Underscoring growth with price stability

ANNUAL POLICY 2005-06/ POLICY STANCE: EXCERPTS

Against the background of developments during 2004-05, the stance of monetary policy will depend on several factors, including macroeconomic prospects, global developments and the balance of risks.

First, the outlook for growth in 2005-06, may get moderated by the conditions in oil markets which remain tight. Second, if the impact of mineral oil prices on WPI is isolated, the underlying inflationary pressures appear moderate.

Third, the non-food credit during 2004-05 recorded its second highest growth in 55 years. Hence, adequate credit growth needs to be ensured for productive sectors and the borrowing programme of governments accommodated.

Fourth, while the borrowing programme for 2005-06 is significantly higher than the previous year, it is in line with the magnitudes in 2002-03 and 2003-04, though the credit growth was sluggish in those years.

Fifth, the current account, which was in surplus for three consecutive years, is turning into a deficit. The capital account continues to be in surplus in a significant way.

Current indications are that these trends will continue in 2005-06 and, consequently, the external sector will exhibit strength and resilience, though unanticipated, globally-transmitted shocks cannot be ruled out.

Considering all these issues, the real GDP growth during 2005-06, could be placed around 7.0 per cent for the purpose of monetary policy formulation. The inflation rate in 2005-06, on a point-to-point basis, may be placed in a range of 5.0-5.5 per cent subject to the growing uncertainties on the oil front both in regard to global prices and their domestic absorption.

Consistent with the real growth of GDP and inflation, the projected expansion of money supply (M3) is placed at 14.5 per cent and aggregate deposits of scheduled commercial banks at 15.0 per cent over. Non-food bank credit including non-SLR investments of banks is projected to increase by around 19.0 per cent. This magnitude of credit expansion is expected to meet adequately the credit needs of all the productive sectors of the economy.

The Reserve Bank expects to conduct debt management within the monetary projections for 2005-06 barring unexpected developments. Given the volatility in the inflation rate during 2004-05, there is also a need to consolidate the gains obtained in recent years from reining in inflationary expectations.

The Reserve Bank will continue to ensure that appropriate liquidity is maintained in the system so that all legitimate requirements of credit are met, consistent with the objective of price stability. Towards this end, RBI will continue with its policy of active demand management of liquidity through OMO including MSS, LAF and CRR, and using the policy instruments at its disposal flexibly, as and when the situation warrants.

In sum, barring the emergence of any adverse and unexpected developments in various sectors of the economy and keeping in view the inflationary situation, the overall stance of monetary policy for the year 2005-06 will continue to be as set out in the mid-term Review of October 2004, namely: Provision of appropriate liquidity to meet credit growth and support investment and export demand in the economy while placing equal emphasis on price stability. Consistent with the above, to pursue an interest rate environment that is conducive to macroeconomic and price stability, and maintaining the momentum of growth.

To consider measures in a calibrated manner, in response to evolving circumstances with a view to stabilising inflationary expectations.

 Monetary Measures
Bank Rate - Kept unchanged at 6.0 per cent.

Reverse Repo Rate
In view of the current macroeconomic and overall monetary conditions, it has been decided:

To increase the fixed reverse repo rate by 25 basis points under the liquidity adjustment facility (LAF) of the Reserve Bank effective from April 29, 2005 to 5.00 per cent from 4.75 per cent.

The repo rate will continue to be linked to the reverse repo rate, as at present. However, the spread between the reverse repo rate and the repo rate is reduced by 25 basis points from 125 basis points to 100 basis points with effect from April 29, 2005. Accordingly, the fixed repo rate under LAF will continue to remain at 6.0 per cent.

Cash reserve ratio - kept unchanged at 5.0 per cent.

First Quarter Review of Part I would be undertaken on July 26, 2005 while retaining the flexibility to take specific measures as the evolving circumstances warrant.

Developmental and Regulatory Policies for the Year 2005-06

Governor emphasized that the overall approach has been that of reorienting the role of RBI for improving institutional soundness, strengthening the regulatory and supervisory processes in alignment with international best practices and developing the necessary technological and legal infrastructure.

In order to reinforce stability of the overall system and to serve the common person, the emphasis of the policy Statement, at this stage, is on the following key areas

To debate the current regulations on interest rates and priority sector in terms of their contemporary effectiveness in delivering adequate credit at appropriate prices. To facilitate a balanced development of the financial system, it is necessary to further develop money, forex and government securities markets.

To bridge the financing gaps in agriculture and in small and medium enterprises in order to enhance credit delivery.

Sound corporate governance practices, better risk management and adherence to prudential norms within the financial sector. A roadmap for development and application of technology in the financial sector in the medium-term.

To ensure availability of quality services to all sections of the population.

Interest Rate Prescriptions

The interest rates have been largely deregulated except for (i) savings deposit accounts, (ii) non-resident Indian (NRI) deposits, (iii) small loans up to Rs.2 lakh and (iv) export credit.

While there is merit in moving forward to impart greater competitiveness and depth to the activities of the financial system by further deregulating interest rates in some segments which have hitherto remained regulated for various reasons found relevant at different stages, it is proposed to continue with status quo as various issues pertaining to above regulations on interest rates are being debated.

 Financial Markets

Money Market
In order to review the recent developments and current status of money market in the context of evolving monetary policy framework, a Technical Group on Money Market was constituted. The Report of the Group was discussed in the Technical Advisory Committee on Money, Foreign Exchange and Government Securities Markets (TAC). Accordingly, the following measures are proposed.

Call/Notice/Term Money Market
With effect from the fortnight beginning June 11, 2005, non-bank participants, except PDs, would be allowed to lend, on average in a reporting fortnight, up to 10 per cent of their average daily lending in call/notice money market during 2000-01.

With effect from August 6, 2005, non-bank participants, except PDs, would be completely phased out from the call/notice money market.

With effect from the fortnight beginning April 30, 2005, the benchmark for fixing prudential limits on exposures to call/notice money market in the case of scheduled commercial banks would be linked to their capital funds (sum of Tier I and Tier II capital).

From April 30, 2005, all NDS members are required to report their term money deals on NDS platform. A screen-based negotiated quote-driven system for all dealings in call/notice and term money market transactions is proposed.

Market Repo
An electronic trading platform for conduct of market repo operations in government securities, in addition to the existing voice based system to be facilitated. Participation in market repo facility in government securities for non-scheduled urban co-operative banks (UCBs) and listed companies having gilt accounts with scheduled commercial banks will be allowed subject to eligibility criteria and safeguards.

Certificates of Deposit
The minimum maturity period of certificates of deposit (CDs) reduced from 15 days to 7 days with immediate effect.

The Report of the Group is being placed on RBI website for wider dissemination. Introduction of asset-backed commercial paper (ABCP) and additional intra-day LAF would be considered in future in consultation with market participants. Optionalities in OTC rupee derivatives would be considered, once legal clarity to OTC derivatives is provided and appropriate accounting standards are put in place.

 Gilts Market

Central Government Securities Market: Medium-term Framework

In terms of the stipulation of FRBM Act, RBI will not be participating in primary issuance of government securities with effect from April 1, 2006. In order to address these emerging needs and equip RBI as well as the market participants appropriately, a Technical Group on Central Government Securities Market was constituted. Earlier, another Group (Chairman: Dr.R.H. Patil) had examined the role of primary dealers (PDs) in the government securities market. The Reports were discussed in TAC. Accordingly, the following measures are proposed:

The number of actively traded securities need to be enlarged to enhance liquidity and improve pricing in the market. It is proposed to consolidate debt and build up large liquid securities in consultation with the Government while continuing the programme of reissuances.

Post-FRBM, RBI will reorient government debt management operations while simultaneously strengthening monetary operations. This will entail functional separation between debt management and monetary operations within RBI. For this purpose, RBI will have discussions with market players on the modalities and procedures of market operations.

The settlement system for transactions in government securities will be standardised to T+1 basis.

The Reserve Bank would continue to resort to multiple and uniform price methods flexibly in the auction of government securities.

Permitted structures of PD business will be expanded to include banks which fulfil certain minimum criteria subject to safeguards and in consultation with banks, PDs and the Government.

The recommendations of the Technical Group on restructuring the underwriting obligations of PDs, allowing PDs exclusivity in primary auctions, introduction of 'When Issued Market' and limited short selling in government securities would be considered in consultation with the Government.

Sale of Government Securities: Relaxation In order to facilitate further deepening of the government securities market, it is proposed: To permit sale of government securities allotted in primary issues with and between CSGL account holders also on the same day.

Market Borrowings of State Governments

The Twelfth Finance Commission (TWFC) recommended that the Centre should not act as a financial intermediary for future lending to the States and allow them to approach the market directly to raise the loan portion of the funds. As this would have major implications for the market borrowing programmes, RBI would facilitate smooth transition of the process in consultation with the Central and the state governments. As a first step, consultations were held with State Finance Secretaries on April 8, 2005.

Foreign Exchange Market

(a) Forex Market Group: Medium-term Framework

An internal Group constituted by RBI reviewed forex market liberalisation in select emerging markets and examined the current regulatory regime in the light of liberalisation in related sectors to identify areas for further liberalisation. The Report of the Group was discussed in TAC. As recommended by the Group, the following measures are proposed:

Cancellation and rebooking of all eligible forward contracts booked by residents, irrespective of tenor, to be allowed.

Banks to be allowed to approve proposals for commodity hedging in international exchanges from their corporate customers.

The closing time for inter-bank foreign exchange market in India to be extended by one hour up to 5.00 p.m.

Dissemination of additional information including traded volumes for derivatives such as foreign currency-rupee options to the market.

The other recommendations of the Group pertaining to writing of covered options by corporates and hedging of economic risk of corporates in respect of their domestic operations would be considered taking into account the progress towards capital account convertibility, liberalisation in other sectors of the economy and the trend in overall balance of payments.

(b) Overseas Investment: Liberalisation

With a view to promoting Indian investments overseas, it is proposed:

To raise the ceiling of overseas investment by Indian entities in overseas joint ventures and/or wholly owned subsidiaries from 100 per cent to 200 per cent of their net worth under the automatic route.

(c) Foreign Currency Accounts by Foreign Companies in India: Liberalisation

In order to further liberalise the procedure, it is proposed:

To accord general permission to ADs to open foreign currency accounts of the project offices set up in India by foreign companies and operate the accounts flexibly.

 Credit Delivery Mechanisms

(a) Flow of Credit to Agriculture
With a view to further increasing the flow of credit to agriculture, the following measures have been initiated:

RBI has set up an Expert Group to formulate strategy for increasing investment in agriculture and the report is expected by end-May 2005.

In order to make an assessment of customer satisfaction on credit delivery in rural areas by banks, it is proposed to conduct a survey with the help of an outside agency. Keeping in view the importance of post-harvest operations, it is proposed to increase the limit on loans to farmers through the produce marketing scheme from Rs.5 lakh to Rs.10 lakh under priority sector lending. There is a realisation amongst bankers that there are increasing business opportunities in financing agriculture, banks are, therefore, urged to continue their efforts to step up credit to agriculture.

(b) Micro-finance
In order to give further fillip to micro-finance movement, the following measures have been initiated:

The Reserve Bank has enabled non-governmental organisations (NGOs) engaged in micro-finance activities to access ECBs up to US $ 5 million during a financial year for permitted end-use, under automatic route, as an additional channel of resource mobilisation.

As a follow-up of the Budget proposals, modalities for allowing banks to adopt the agency model by using the infrastructure of civil society organisations, rural kiosks and village knowledge centres for providing credit support to rural and farm sectors and appointment of micro-finance institutions (MFIs) as banking correspondents are being worked out.

(c) Credit Flow to Small Scale Industries
With a view to further smoothening the flow of credit, the following measures have been initiated:

The Credit Information Bureau of India Ltd. (CIBIL) is working out a solution that would provide comprehensive credit reports on SSIs.

The Reserve Bank is reviewing all its existing guidelines on financing small scale sector, debt restructuring, nursing of sick units, etc., with a view to rationalising, consolidating and liberalising them. Banks are urged to take the revised guidelines as indicative minimum requirement and the Boards of the banks are expected to formulate more liberal scheme as appropriate.

Under a scheme to be drawn up by the RBI, banks will be encouraged to establish mechanisms for better co-ordination between their branches and branches of SIDBI which are located in 50 clusters that have been identified by the Ministry of Small Scale Industries, Government of India.

(d) Credit Flow to Medium Enterprises
The Reserve Bank will explore modalities to meet the growing financial needs of medium enterprises. A simplified debt restructuring and rehabilitation mechanism is also being considered for the sector.

(e) Restructuring and Development of Regional Rural Banks
In order to reposition RRBs as an effective instrument of credit delivery in the Indian financial system, RBI is in the process of reviewing the performance of RRBs, exploring restructuring of RRBs through merger/ consolidation, changing of sponsor banks, reviewing minimum capital requirement and suggesting suitable measures for regulation, supervision and governance of RRBs.

(f) Priority Sector Lending
Since there are several issues that need to be considered in this regard, it is appropriate that these are debated and examined in depth.

 Prudential Measures 

Policy on Merger and Amalgamation of Banks
Based on the recommendations of the Working group constituted by RBI in pursuance of the recommendations of the Joint Parliamentary Committee (JPC), and in consultation with the Government, it is proposed:

To issue guidelines on merger and amalgamation between private sector banks and with NBFCs. The guidelines would cover: process of merger proposal, determination of swap ratios, disclosures, norms for buying/selling of shares by promoters before and during the process of merger and the Board's involvement in the merger process. The principles underlying these guidelines would also be applicable as appropriate to public sector banks, subject to relevant legislation.

Supervision of Financial Conglomerates
With a view to monitoring intra-group transactions and exposures, a pilot process was initiated to obtain information from the designated entities of each FC by the principal regulators. In order to appropriately focus on monitoring of the process, in consultation with Chairman, SEBI and Chairman, IRDA, it is proposed:

To hold a half-yearly discussion with the CEO of the designated entity, which would be convened by the lead regulator with other regulators, on the basis of available information for review and addressing concerns, if any.

Interests of the Depositors
Depositors' interests form the focal point of the regulatory framework for banking in India and it has been appropriately enshrined at several places in the Banking Regulation Act, 1949. Furthermore, as per the Act, some of the considerations that are required to be taken into account while granting licence for banking business, is whether the affairs of the company are not being or are not likely to be detrimental to the interests of the depositors or prejudicial to public interest. In our country, the socio-economic profile for a typical depositor who seeks safe avenues for his savings deserves special attention relative to other stakeholders in the banks.

The Committee on Procedures and Performance Audit on Public Services (CPPAPS) (Chairman: S.S. Tarapore) expressed its dissatisfaction over treatment of ordinary depositors by banks.

Accordingly Governor proposed that, Banks are urged to refocus on deposit mobilisation and empower the depositors, by providing wider access and better quality of banking services.

RBI will persist with its efforts to ensure quality of banking services, in particular, to small individual depositors.

Financial Exclusion
There are legitimate concerns in regard to the banking practices that tend to exclude rather than attract vast sections of population, in particular pensioners, self-employed and those employed in unorganised sector. Against this background:

RBI will implement policies to encourage banks which provide extensive services while disincentivising those which are not responsive to the banking needs of the community, including the underprivileged.

The nature, scope and cost of services will be monitored to assess whether there is any denial, implicit or explicit, of basic banking services to the common person. Banks are urged to review their existing practices to align them with the objective of financial inclusion.

Customer Service
Liberalisation and enhanced competition accord immense benefits, but experience has shown that consumers' interests are not necessarily accorded full protection and their grievances are not properly attended to.

Taking account these considerations, it has been decided:
To set up an independent Banking Codes and Standards Board of India on the model of the mechanism in the UK in order to ensure that comprehensive code of conduct for fair treatment of customers are evolved and adhered to.

To issue appropriate guidelines to banks to ensure transparency and disclosure of information by the card issuing banks and customer rights protection including facilitating enforcement of such rights.

To widen the scope of the Banking Ombudsman inter alia to cover all individual cases/grievances relating to non-adherence to the fair practices code evolved by IBA and adopted by individual banks.

(f) New Capital Adequacy Framework in India: Implementation
In order to maintain consistency and harmony with international standards, banks were advised to adopt Standardised Approach for credit risk and Basic Indicator Approach for operational risk with effect from March 31, 2007. The Reserve Bank may consider allowing some banks to migrate to Internal Rating Based (IRB) approach after developing adequate skills both in banks and at supervisory levels.

(g) Ownership and Governance in Private Banks
Based on the feedback received on the draft guidelines on the policy framework for ownership and governance in private sector banks, RBI in consultation with the Government has since issued final guidelines. The Reserve Bank would enter into bank-wise dialogues to ensure a time-bound framework for compliance.

(h) Guidelines on Securitisation of Standard Assets In order to ensure orderly development of the market, draft guidelines on securitisation of standard assets by banks/financial institutions and NBFCs were issued and placed on the RBI website for comments. On the basis of the feedback, the draft guidelines would be finalised.

(i) Guidelines on Purchase/Sale of Non-Performing Assets
With a view to further increasing the options available to banks for effectively addressing the issue of non-performing assets, draft guidelines were issued on sale/purchase of non-performing assets and comments thereon were sought from the banks by end-April 2005. The guidelines would be finalised on the basis of feedback.

(j) Modification of CDR Mechanism
Performance of the corporate debt restructuring (CDR) mechanism has been reviewed. Draft circular is being put in the public domain for wider dissemination before taking final decisions.

(k) Working Group on Conflicts of Interest in the Indian Financial Services Sector
The Report of the Working Group on Conflicts of Interest in the Indian Financial Services Sector (Chairman: Shri D.M. Satwalekar) is expected by July 2005, which would be put in the public domain for wider dissemination before recommending for adoption.

 Institutional Developments 

Payment and Settlement Systems: Action Points
Based on the feedback on the Vision Document for Payment and Settlement Systems, a roadmap for upgradation of payment systems was drawn up for implementation in the next three years (2005-08). The Vision Document indicating action points would be placed in the public domain for wider dissemination by June 2005.

Board for Regulation and Supervision of Payment and Settlement Systems A Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) was constituted as a Committee of the Central Board of RBI as notified in the Gazette of India on February 18, 2005.

Electronic Payment Products: Status and Proposed Action
The Reserve Bank proposes operationalisation of National Electronic Funds Transfer (NEFT) System, which would enable T+0 settlement for all networked branches of banks all over the country for electronic transfer of funds. In order to facilitate non-networked branches of banks to transfer funds electronically, the NEFT (Extended) System would be implemented.

Reinforcing of Information Security
In view of the increasing dependence of the financial sector on internal and external networks for their operations, information security has assumed greater importance. In this direction, RBI has initiated several measures to ensure information security in banks. Banks are encouraged to make increasing use of SFMS which is PKI-enabled for inter/intra bank transactions.

Information Technology
Technology Policy: Vision Document
In order to facilitate the technology plans of the financial sector, RBI is preparing a Financial Sector Technology Vision Document which would be put in the public domain for wider dissemination. Based on the feedback, action points would be finalised.

Urban Co-operative Banks
(a) UCBs: Medium-term Framework
A draft 'Vision Document for Urban Co-operative Banks' was prepared keeping in view the heterogeneity of the sector in terms of size, area of operation, performance and strength and was placed on the RBI website. Based on the feedback, a medium-term framework for urban co-operative banks (UCBs) up to 2010 is being drawn up. The medium-term framework would be placed in the public domain for wider dissemination and for implementation as appropriate. The Standing Advisory Committee for

(b) Restructuring of Weak Scheduled UCBs
Keeping in view the importance of scheduled UCBs, RBI has begun a consultative process involving officials of the concerned state governments and banks for revitalising and rehabilitating the weak scheduled UCBs. The option of merger/amalgamation could also be explored wherever necessary.

Non-banking Financial Companies
The non-banking financial companies (NBFCs) play a critical role as an instrument of credit delivery. In this context, RBI is examining the issue of smooth flow of bank finance to NBFCs.

Working Group on Computerisation of State Treasuries and On-line Connectivity

The Reserve Bank has constituted a Working Group on Computerisation of State Treasuries and On-line Connectivity to study the existing practices in treasury functions of various states, system of accounting of receipts and payments, etc.

Standing Committee on Procedures and Performance
Audit on Public Services
The Standing Committee on Procedures and Performance Audit on Public Services (Chairman: Shri S.S. Tarapore) constituted by RBI has ceased its operations in March 2005. In order to facilitate regular monitoring, Ad hoc Committees in banks have been converted to permanent Standing Committees on Customer Service. A system for monitoring on a regular basis the customer services rendered by RBI offices is being put in place.

Legal Reforms: Review of Developments
The Credit Information Companies (Regulation) Bill, 2004 and Government Securities Bill, 2004 were introduced in the Parliament. As indicated in the Union Budget, 2005-06, certain amendments to the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934 will be considered by the Government. In addition, the Payment and Settlement Bill is being finalised by the Board for Regulation and Supervision of Payment and Settlement Systems.