Johann Fernandes

TYBBI Roll No.16

Reserve Bank of India Second Quarter Review of Monetary Policy 2013-14 By Dr. Raghuram G. Rajan Governor Monetary Policy Monetary and Liquidity Measures 1. Following an assessment of the evolving macroeconomic situation, the Reserve Bank has decided to: reduce the marginal standing facility (MSF) rate by 25 basis points from 9.0 per cent to 8.75 per cent with immediate effect; increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5 per cent to 7.75 per cent with immediate effect keep cash reserve ratio (CRR) unchanged at 4.0 per cent of net demand and time liability increase the liquidity provided through term repos of 7 -day and 14-day tenor from 0.25 per cent of NDTL of the banking system to 0.5 per cent with immediate effect. Consequently, the reverse repo rate under the LAF stands adjusted to 6.75 per cent an d the Bank Rate stands reduced to 8.75 per cent with immediate effect. With these changes, the MSF rate and the Bank Rate are recalibrated to 100 basis points above the repo rate. Assessment 2. Since the Mid-Quarter Review in September, the outlook for global growth has improved modestly, with fiscal concerns abating in the US and lead indicators of activity firming up in the Euro area and the UK. 3. In emerging and developing economies, the prospect of delay in the taper of the Federal Reserves bond purchases has brought calm to financial markets, and capital flows have resumed. Nevertheless, headwinds to growth from domestic constraints continue to pose downside risks, and vulnerabilities to sudden shifts in the external environment remain.

Johann Fernandes
TYBBI Roll No.16

4.

In India, industrial activity has weakened, with a contraction in consumer durables and tepid growth in capital goods reflecting the ongoing downturn in both consumption and investment demand. Strengthening export growth and signs of revival in some services, along with the expected pick -up in agriculture, could support an increase in growth in the second half of 2013-14 relative to the first half, raising real GDP growth from 4.4 per cent in Q1 to a central estimate of 5.0 per cent for the year as a whole (Chart 1). The revival of large stalled projects and the pipeline cleared by the Cabinet Committee on Investment may buoy investment and overall activity towards the close of the year.

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In the meantime, with many large entities holding back on payments, liquidity pressures are building up on small and medium enterprises. A number are facing conditions of financial distress. Remedies partly lie in the speed-up of government and public sector payments, and on measures to channel credit to small and medium enterprises. Inflation measured by the wholesale price index (WPI) rose in September for the fourth month in succession. The pass-through of rupee depreciation into prices of manufactured products is acting, along with elevated food and fuel inflation, to offset possible disinflationary effects of low growth. While food price pressures may ease with the arrival of the kharif harvest and the usual seasonal moderation, overall WPI inflation is expected to remain higher than current levels through most of the
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Johann Fernandes
TYBBI Roll No.16

remaining part of the year (Chart 2), warranting an appropriate policy response.

7. Retail inflation measured by the consumer price index (CPI) has also risen sharply across food and non-food constituents, including services, keeping inflation expectations high. Notwithstanding the expected edging down of food inflation, retail inflation is likely to remain around or even above 9 per cent (Chart 3) in the months ahead, absent policy action.

Johann Fernandes
TYBBI Roll No.16

8. Liquidity management has been calibrated to the system s requirements arising from the sharp pick-up in credit relative to deposit growth and festival -related demand for currency. Liquidity up to 0.5 per cent of bank -wise NDTL is available through overnight LAF repos. Furthermore, export credit refinances of up to 50 per cent of eligible export credit outstanding amounts to approximately 0.5 per cent of systemlevel NDTL. To provide market participants with additional access to primary liquidity, as well as greater flexibility in managing reserve requirements, term repos of 7-day and 14-day tenor have been introduced to provide liquidity equivalent to 0.25 per cent of NDTL. As a result of the measures taken by the Reserve Bank to ease liquidity, the average w i t h drawal on the MSF has declined significantly from about `1.4 trillion in mid-September to `0.4 trillion by mid-October, and money market rates have fallen by 125 basis points. Going forward, however, the more durable strategy for mitigating mismatches between the supply of, and demand for, funds is for banks t o step up efforts to mobilize deposits. 9. As regards the external sector, the improvement in export performance over the last two months, coupled with the contraction in non-oil import demand, has enabled a perceptible narrowing of the trade deficit with favourable implications for the current account deficit (CAD) going forward. Policy interventions have bridged the external financing gap. These factors have brought some calm to the foreign exchange market. However, normalcy will be restored to the exchange market only when the demand for dollars from public sector oil marketing companies is fully returned to the market. Policy Stance and Rationale 10. From September, as steps to contain the CAD started taking effect in an improving external environment, volatility in the foreign exchange market ebbed and it became possible to unwind the exceptional liquidity tightening measures. Keeping in view the need to infuse liquidity into the system to normalize liquidity conditions, term repos will now be conducted for a total notified amount equivalent to 0.5 per cent of NDTL of the banking system. In addition, the MSF rate will be reduced by 25 basis points. 11. With the more recent upturn of inflation, and with inflation expectations remaining elevated anticipating the pass-through of exchange rate depreciation and ongoing adjustment in administered fuel prices, it is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen
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Johann Fernandes
TYBBI Roll No.16

the foundations of growth. It is in this context that the LAF repo rate has been increased by 25 basis points. 12. With the reduction of the MSF rate and the increase in the repo rate in this review, the process of re-aligning the interest rate corridor to normal monetary policy operations is now complete. Developmental and Regulatory Policies
13. This part of the Statement reviews the progress on various developmental and regulatory policy measures announced by the Reserve Bank in recent policy statements and also sets out new measures. 14. The Reserve Bank s developmental measures over the next few quarters will be built on five pillars. These are: a. Clarifying and strengthening the monetary policy framework. b. Strengthening banking structure through new entry, branch expansion, encouraging new varieties of banks, and moving foreign banks into better regulated organizational forms. c. Broadening and deepening financial markets and increasing their liquidity and resilience so that they can help absorb the risks entailed in financing India s growth. d. Expanding access to finance to small and medium enterprises, the unorganized sector, the poor, and remote and underserved areas of the country through measures to foster financial inclusion. e. Improving the system s ability to deal with corporate distress and financial institution distress by strengthening real and financial restructuring as well as debt recovery. 15. Action on the monetary policy framework will follow the submission of the Dr. Urjit Patel Committee report. A number of measures to strengthen bank structures and financial markets have already been announced, and more will follow as they are worked out. The strategy to expand financial inclusion will be informed by the Dr. Nachiket Mor Committee report, though significant efforts to explore the use of technology are already underway. Finally, some steps to improve restructuring and recovery will be announced soon.

Johann Fernandes
TYBBI Roll No.16

Developments and Policies: Banking Structure Basel III Regulation on Countercyclical Capital Buffer 16. As part of the Basel III capital framework, an internal Working Group (Chairman: Shri B. Mahapatra) was constituted to operationalise the countercyclical capital buffer framework in India. It is proposed to: place the draft report of the group on the Reserve Banks website by end-November 2013 for inviting comments/suggestions from various stakeholders. Framework for Dealing with Domestic Systemically Important Banks 17. The Basel Committee on Banking Supervision (BCBS) provided a framework for dealing with domestic systemically important banks (D -SIBs) in October 2012. The D-SIBs framework is principle-based and provides broad guidance to national authorities on assessment of the systemic importance of banks and additional capital requirements of D-SIBs. It is proposed to: place a draft of the proposed framework for D -SIBs on the Reserve Banks website by end November 2013. Guidelines on Stress Testing 18. The Reserve Bank had issued guidelines on stress testing in June 2007. These guidelines required banks to have a sound stress testing policy which will determine liquidity risk, interest rate risk, credit risk and foreign exchange risk under stressed scenarios. Drawing from the BCBS principles on the subject and subsequent global developments, it is proposed to: issue updated guidelines on stress testing by end-November 2013. Unhedged Foreign Currency Exposures of Corporates 19. Unhedged foreign currency exposures of corporate are a cause for concern as they pose a risk to individual corporate as also to the entire financial system. Based on feedback received from industry participants, it is proposed to: issue final guidelines on unhedged foreign currency exposures by end -December 2013.

Johann Fernandes
TYBBI Roll No.16

Periodicity of Payment of Interest on Rupee Savings/Term Deposits 20. As per extant instructions, banks are required to pay interest on savings deposits and term deposits at quarterly or longer intervals. As all commercial banks are now on core banking platforms, it has been decided to: give banks the option to pay interest on savings deposits and term deposits at intervals shorter than quarterly intervals.
Licensing of New Banks in the Private Sector - Constitution of High Level Advisory Committee

21. In terms of the guidelines for licensing of new banks in the private sector released on February 22, 2013 applications will be screened by the Reserve Bank to ensure prima facie eligibility, and thereafter, the applications will be referred to a High Level Advisory Committee (HLAC). The HLAC will devise its own procedures for screening the applications and submit its recommendations to the Reserve Bank for consideration. The decision to issue an in-principle approval for setting up of a bank will be taken by the Reserve Bank whose decision in this regard will be final. 22. The HLAC has been set up under the Chairmanship of Dr. Bimal Jalan, former Governor of the Reserve Bank with Smt. Usha Thorat, former Deputy Governor of the Reserve Bank, Shri C.B. Bhave, former Chairman, Securities and Exchange Board of India (SEBI) and Dr. Nachiket M. Mor, Director, Central Board of Directors of the Reserve Bank as members. The Committee will hold its first meeting on November 1, 2013.
Mode of Presence of Foreign Banks in India Scheme of Subsidiarization

23. As a sequel to the roadmap for presence of foreign banks in India released by the Reserve Bank in 2005 and pursuant to the announcement made in the Monetary Policy Statement of April 2010, the Reserve Bank released a Discussion Paper on the presence of foreign banks in India on January 21, 2011 factoring in the lessons from the crisis which favored a subsidiary mode of presence from a financial stability perspective. Taking into account the feedback received from stakeholders, a scheme of subsidiarisation of foreign banks in India, guided by the two cardinal principles of reciprocity and single mode of presence, is being finalized. The Wholly Owned Subsidiaries (WOSs) would be given near-national treatment, including in the opening of branches.
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Johann Fernandes
TYBBI Roll No.16

24. While it will not be mandatory for existing foreign banks ( i.e., banks set up before August 2010) to convert into WOSs, they will be incentivized to convert into WOSs by the attractiveness of the near-national treatment afforded to WOSs. The initial minimum paid-up voting equity capital or net worth for a WOS shall be `5 billion. It is proposed: to issue the Scheme by mid-November 2013.

Developments and Policies: Financial Markets

25. The Union Budget, 2013-14 proposed to introduce instruments that will protect savings from inflation and provide an alternative to gold as an investment avenue for individuals. Inflation indexed securities for retail investors of 10 year tenor would be linked to the new (combined) consumer price index. Eligible investors would consist of individuals, hindu undivided families (HUFs), trusts and charitable institutions. The rate of interest on these securities would comprise of a fixed rate plus inflation. Interest would be compounded half- yearly and paid cumulatively at redemption. These securities will be distributed through banks to reach out to the masses. Accordingly, it is proposed to: launch Inflation Indexed National Saving Securities (IINSSs) for retail investors in November/December 2013 in consultation with the Government of India. Developments and Policies: Financial Inclusion and Payment and Settlement Systems
General Credit Card Scheme

26. The coverage of the General Credit Card (GCC) Scheme is being revised to enhance credit linkage of individuals to all non-farm entrepreneurial activities within the rubric of the overall priority sector. It is expected that the revised scheme will give a fillip to flow of credit to small businesses and low income households. Detailed guidelines in this regard will be issued before midNovember 2013.

Johann Fernandes
TYBBI Roll No.16

Roadmap for Provision of Banking Services in Unbanked Villages 27. State Level Bankers Committees are mandated to prepare a roadmap covering al l unbanked villages of population less than 2000 and to notionally allot these villages to banks for providing banking services. Accordingly, about 4,90,000 unbanked villages have been identified and allotted to various banks to be covered by March 2016. Customer Service - Charges Levied by Banks for Sending SMS Alerts 28. With a view to ensuring reasonableness and equity in the charges levied by banks for sending SMS alerts to customers, banks are advised to leverage the technology available with them and the telecom service providers to ensure that such charges are levied on all customers on actual usage basis.

Johann Fernandes
TYBBI Roll No.16

Analysis Highlights POLICY MEASURES Repo rate hiked by 25 bps to 7.75 pct Reverse repo rate rises to 6.75 pct Banks' cash reserve ratio unchanged at 4 pct Marginal Standing Facility Rate (MSF) cut by 25 bps to 8.75 pct Increases cash provided to banks through term repo to 0.50 pct of net demand and time liability from 0.25 pct POLICY STANCE WPI inflation to remain higher than current levels, warranting "appropriate policy response" Important to break the spiral of rising price pressures in order to curb the erosion of financial saving Process of realigning interest rate corridor to normal monetary policy operation now complete Will closely monitor inflation risks while being mindful of the evolving growth dynamics FORECASTS India's GDP growth at 5 percent for 2013/14 Retail inflation likely to remain around or even above 9 percent without policy action MEASURES FOR BANKS, NON-BANK FINANCIAL COMPANIES Foreign banks setting up wholly-owned subsidiaries will be given near-national treatment, to issue scheme by mid-Nov Initial minimum paid-up voting equity capital or net worth for wholly owned foreign bank's subsidiary will be $5 billion More durable way for banks to mitigate mismatch in demand and supply of cash is to step up efforts to mobilize deposits Draft report on Basel III capital framework likely by end-November Draft of proposed framework for domestic systemically important banks by endNovember To issue updated guidelines on stress testing for banks by end-November To give banks option to pay interest on savings deposits and term deposits at intervals shorter than quarterly intervals First meeting of High Level Advisory Committee on new bank licences on November 1 To issue guidelines on restructuring for non-bank finance companies (NBFCs) by endNovember

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Johann Fernandes
TYBBI Roll No.16

MEASURES FOR MARKETS, LIQUIDITY To issue 10-year retail inflation-indexed securities in November/December To launch 10-year interest rate futures contracts by end-December Allows partial credit enhancement for corporate bonds by banks via credit, liquidity facilities To issue final guidelines on unhedged foreign currency exposures by end-December To revise timings for conducting MSF operations from November 5 between 1330 GMT and 1400 GMT To close special repo window for mutual funds with immediate effect.

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