prices. Emerging market economies (EMEs) are generally recovering faster than advanced economies. But they are also likely to face increased inflationary pressures due to easy liquidity conditions resulting from large capital inflows.

3. While conditions in the beginning of 2010 are significantly better than they were at the beginning of

2009, a different set of policy challenges has emerged for both advanced economies and EMEs. In 2009, while advanced economies were focused on dealing with the financial crisis, especially reviving the credit market and restoring the health of the financial sector, EMEs were engaged in mitigating the adverse impact of the global financial crisis on their real economies. In 2010, the effort in advanced economies will be to further improve the financing conditions and strengthen the growth impulses, while the endeavour in the EMEs will be to strengthen the recovery process without compromising on price stability and to contain asset price inflation stemming from large capital inflows.

4. Domestic Economy As stated in the Second Quarter Review of October 2009, India's macroeconomic context is different from that of advanced and other EMEs in at least four respects. One, India is facing rising inflationary pressures, albeit largely due to supply side factors. Two, households, firms and financial institutions in India continue to have strong balance sheets, although there is a need to encourage

domestic consumption and investment demand. Three, since the Indian economy is supplyconstrained, pick-up in demand could exacerbate inflationary pressures. Four, India is one of the few large EMEs with twin deficits - fiscal deficit and current account deficit.

5. Growth during Q2 of 2009-10, at 7.9 per cent, reveals a degree of resilience that surprised many. Subsequent data releases, whether on industrial production, infrastructure or exports, confirm the assessment that the economy is steadily gaining momentum. Based on this better-than- expected performance, growth forecasts for 2009-10 have generally been revised upwards. As reassuring as this recovery is, it is still unbalanced. Public expenditure continues to play a dominant role and performance across sectors is uneven, suggesting that recovery is yet to become sufficiently broad-based. 6. For several months, rapidly rising food inflation has been a cause for concern. More recently, there are indications that the sustained increase in food prices is beginning to spill over into other commodities and services as well. The increases in the prices of manufactured goods have accelerated over the past two months. While food products, understandably, contribute significantly to this, pressures in other sectors are also visible. Further, prices of non-administered fuel items have increased

significantly in line with rising international prices. With growth accelerating in the second half of 200910 and expected to gain momentum over the next year, capacity constraints could potentially reinforce supply-side inflationary pressures. 7. The inflation risk looms larger when viewed in the context of global price movements. As already indicated, global commodity prices are showing signs of firming up, driven both by the recovery in demand and the asset motive. Significantly, prices of important food items are also firming up. Going by the Food and Agriculture Organisation (FAO) data, the global rates of increase in the prices of sugar, cereals and edible oils are now appreciably higher than domestic rates. The opportunity to use imports as a way to contain domestic food prices is, therefore, quite limited. 8. Monetary aggregates during 2009-10 have so far moved broadly in line with their projections. However, non-food bank credit growth decelerated significantly from its peak of over 29 per cent in October 2008 to a little over 10 per cent in October 2009. Thereafter, it recovered to over 14 per cent by mid-January 2010. This credit performance should be seen in the context of improved access of corporates to non-bank sources of funds this year. Rough calculations show that the total flow of financial

resources from banks, domestic non-bank and external sources to the commercial sector during 2009-10 (up to January 15, 2010) at Rs.5,89,000 crore was only marginally lower than Rs.5,95,000 crore in the corresponding period of the previous year. These numbers suggest that non-bank sources of finance have, to a large extent, mitigated the impact of the slow down in bank credit growth.

9. Our previous Reviews have commented on the monetary transmission during the crisis period. While the changes in the Reserve Bank's policy rates were quickly transmitted to the money and government securities markets, transmission to the credit market was slower. Evidently, the transmission is still in progress. The effective average lending rate of scheduled commercial banks declined from 12.3 per cent in March 2008 to 11.1 per cent in March 2009. Although relevant information for the subsequent period is not available, the effective average lending rates may have declined further as banks' benchmark prime lending rates (BPLRs) softened by 25-100 basis points during this period. 10. Financial markets have remained orderly. Overnight money market rates remained below or close to the lower bound of the liquidity adjustment facility (LAF) corridor. Liquidity conditions

remained comfortable with the Reserve Bank absorbing about Rs.1,09,000 crore on a daily average basis during the current financial year. Yields on government securities could potentially have increased sharply because of the abrupt increase in government borrowings. However, the upward pressure on yields was contained by lower commercial credit demand, open market operation (OMO) purchases and active liquidity management by the Reserve Bank. Equity markets are behaving in a manner consistent with global patterns. Real estate prices have firmed up as has been the trend in several other EMEs. Increasing optimism about the recovery and high levels of liquidity are driving up real estate prices although they are still some distance away from the pre-crisis peaks.

11. On the fiscal front, the stimulus by the government in the second half of 2008-09 has clearly contributed significantly to the recovery. It may be recalled that the crisis-driven stimulus by way of reduction in excise levies, interest rate subventions and additional capital expenditure came on top of structural measures already built into the budget such as the Sixth Pay Commission Award and farm debt waiver.

12. We will have to await the forthcoming budget in end-February 2010 for the Government's decision on phasing out the transitory components of the stimulus. As regards the structural components, even though they were one- off, some of their impact is expected to continue over the next couple of years, as state governments and public sector enterprises align their compensation structures with the recommendations of the Sixth Pay Commission. 13. Managing the government borrowing programme to finance the large fiscal deficit posed a major challenge for the Reserve Bank. In order to address this, the Reserve Bank front-loaded the government borrowing programme, unwound MSS securities and undertook OMO purchases.

14. On the external front, exports have begun responding to the revival in global demand. Right through the difficulties of 2008-09 and the early months of the current financial year, there was never any pressure on the current account. However, capital outflows in the third quarter of 2008-09 led to some stress on the balance of payments, but we rode this out on the strength of our forex reserves. The Reserve Bank, however, had to initiate some conventional and non-conventional measures to ease the pressure on forex and rupee liquidity. In the space of a year, the situation has clearly stabilised.

15. The current account deficit during AprilSeptember 2009 was US$ 18.6 billion, up from US$ 15.8 billion during April-September 2008. Over the first half of 2009-10, capital inflows resumed, but were not significantly in excess of the current account deficit. India's improving growth prospects, combined with persistently high levels of global liquidity, may result in a significant increase in net inflows over the coming months. Depending on how these are handled, there will be implications in terms of a combination of exchange rate appreciation, larger systemic liquidity and the fiscal costs of sterilisation. II. Outlook and Projections Global Outlook Global Growth 16. Global economic performance improved during the third and fourth quarters of 2009, prompting the IMF to reduce the projected rate of economic contraction in 2009 from 1.1 per cent made in October 2009 to 0.8 per cent in its latest World Economic Outlook (WEO) Update released on January 26, 2010. The IMF has also revised the projection of global growth for 2010 to 3.9 per cent, up from 3.1 per cent (Table 1). The IMF expects the growth performance, which will be led by major Asian economies, to vary considerably across

countries and regions, reflecting different initial conditions, external shocks, and policy responses.

Table 1: Projected Global GDP Growth (%)* Country/Region 2009 2010 US (-) 2.5 2.7 UK (-) 4.8 1.3 Euro Area (-) 3.9

1.0 Japan (-) 5.3 1.7 China 8.7 10.0 India 5.6 7.7 Emerging and Developing Economies 2.1 6.0 World (-)0.8 3.9 Source: World Economic Outlook Update, IMF, January 26.201 0 17. The IMF has also revised upwards its projection of the real GDP growth of emerging and developing economies for 2009 to 2.1 per cent from its earlier number of 1.7 per cent. The estimates are even more optimistic for 2010. The growth of emerging and developing economies is now projected at 6.0 per cent, up from 5.1 per cent earlier. The growth in EMEs such as China and India and other emerging Asian economies is expected to be robust. Commodity-producing countries are likely to recover quickly in 2010 on the back of a rebound in commodity prices. Global Inflation

18. The IMF expects that the high levels of slack in resource utilisation and stable inflation expectations will contain global inflationary pressures in 2010. In the advanced economies, headline inflation is expected to increase from zero in 2009 to 1.3 per cent in 2010, as rising energy prices may more than offset deceleration in wage levels. In emerging and developing economies, inflation is expected to rise to 6.2 per cent in 2010 from 5.2 per cent in 2009 due to low slack in resource utilisation and increased capital inflows. Domestic Outlook Growth

19. During 2009-10, real GDP growth accelerated from 6.1 per cent in Q1 to 7.9 per cent in Q2 driven by revival in industrial growth, and pick-up in services sector growth, aided by payment of arrears arising out of the Sixth Pay Commission Award. It is expected that Q3 growth, which will reflect the full impact of the deficient south-west monsoon rainfall on kharif crops, would be lower than that of Q2. As rabi prospects appear to be better, on the whole, agricultural GDP growth in 2009-10 is expected to be near zero.

20. As a result of the improvement in the global economic situation since the Second Quarter Review in October 2009, exports expanded in November 2009, after contracting for 13 straight months. This positive trend is expected to persist. The industrial sector recovery, some signs of which were noted in the Second Quarter Review, is now consolidating. The performance of the corporate sector has picked up. Increased business optimism also reflects brighter prospects for the industrial sector. Services sector activities have improved. Domestic and international financing conditions have eased considerably, and this too should support domestic demand. 21. In the Second Quarter Review of October 2009, we had placed the baseline projection for GDP growth for 2009-10 at 6.0 per cent with an upside bias. The movements in the latest indicators of real sector activity indicate that the upside bias has materialised. Assuming a near zero growth in agricultural production and continued recovery in industrial production and services sector activity, the baseline projection for GDP growth for 2009- 10 is now raised to 7.5 per cent (Chart 1).

22. Looking ahead to 2010-11, our preliminary assessment of the baseline scenario is that the current growth will be sustained. This is a tentative assessment. We shall formally indicate our growth projection for 2010-11 in our Monetary Policy in April 2010. Inflation 23. Headline wholesale price index (WPI) inflation was 1.2 per cent in March 2009. It continued to decline and became negative during June-August 2009 due to the large statistical base effect. It turned positive in September 2009, accelerated to 4.8 per

cent in November 2009 and further to 7.3 per cent in December 2009. On a financial year basis, between April-December 2009, WPI moved up by 8 per cent. 24. The deficient monsoon rainfall and drought conditions in several parts of the country have accentuated the pressure on food prices, pushing up the overall inflation rate both of the WPI and consumer price indices (CPIs). Going forward, the rabi crop prospects are assessed to be better. The large stock of foodgrains with public agencies should help supply management. On the other hand, there is a risk that inflationary pressures may emanate from the rebound in global commodity prices. 25. Assessment of inflationary pressures has become increasingly complex in the recent period as the WPI and CPI inflation rates have shown significant divergence. All the four CPIs have remained elevated since March 2008 due to the sharp increase in essential commodity prices. The Reserve Bank monitors an array of measures of inflation, both overall and disaggregated components, in conjunction with other economic and financial indicators to assess the underlying inflationary pressures for formulating its monetary policy stance.

26. The Second Quarter Review of October 2009 projected WPI inflation of 6.5 per cent with an upside bias for end-March 2010. The upside risks in terms of higher food prices reflecting poor monsoon have clearly materialised. However, some additional factors have also exerted upward pressure on WPI inflation. One, the expected seasonal moderation has not taken place, other than in vegetables. Two, prices of the non-administered component of the fuel group, tracking the movement in global crude prices, have also risen significantly. Three, there have also been some signs of demand side pressures. The Reserve Bank's quarterly inflation expectations survey for households indicates that inflation expectations are

on the rise. Keeping in view the global trend in commodity prices and the domestic demand-supply balance, the baseline projection for WPI inflation for end- March 2010 is now raised to 8.5 per cent (Chart 2). 27. As with growth, we shall formally announce our inflation projection for 2010-11 in our Monetary Policy in April 2010. However, on the assumption of a normal monsoon and global oil prices remaining around the current level, it is expected that inflation will moderate from July 2010. This moderation in inflation will depend upon several factors, including the measures taken and to be taken by the Reserve Bank as a part of the normalisation process. 28. As always, the Reserve Bank will endeavour to ensure price stability and anchor inflation expectations. The conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0- 4.5 per cent. This will be in line with the medium-term objective of 3.0 per cent inflation consistent with Indias broader integration with the global economy. Money and Credit Aggregates 29. During the current financial year, the year-onyear growth in money

supply (M3) moderated from over 20.0 per cent at the beginning of the financial year to 16.5 per cent on January 15, 2010, reflecting deceleration in bank credit growth during 2009-10. Year-on-year increase in non-food bank credit to the commercial sector, at 14.4 per cent as on January 15, 2010, was significantly lower than the 22.0 per cent growth a year ago. Consequently, the more important source of M3 expansion this year has been bank credit to the government, reflecting the enlarged support to the market borrowing of the government and unwinding of MSS securities.

30. Aided by the measures initiated by the Reserve Bank (see para 13), over 98 per cent of the net market borrowing programme of the Central Government for 2009-10 has already been completed by January 28, 2010. The anticipated increase in credit demand by the commercial sector in the remaining period of 2009-10 can, therefore, be easily met from the market as adequate liquidity is available in the system. In view of the increased availability of funds from domestic non-bank and external sources (see para 8), the 18 per cent growth in adjusted nonfood credit growth projected earlier is unlikely to be realised. Accordingly, the indicative adjusted nonfood credit growth projection for 2009-10 is now reduced to 16 per cent. Based on this projected credit

growth and the remaining very marginal market borrowing of the government, the projected M3 growth in 2009-10 has been reduced to 16.5 per cent for policy purposes. Consistent with this, aggregate deposits of scheduled commercial banks are projected to grow by 17 per cent. These numbers, as before, areprovided as indicative projections and not as targets.

Risk Factors 31. While the baseline scenario is comforting, a number of downside risks to growth and upside risks to inflation need to be recognised. (i) There is still uncertainty about the pace and shape of global recovery. There are concerns that it is too dependent on public spending and will unravel if governments around the world withdraw their fiscal stimuli prematurely. As the world discovered during the recent crisis, the global economy is heavily interlinked through the business cycle. A downturn in

global sentiment will affect not only our external sector but also our domestic investment. (ii) Oil prices have been range-bound in the recent period. However, if the global recovery turns out to be stronger than expected, oil prices may increase sharply, driven both by prospects of demand recovery and the return of the investment motive, which will affect all commodities. This could stoke inflationary pressures even as growth remains below potential.

(iii) Expectations of softening domestic inflation are contingent on food prices moderating. This, in turn, depends significantly on the performance of the south-west monsoon in 2010. If rainfall is inadequate, high food prices will continue to intensify inflationary pressures. (iv) So far, capital inflows have been absorbed by the current account deficit. However, sharp increase in capital inflows, above the absorptive capacity of the economy, may complicate exchange rate and monetary management. (v) As growth accelerates and the output gap closes, excess liquidity, if

allowed to persist, expectations.

may

exacerbate

inflation

32. Beyond the above risk factors, by far a bigger risk to both short-term economic management and to medium-term economic prospects emanates from the large fiscal deficit. The counter-cyclical public finance measures taken by the government as part of the crisis management were necessary; indeed they were critical to maintaining demand when other drivers of demand had weakened. But as the recovery gains momentum, it is important that there is coordination in the fiscal and monetary exits. The reversal of monetary accommodation cannot be effective unless there is also a roll back of government borrowing. As indicated earlier (para 13), even as the government borrowing had increased abruptly during 2008-09 and 2009-10, it could be managed through a host of measures that bolstered liquidity. Those liquidity infusion options will not be available to the same extent next year. On top of that, there will be additional constraints. Inflation pressures will remain and private credit demand will be stronger with the threat of crowding out becoming quite real. 33. There are standard, well-known and well-founded reasons for fiscal consolidation. For both short-term economic management and medium-term fiscal

sustainability reasons, it is imperative, therefore, that the government returns to a path of fiscal consolidation. The consolidation can begin with a phased roll back of the transitory components. Beyond that, in the interest of transparency and predictability, the government should ideally do two things: first, indicate a roadmap for fiscal consolidation; and second, spell out the broad contours of tax policies and expenditure compression that will define this roadmap.

III. The Policy Stance 34. The Reserve Bank has pursued an accommodative monetary policy beginning mid-September 2008 in order to mitigate the adverse impact of the global financial crisis on the Indian economy. The measures taken instilled confidence in market participants and helped cushion the spillover of the global financial crisis on to our economy. However, in view of rising food inflation and the risk of it impinging on inflationary expectations, the Reserve Bank announced the first phase of exit from the expansionary monetary policy by terminating some sector-specific facilities and restoring the statutory

liquidity ratio (SLR) of scheduled commercial banks to its pre- crisis level in the Second Quarter Review of October 2009.

35. Against the above backdrop of global and domestic macroeconomic conditions, outlook and risks, our policy stance in this Quarter is shaped by three important considerations: (i) A consolidating recovery should encourage us to clearly and explicitly shift our stance from 'managing the crisis' to 'managing the recovery'. We articulated this change in our stance in the October quarterly review, but the growing confidence in the recovery justifies our moving further in reversing the crisisdriven expansionary stance. Our main policy instruments are all currently at levels that are more consistent with a crisis situation than with a fastrecovering economy. It is, therefore, necessary to carry forward the process of exit further. (ii) Though the inflationary pressures in the domestic economy stem predominantly from the supply side, the consolidating recovery increases the risks of these pressures spilling over into a wider inflationary process. Looking ahead into 2010-11, if the growth momentum turns out to be as expected, pressures on capacities in an increasing number of sectors are

likely to strengthen the transmission of higher input and wage costs into product prices. (iii) Even amidst concerns about rising inflation, we must remember that the recovery is yet to fully take hold. Strong anti-inflationary measures, while addressing one problem, may precipitate another by undermining the recovery, particularly by deterring private investment and consumer spending. 36. Against this backdrop, the stance of monetary policy of the Reserve Bank for the remaining period of 2009-10 will be as follows: Anchor inflation expectations and keep a vigil on the trends in inflation and be prepared to respond swiftly and effectively through policy adjustments as warranted. Actively manage liquidity to ensure that credit demands of productive sectors are adequately met consistent with price stability. Maintain an interest rate environment consistent with price stability and financial stability, and in support of the growth process.

IV. Monetary Measures 37. On the basis of the current assessment and in line with the policy stance as outlined in Section III, the Reserve Bank announces the following policy measures: Bank Rate 38. The Bank Rate has been retained at 6.0 per cent. Repo Rate 39. The repo rate under the Liquidity Adjustment Facility (LAF) has been retained at 4.75 per cent. Reverse Repo Rate 40. The reverse repo rate under the LAF has been retained at 3.25 per cent. Cash Reserve Ratio 41. It has been decided to: increase the cash reserve ratio (CRR) of scheduled banks by 75 basis points from 5.0 per cent to 5.75 per cent of their net demand and time liabilities (NDTL) in two stages; the first stage of increase of 50 basis points will be effective the fortnight beginning February 13, 2010, followed by the next stage of increase of 25 basis points effective the fortnight beginning February 27, 2010.

42. As a result of the increase in the CRR, about Rs. 36,000 crore of excess liquidity will be absorbed from the system. 43. The Reserve Bank will continue to monitor macroeconomic conditions, particularly the price situation closely and take further action as warranted. Expected Outcomes

44. The expected outcomes of the actions are: (i) Reduction in excess liquidity will help anchor inflationary expectations. (ii) The recovery process will be supported without compromising price stability. (iii) The calibrated exit will align policy instruments with the current and evolving state of the economy. Monetary Policy 2010-11

45. The Monetary Policy for 2010-11 will be announced on April 20, 2010. Mumbai January 29, 2010

Control Measures In past few months we saw RBI using 2 of its possible measures to tackle the inflation. RBI actually has four chief weapons in its arsenal to control the inflation. They are Open Market Operations (OMO), Reserve Requirements (CRR and SLR), Bank Rate or Discount rate and Repo rate. We now discuss each one of them in detail and their effects as well: Open Market Operations (OMO)

In this case RBI sells or buys government securities in open market transaction depending upon whether it wants to increase the liquidity or reduce it. So when RBI sells government securities in secondary market it sucks out the liquidity (stock of money) in the economy. So overall it reduces the money supply available with banks in effect the capital available with banks for lending purpose becomes scarce hence interest rates move in upward direction. Exactly opposite happens when RBI buys securities from open market. The transaction increases the money supply available with banks so the cost of money (interest rate) moves in downward direction and business activities like new investments, capacity expansion gets boost. In a nutshell RBI buys securities when the economy is sluggish and demand is not picking up and sells securities when the economy is overheated and needs to cool down. OMO is also used in curbing the artificial liquidity created to avoid strengthening of rupee against dollar in order to remain competitive in exports.

Reserve Requirements This mainly constitute of Cash to Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR). CRR is the portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes: firstly, it ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation. Whereas SLR is the portion of their deposits banks are required to invest in government securities. So due to CRR and SLR obligation towards RBI financial institutions will be able to lend only the part of money available with them although this effect is small when transaction is between just two entities and constitute one layer. But when money flows through series of players and layers very less money will be left with the institutions present at the bottom of pyramid. So higher is the CRR less is the money available in the economy. So interest rates will move in upward direction and opposite happens when CRR is reduced.

Recently RBI raised CRR from 4.5% to 5% in two stages which enabled to transfer about 8000 Crore rupees from money in supply to RBIs coffers. CRR has actually been reduced to this level of 5% from 15% in 1981. Bank Rate or Discount rate This is the rate at which the RBI makes very short term loans to banks. Banks borrow from the RBI to meet any shortfall in their reserves. An increase in the discount rate means the RBI wants to slow the pace of growth to reduce inflation. A cut means that the RBI wants the economy to grow and take up new ventures. Indian bank rate is at 6 per cent down from 10 per cent in 1981 and 12 per cent in 1991 Repo rate It is the rate at which the RBI borrows short term money from the market. After economic reforms RBI started borrowing at market prevailing rates. So it makes more sense to banks to lend money to RBI at competitive rate with no risk at all. Although the repo rate transactions are

for very short duration the everyday quantum of operations is approximately Rs 40,000 crore everyday. Thus, large amount of capital is not available for circulation. With increase in repo rate banks tend to invest more in repo transactions. Open market operation have limitations due to amount of government securities with RBI is limited and close to Rs 60,000 Crore and out of that only Rs 45,000 Crore is in form of marketable securities. Considering Bank Rate which is untouched in current scenario RBI is left with only 2 major measures viz. CRR and Repo Rate in its armory to guard against the onslaught of inflation. Since large part of inflation is attributed to large increase in international oil and metal prices, the cooling price trend in them comes as a great relief to RBI and Indian economy as a whole and along with RBI measures has helped stabilize inflation.

Board of directors The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.

History
19351950

The old RBI Building in Mumbai

The central bank was founded in 1935 to respond to economic troubles after the first world war. The Reserve Bank of India was set up on the recommendations of the Hilton-Young Commission. The commission submitted its report in the year 1926, though the bank was not set up for another nine years. The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as to regulate the issue of bank notes, to keep reserves with a view to securing monetary stability in India and generally to operate the currency and credit system in the best interests of the country. The Central Office of the Reserve Bank was initially established in Kolkata, Bengal, but was permanently moved to Mumbai in 1937. The Reserve Bank continued to act as the central bank for Myanmar till Japanese occupation of Burma and later up to April 1947, though Burma seceded from the Indian Union in 1937. After partition, the Reserve Bank served as the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations. Though originally set up as a shareholders bank, the RBI has been fully owned by the government of India since its nationalization in 1949. 19501960 Between 1950 and 1960, the Indian government developed a centrally planned economic policy and focused on the agricultural sector. The administration nationalized commercial banks and established, based on the Banking Companies Act, 1949 (later called Banking Regulation Act) a central bank regulation as part of the RBI. Furthermore,

the central bank was ordered to support the economic plan with loans. 19601969 As a result of bank crashes, the reserve bank was requested to establish and monitor a deposit insurance system. It should restore the trust in the national bank system and was initialized on 7 December 1961. The Indian government founded funds to promote the economy and used the slogan Developing Banking. The Government of India restructured the national bank market and nationalized a lot of institutes. As a result, the RBI had to play the central part of control and support of this public banking sector. 19691985 Between 1969 and 1980, the Indian government nationalized 6 more commercial banks, following 14 major commercial banks being nationalized in 1969(As mentioned in RBI website). The regulation of the economy and especially the financial sector was reinforced by the Government of India in the 1970s and 1980s. The central bank became the central player and increased its policies for a lot of tasks like interests, reserve ratio and visible deposits. The measures aimed at better economic development and had a huge effect on the company policy of the institutes. The banks lent money in selected sectors, like agri-business and small trade companies. The branch was forced to establish two new offices in the country for every newly established office in a town. The

oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the effects. 19851991 A lot of committees analysed the Indian economy between 1985 and 1991. Their results had an effect on the RBI. The Board for Industrial and Financial Reconstruction, the Indira Gandhi Institute of Development Research and the Security & Exchange Board of India investigated the national economy as a whole, and the security and exchange board proposed better methods for more effective markets and the protection of investor interests. The Indian financial market was a leading example for so-called "financial repression" (Mackinnon and Shaw). The Discount and Finance House of India began its operations on the monetary market in April 1988; the National Housing Bank, founded in July 1988, was forced to invest in the property market and a new financial law improved the versatility of direct deposit by more security measures and liberalisation. 19912000 The national economy came down in July 1991 and the Indian rupee was devalued. The currency lost 18% relative to the US dollar, and the Narsimahmam Committee advised restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to establish a private banking sector. This turning point should reinforce the market and was often called neo-liberal. The central bank

deregulated bank interests and some sectors of the financial market like the trust and property markets. This first phase was a success and the central government forced a diversity liberalisation to diversify owner structures in 1998. The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalized banks in July to interact with the capital market to reinforce their capital base. The central bank founded a subsidiary companythe Bharatiya Reserve Bank Note Mudran Limitedin February 1995 to produce banknotes. Since 2000 The Foreign Exchange Management Act from 1999 came into force in June 2000. It should improve the foreign exchange market, international investments in India and transactions. The RBI promoted the development of the financial market in the last years, allowed online banking in 2001 and established a new payment system in 2004 - 2005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes and coins. The national economy's growth rate came down to 5.8% in the last quarter of 2008 - 2009 and the central bank promotes the economic development. The RBI Regional Office in Nagpur(Maharashtra) On June 27, 2006, the Union Government of India reconstituted the Central Board of Directors of the Reserve

Bank of India (RBI) with 13 members, including Azim Premji and Kumar Mangalam Birla. Other members of the board

Suresh Tendulkar, Economist and Member, Prime Minister's Economic Advisory Council (to represent Eastern Area Local Board) U. R. Rao, former Chairman, ISRO and Chairman Research Council, Physical Research Laboratory, Department of Space (to represent Northern Area Local Board) Lakshmi Chand, IAS (Retd.) (to represent Southern Area Local Board) Shashi Rekha Rajagopalan, Consultant, Co-operatives Suresh Kumar Neotia, Chairman, Ambuja Cement A. Vaidyanathan, Madras Institute of Development Studies

Reserve Bank of India regional office, Delhi entrance with the Yakshini sculpture depicting "Prosperity through agriculture".

The RBI Regional Office in Delhi.

The regional offices of GPO (in white) and RBI (in sandstone) at Dalhousie Square, Kolkata.

ORGANISATION STRUCTURE : CENTRAL BOARD OF DIRECTORS