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RBI announces Second Quarter Review of Monetary Policy

India Infoline News Service | Mumbai |

This moderation is, in part, due to the anti-inflationary stance of monetary policy, a necessary pre-condition to bring inflation down. But there are also other factors responsible for the moderation in growth, particularly for the significant slowdown in investment activity, such as policy and regulatory matters.


From a macroeconomic perspective, the last quarter witnessed significant developments, both globally and domestically. Growth momentum in the US and the euro area economies has weakened. In the euro area, macroeconomic prospects are intimately tied in to its ability to credibly resolve its sovereign debt and financial sector problems. In turn, trade and financial linkages increase the risks of euro area instability transmitting through to emerging market economies (EMEs), which have already experienced large volatility in their financial markets, particularly their currency markets. Significantly, while the prices of many commodities declined over the quarter, crude oil prices remained relatively firm. The impact of this on commodity importing EMEs has been exacerbated by currency depreciation.


Amidst this turbulence and heightened uncertainty, the Indian economy is clearly seeing slowing growth. This moderation is, in part, due to the anti-inflationary stance of monetary policy, a necessary pre-condition to bring inflation down. But there are also other factors responsible for the moderation in growth, particularly for the significant slowdown in investment activity, such as policy and regulatory matters. These issues clearly have adverse implications for sustaining rapid growth.


Of larger concern is the fact that even with the visible moderation in growth, inflation has persisted. Reassuringly, momentum indicators are turning down, consistent with the Reserve Bank’s projections that inflation rate will decline significantly in December and continue on that trajectory into 2012-13.


The policy stance and guidance in this Review are shaped by the need to balance concerns about persistent inflation and moderating growth. Recent policy actions have been firmly based on the proposition that sustained growth over a long period of time is compatible only with low and stable inflation. Persistently high inflation strongly influences expectations adversely and, through them, consumption and investment decisions. Changing the policy stance when inflation is still far above the tolerance level entails risks to the credibility of the Reserve Bank’s commitment to low and stable inflation. However, growth risks are undoubtedly significant in the current scenario, and these need to be given due consideration.


This policy review is set in the context of the above global and domestic concerns. It should be read and understood together with the detailed review in Macroeconomic and Monetary Developments releasedyesterday by the Reserve Bank.


This Statement is organised in two parts. Part A covers Monetary Policy and is divided into four sections: Section I provides an overview of global and domestic macroeconomic developments; Section II sets out the outlook and projections for growth, inflation and monetary aggregates; Section III explains the stance of monetary policy; and Section IV specifies the monetary measures. Part B covers Developmental and Regulatory Policies and is organised in six sections: Interest Rate Policy (Section I), Financial Markets (Section II), Financial Stability (Section III), Credit Delivery and Financial Inclusion (Section IV), Regulatory and Supervisory Measures for Commercial Banks (Section V) and Institutional Developments (Section VI).


Part A. Monetary Policy


I. The State of the Economy


Global Economy

Economic activity in advanced economies weakened further during Q3 of 2011 (July-September). Escalating concerns over medium-term sovereign debt dynamics in the euro area and, in particular, substantial potential losses to banks holding this debt have impacted global financial markets enormously. The adverse feedback loops among sluggish growth, weak sovereign balance sheets, large exposures of banks to sovereign debt and political compulsions coming in the way of a credible solution have created a crisis of confidence, which is a potential threat to regional and global financial stability.


High prices of crude oil and other commodities, persistently high unemployment and weak housing markets continued to impact consumer confidence and private consumption. Fiscal tightening, driven by medium-term sovereign debt concerns, also contributed to the loss in the growth momentum. This is reflected in the fall in the global manufacturing purchasing managers’ index (PMI) to  49.9 in September, its lowest level since June 2009.


The above factors also had a knock-on impact on major EMEs. According to the IMF, global growth decelerated from 4.3% year-on-year (y-o-y) in Q1 of 2011 to 3.7% in Q2, and further to an estimated 3.6% in Q3, as growth in advanced economies fell from 2.2% to 1.5% and 1.3% over the same period.


Significantly, the weaker global growth since Q2 has resulted in only a small correction in international commodity prices, particularly crude oil. Brent and Dubai Fateh prices (which comprise the Indian basket) have declined only modestly. The World Bank’s September 2011 indices of energy prices were higher by 32% (y-o-y) and of non-energy by 17%.


Reflecting the above trend, headline measures of inflation remained above the comfort zones/targets in both advanced economies and EMEs. In the case of EMEs, strong domestic demand pressures added to inflationary pressures. Amongst major economies, headline consumer price inflation (y-o-y) in September 2011 was 3.9% in the US, 3.0% in the euro area, 5.2% in the UK, 6.1% in China, 7.3% in Brazil and 6.2% in Turkey. In response to turbulent global conditions and domestic considerations, central banks in major EMEs have displayed a variety of responses, depending on their specific macroeconomic conditions.


Domestic Economy

  • GDP growth decelerated to 7.7% in Q1 (April-June) of 2011-12 from 8.8% a year ago, and 7.8% in Q4 of 2010-11. From the supply side, the deceleration in growth in Q1 was mainly due to slower growth in mining, manufacturing, construction and ‘community, social and personal services’.
  • 13. Rainfall during the south-west monsoon was one% above normal. The Reserve Bank’s production weighted rainfall was also one% above normal. The first advance estimates for the 2011-12 kharif season point to record production of rice, oilseeds and cotton. However, the output of pulses may decline due to a reduction in acreage.
  • Industrial growth, as measured by the index of industrial production (IIP), decelerated to 5.6% during April-August 2011 from 8.7% in the corresponding period of the previous year. This was mainly on account of slowdown in capital goods, intermediate goods and consumer durables. Growth of eight core infrastructure industries during April-August 2011 also slowed down to 5.3% from 6.1% in the corresponding period of last year.

According to the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS), capacity utilisation moderated during Q1 of 2011-12 compared with  the previous quarter. Business sentiment, as indicated by the business expectations index of the Reserve Bank’s industrial outlook survey, declined in Q2 of 2011-12 and showed further moderation for the following quarter. PMI indices for both manufacturing and services declined during September 2011.


Based on an analysis of a sample of 2,426 non-financial companies, margins of corporates in Q1 of 2011-12 moderated across sectors compared with their levels in Q4 of 2010-11. A classification of companies into the use-based segments of the IIP indicated that the intermediate goods segment registered the maximum decline in margins, reflecting the impact of commodity prices. Other segments saw lower margin compression, suggesting that pricing power was reducing, albeit gradually. Early results for Q2 of 2011-12 (of 161 companies analysed till October 20, 2011) suggest that both sales growth and margins moderated marginally.


Y-o-Y headline WPI inflation has remained stubbornly high during the financial year so far, averaging 9.6%. Inflation was driven by all the three major groups, viz., primary articles; fuel and power; and manufactured products. As indicated in the First Quarter Review, both the level and persistence of inflation remain a cause of concern. However, there is some comfort coming from de-seasonalised sequential quarterly WPI data which suggest that inflation momentum has turned down.


Y-o-Y primary food inflation was 9.2% in September 2011 as compared with 9.6% in August. The elevated level of primary food inflation was  mainly on account of increase in prices of vegetables, milk and pulses.


Y-o-Y fuel-group inflation increased from 12.8% in August 2011 to 14.1% in September mainly due to the increase in petrol prices and upward revision in electricity prices.


Y-o-Y non-food manufactured products inflation was 7.6% in September as compared with 7.7% in August; it was 7.0% in April. This should be seen in comparison with the average non-food manufactured product inflation of a little over 4.0% during the last six years. The current high level reflects a combination of high commodity prices and persistent pricing power as evidenced from the early corporate results of Q2 of 2011-12.


Y-o-Y inflation as measured by the consumer price index (CPI) for industrial workers, which had moderated during April-July 2011, rose to 9.0% in  August reflecting increase in food prices. The new combined (rural and urban) CPI (Base: 2010=100) rose to 113.1 in September from 111.7 in August. Inflation based on other CPIs was in the range of 9.3 to 9.4% during September.


Y-o-Y money supply (M3) growth moderated from 17.2% at the beginning of the financial year to 16.2% on October 7, 2011. This level, however, was still higher than the indicative projection of 15.5% for 2011-12, essentially reflecting the growth in bank deposits as term deposit rates increased. In turn, this has resulted in moderation in currency growth.


Although non-food credit growth decelerated from 22.6% on a y-o-y basis in April to 19.3% on October 7, 2011, it was still running higher than the indicative projection of 18% set out in the First Quarter Review of Monetary Policy 2011-12. Disaggregated data on a financial year basis (April-September) show that credit growth to industry decelerated to 7.5% from 8.1% in the previous year, with credit to infrastructure decelerating sharply. There was also deceleration in credit growth in services and personal loans. However, growth of housing loans accelerated.


The estimated total flow of financial resources from banks, non-banks and external sources to the commercial sector during the first half of 2011-12 was around Rs. 5,00,000 crore, up from `4,80,000 crore during the same period of last year. The deceleration in bank credit was more than offset by higher flows from non-bank and external sources, particularly foreign direct investment and external commercial borrowings, reflecting still buoyant demand for financial resources.


During the first half of 2011-12, the modal deposit rate of banks increased by 80 basis points (bps) to 7.45%. The rise in deposit rates was relatively sharper for maturities up to one year across the banking system. During the same period, the modal Base Rate of banks increased by 125 bps to 10.75%.


Liquidity conditions continued to remain in deficit during the current financial year (up to October 21), consistent with the anti-inflationary stance of monetary policy. The liquidity deficit in the system, as reflected by the daily borrowings under the liquidity adjustment facility (LAF) repos, averaged around Rs. 47,000 crore till October 21, 2011. The systemic deficit thus remained within one% of banks’ net demand and time liabilities (NDTL), the comfort zone assessed by the Reserve Bank.


The Central Government’s key deficit indicators widened during April-August 2011. This was due to both deceleration in tax revenues and increase in expenditure, particularly relating to fertiliser and petroleum subsidies. The fiscal deficit during April-August 2011 was 66.3% of budget estimates as compared with 58.4% in 2010-11, even after adjusting for higher than budgeted spectrum receipts.

The Central Government has announced an increase in the budgeted borrowing by about `53,000 crore to meet the shortfall in other financing items. Consequently, the revised gross (net) borrowings for the year work out to about Rs. 5,23,000 crore (Rs. 4,06,000 crore). The Central Government raised 61% of gross (Rs. 3,20,000 crore) and 59% of net market borrowings (Rs. 2,41,000 crore) up to October 14, 2011.


In the money market, the overnight interest rates have remained generally close to the repo rate during 2011-12 so far. The 10-year benchmark government security yield, which remained range-bound during the first half of 2011-12, increased by 38 basis points during October 2011 (to 8.82% as on October 21), reflecting in part, increased government borrowings for the second half of the year.


Following a period of stability in Q1 of 2011-12, equity and forex markets came under some pressure in Q2 of 2011-12 reflecting the volatility in the global financial markets. Domestic equity prices declined in recent weeks due to significant outflows by foreign institutional investors (FIIs), driven largely by global risk aversion.


Between March and September 2011, the 6, 30 and 36-currency trade weighted real effective exchange rates (REER) depreciated by 6.3%, 2.0per cent and 4.1%, respectively, primarily reflecting the nominal depreciation of rupee against the US dollar by 8.7%. The rupee depreciated further against the US dollar by 2.3% between end-September and October 21, 2011. It is relevant to note in this context that the Reserve Bank’s exchange rate policy is not guided by a fixed or pre-announced target or band. The policy has been to retain the flexibility to intervene in the market to manage excessive volatility and disruptions to macroeconomic stability.


Notwithstanding slowing and uncertain global conditions, exports grew by 47% during Q1 of 2011-12 reflecting diversification in products and destinations. During the same period, imports increased by 33% largely reflecting higher oil prices. Consequently, the trade deficit widened to US$ 35.4 billion in Q1 of 2011-12 from US$ 32.3 billion in the corresponding period of last year. If the current trend persists, the current account deficit (CAD) as a percentage of GDP this year may be higher than it was last year.


II. Outlook and Projections


Global Outlook



33. Global growth prospects have significantly weakened over the past few months, primarily reflecting increased concerns over sovereign debt sustainability in some euro area countries. This has added to the existing vulnerabilities in the major advanced economies arising out of elevated oil and other commodity prices, high unemployment rates, depressed consumer confidence and weak housing markets. In contrast, growth has remained relatively resilient in EMEs, notwithstanding some moderation in response to monetary tightening. However, a prolonged slowdown in advanced economies would also weaken the growth prospects of EMEs. In its September 2011 World Economic Outlook (WEO), the IMF scaled down its projection for world GDP growth to 4.0% for both 2011 and 2012 from its earlier (June) projections of 4.3% and 4.5%, respectively.



34. Despite significant weakening of economic activity, global commodity prices have corrected only marginally. Supply limitations remain a key upside risk to commodity prices. According to the IMF (WEO, September 2011), consumer price inflation is likely to increase from 1.6% in 2010 to 2.6% in 2011 in advanced economies, and from 6.1% to 7.5% in emerging and developing economies.


Domestic Outlook




In its May and July Quarterly Review Statements, the Reserve Bank projected GDP growth of 8.0% for 2011-12. The mid-quarter review of September, however, pointed out that the risk to the growth projection was on the downside mainly on account of slowing down of the global economy and moderating domestic demand. Slower global growth will have an adverse impact on domestic growth, particularly on industrial production, given the rising inter-linkages of the Indian economy with the global economy. The growth in the service sector is holding up well, although some moderation is possible here too on account of inter-sectoral linkages. Based on the normal south-west monsoon and first advance estimates that suggest a record kharif production, agricultural prospects look good. This should provide a boost to rural demand. However, investment demand has slackened reflecting slower clearance and execution of projects, concerns about inflation and rising interest rates. On these considerations, the baseline projection of GDP growth for 2011-12is revised downwards to 7.6% .





Going forward, the inflation path will be shaped by both demand and supply factors. First, it will depend on the extent of moderation in aggregate demand. Some signs of demand moderation are evident, although the impact is being felt more on the investment side.


Second, the behaviour of crude prices will be a crucial factor in shaping the outlook of domestic inflation in the near future. Despite the sluggish growth prospects of the global economy, crude prices have moderated only marginally. Also, the benefit of decline in global crude prices in the recent period so far has been more than offset by the depreciation of the rupee in nominal terms. Thus, the exchange rate will also have some impact on the behaviour of domestic petroleum prices.


Third, the inflation outlook will also depend on the supply response in respect of those commodities where there are structural imbalances, particularly protein items. Therefore, concerted policy focus to generate adequate supply response in respect of items such as milk, eggs, fish, meat, pulses, oilseeds, fruits and vegetables will play a major role in shaping the behaviour of food inflation in the near term.


Fourth, there is still an element of suppressed inflation as domestic prices of administered petroleum products do not reflect the full pass-through of global commodity prices. As the decline in crude prices has been offset by the depreciation of the rupee, under-recoveries continue to occur in respect of administered petroleum products. In addition, there are already large accumulated under-recoveries. Therefore, an increase in administered petroleum prices cannot be ruled out even in a scenario of stable or declining global crude prices. In addition, there are other items such as coal whose current prices do not reflect the underlying market conditions. Since coal is an input for electricity, coal prices, as and when raised, will also have implications for electricity tariffs.


Keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario, the baseline projection for WPI inflation for March 2012 is kept unchanged at 7% . Elevated inflationary pressures are expected to ease from December 2011, though uncertainties about sudden adverse developments remain.



Although inflation has remained persistently high over the past two years, it is important to note that during the 2000s, it averaged around 5.5%, both in terms of WPI and CPI, down from its earlier trend rate of about 7.5%. Given this record, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5%. This is in line with the medium-term objective of 3.0% inflation consistent with India’s broader integration into the global economy.


Monetary Aggregates


The current trends in money supply (M3) and credit growth remain above the indicative trajectories of the Reserve Bank. Deposit growth has been much higher this year than that in the last year due to increase in interest rates, especially of term deposits. Credit growth showed some moderation for a time, but thereafter it accelerated again. It is expected that monetary aggregates will evolve along the projected trajectory indicated in the First Quarter Review of Monetary Policy. Accordingly, M3 growth projection for 2011-12 has been retained at 15.5% and growth of non-food credit at 18%.


As always, these numbers are indicative projections and not targets.


Risk Factors


The indicative projections of growth and inflation for 2011-12 are subject to several risks as detailed below:

  • A major downside risk to growth emanates from the global macroeconomic environment. While growth in advanced economies is already weakening, there is a risk of sharp deterioration if a credible solution to the euro area debt and financial problems is not found, in which case it will impact domestic growth through trade, finance and confidence channels.

  • Despite recent moderation, global commodity prices remain high. However, weakening of global recovery has the potential to lead to significant softening of crude prices, which will have favourable impact for both  growth and inflation.

  • The Government has announced increased market borrowings, which can potentially crowd out more productive private sector investment. The Government has indicated that this will not impact the budgeted fiscal deficit. However, should the fiscal deficit slip from the budgeted level, it will have implications for domestic inflation. The large fiscal deficit has been an important source of demand pressure. Clearly, the impact of tightening monetary policy has been diluted by the expansionary fiscal position, which is a sub-optimal outcome.

  • Structural imbalances in protein-rich items such as egg,  fish and meat will persist. In particular, production of pulses this year is expected to be lower than last year. Consequently, food inflation is likely to remain under pressure.

III. The Policy Stance


The Reserve Bank began exiting from the crisis driven expansionary policy in October 2009. Since then, the Reserve Bank has cumulatively raised the cash reserve ratio (CRR) by 100 basis points, and raised the policy rate (the repo rate) 12 times by 350 basis points. The effective tightening has been of 500 basis points as liquidity in the system transited from surplus to deficit. This monetary policy response has been calibrated on the basis of India specific growth-inflation dynamics in the broader context of persistent global uncertainty.


Considering the persistence of inflation at a level much above the comfort zone of the Reserve Bank for almost two years, the Reserve Bank persevered with its anti-inflationary stance during the current year.


The monetary policy tightening effected so far has helped in containing inflation and anchoring inflation expectations, even as both remain elevated. While  the impact of past monetary actions is still unfolding, it is necessary to persist with the anti-inflationary stance. Against that background, the policy stance in this review is shaped by the following two major considerations.


First, both inflation and inflation expectations remain high. Inflation is broad-based and above the comfort level of the Reserve Bank. Further, these levels are expected to persist for two more months. Risks to expectations becoming unhinged in the event of a pre-mature change in the policy stance cannot be ignored. However, reassuringly, momentum indicators, particularly the de-seasonalised quarter-on-quarter headline and core inflation measures indicate moderation, consistent with the projection that inflation will begin to decline beginning December 2011.


Second, growth is clearly moderating on account of the cumulative impact of past monetary policy actions as well as some other factors. As inflation begins to decline, the opportunity emerges for the policy stance to give due consideration to growth risks, within the overall objective of maintaining a low and stable inflation environment.


Against this backdrop, the stance of monetary policy is intended to:

  • Maintain an interest rate environment to contain inflation and anchor inflation expectations.

  • Stimulate investment activity to support raising the trend growth.

  • Manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission.

IV. Monetary Measures

On the basis of current assessment and in line with the policy stance outlined in Section III, the Reserve Bank announces the following policy measures:


Repo Rate

It has been decided to

  • Increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.25% to 8.5% with immediate effect.

Reverse Repo Rate

  • The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, automatically adjusts to 7.5% with immediate effect.

Marginal Standing Facility (MSF) Rate

The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, stands recalibrated at 9.5% with immediate effect.


Bank Rate


The Bank Rate has been retained at 6.0%.

Cash Reserve Ratio


The cash reserve ratio (CRR) of scheduled banks has been retained at 6.0% of their net demand and time liabilities (NDTL).



The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7% by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on evolving macroeconomic conditions.

It must be emphasised, however, that several factors – structural imbalances in agriculture, infrastructure capacity bottlenecks, distorted administered prices of several key commodities and the pace of fiscal consolidation – combine to keep medium-term inflation risks in the economy high. These risks can only be mitigated by concerted policy actions on several fronts. In the absence of progress on these, over the medium term, the monetary policy stance will have to take into account the risks of inflation surging in response to even a moderate growth recovery.


Expected Outcomes

These actions and the guidance that is given are expected to:

  • Continue to anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation.

  • Reinforce the emerging trajectory of inflation, which is expected to begin to decline in December 2011.

  • Contribute to stimulating investment activity.

Mid-Quarter Review of Monetary Policy 2011-12

The next mid-quarter review of Monetary Policy for 2011-12 will be announced through a press release on December 16, 2011.


Third Quarter Review of Monetary Policy 2011-12

The Third Quarter Review of Monetary Policy for 2011-12 is scheduled for Tuesday, January 24, 2012.


Part B. Developmental and Regulatory Policies

This part of the Statement reviews the progress in various developmental and regulatory policy measures announced by the Reserve Bank in the recent policy statements and also sets out new measures.


In an increasingly globalised world and closely integrated financial markets, shocks in any one part of the world are now quickly transmitted to the rest of the world. This was clearly evident during the global financial crisis of 2008, and now with the re-emergence of global financial risks. This inter-connectedness has reinforced the significance of financial stability for the macroeconomic stability. Financial stability has been one of the key objectives of the Reserve Bank’s policy. Even as the financial system in India emerged unscathed from the global financial crisis, there was still a need to further strengthen the financial sector, drawing lessons from the global financial crisis.


In the banking sector, the focus of the Reserve Bank’s regulatory policies in the recent period has been to strengthen capital and liquidity norms and macroprudential framework so that it remains resilient. The thrust of various regulatory measures in the financial markets is to make them more deep and liquid. The Reserve Bank has also been strengthening the regulation of systemically important non-banking financial companies.


The Reserve Bank has also been playing a developmental role, although the focus of developmental activity has changed from time to time. In the recent period, concerted attention has been paid to promote financial inclusion. In addition, the promotion of secure and efficient technology based services remains on the Reserve Bank’s priority agenda.


I. Interest Rate Policy


Deregulation of Savings Bank Deposit Interest Rate

As indicated in the Second Quarter Review of November 2010, the Reserve Bank prepared a discussion paper on ‘Deregulation of Savings Bank Deposit Interest Rate’, which was posted on its website in April 2011, for public comments/suggestions. The discussion paper spelt out both the pros and cons of deregulating the savings bank deposit interest rate. The discussion paper evoked wide-ranging responses from a cross-section of stakeholders, ranging from the suggestion that savings bank deposit interest rate should not be deregulated at all to the suggestion that it should be deregulated completely. The Reserve Bank has examined the suggestions received and weighed the pros and cons of deregulation of the savings bank deposit interest rate. On balance, it is felt that the time is appropriate to move forward and complete the process of deregulation of rupee interest rates. Accordingly, it has been decided:


To deregulate the savings bank deposit interest rate with immediate effect; banks are free to determine their savings bank deposit interest rate, subject to the following two conditions:

First, each bank will have to offer a uniform interest rate on savings bank deposits up to `1 lakh, irrespective of the amount in the account within this limit.

Second, for savings bank deposits over `1 lakh, a bank may provide differential rates of interest, if it so chooses. However, there should not be any discrimination from customer to customer on interest rates for similar amount of deposit.


The operational guidelines in this regard will be issued separately.


II. Financial Markets


Financial Market Products


Interest Rate Futures

In pursuance of the announcement made in the Second Quarter Review of November 2010, exchange traded interest rate futures (IRFs) on 91-day Treasury Bills with cash settlement in Indian Rupees were permitted with effect from March 2011. It was indicated in the Monetary Policy Statement of May 2011 that the guidelines for 5-year and 2-year IRFs were being finalised in consultation with the Securities and Exchange Board of India (SEBI). Accordingly, it is proposed:

  • To issue the final guidelines on the cash settled 5-year and 2-year IRFs, including the final settlement price by end-December 2011.

Introduction of Credit Default Swaps

As announced in the Monetary Policy Statement of May 2011, the final guidelines on credit default swaps (CDSs) for corporate bonds were issued in May 2011 with the indication that they would be launched once the necessary market infrastructure was in place. Accordingly, it is proposed:

  • To make the guidelines on CDS effective by end-November 2011.

Review of Short Sale in Government Securities

It was indicated in the Monetary Policy Statement of May 2011 that with a view to providing a fillip to the IRF market and the term repo market, the period of short sale would be extended from the earlier limit of five days to a maximum period of three months. The existing reporting mechanism for short sale is being revised. It is proposed:

  • To issue guidelines on short sale in government securities by end-December 2011.

Extension of DvP III Facility to Gilt Account Holders

It was announced in the Monetary Policy Statement of May 2011 to extend delivery versus payment (DvP) III facility to transactions by the gilt account holders (excluding transactions between the gilt account holders of the same custodian) so that the gilt account holders get the benefit of efficient use of funds and securities. The final guidelines were issued in July 2011.


Financial Market Infrastructure


Working Group on the G-Sec and Interest Rate Derivatives Markets

The various reform measures initiated since the early 1990s have resulted in the development of a robust government securities market that is able to meet the funding requirement of the Central and State Governments in an efficient and transparent manner. However, there is a need to further broaden and deepen the market for government securities and the allied derivatives. Accordingly, it is proposed:

  • To set up a Working Group comprising representatives from various stakeholders to examine and suggest ways for enhancing secondary market liquidity in the G-Sec and the interest rate derivatives markets.

Details of the Working Group will be announced separately.

Committee for Review of Procedures relating to Facilities to Individuals – Residents/NRIs and PIOs


It was indicated in the Monetary Policy Statement of May 2011 that a Committee (Chairperson: Smt. K. J. Udeshi) was constituted by the Reserve Bank to identify areas for streamlining and simplifying the procedure so as to remove the operational impediments, and assess the level of efficiency in the functioning of authorised persons, including the infrastructure created by them. The Committee submitted its report in August 2011. The recommendations of the Committee were examined by the Reserve Bank. Some of the recommendations of the Committee, which have already been implemented, are: (i) permission to non-resident Indians (NRIs) to be joint holders in resident bank accounts; (ii) permission to residents to be joint holders in non-resident (external) Rupee account (NRE) scheme/foreign currency (non-resident) (FCNR) account (banks) scheme; (iii) permission to residents to gift shares/debentures up to US $50,000 to non-residents; (iv) sale proceeds of foreign direct investment (FDI) allowed to be credited to NRE/FCNR (B) accounts; and (v) permission to residents to repay loans given to NRIs’ close relatives, as also bear medical expenses of NRIs. Other recommendations of the Committee are under examination.


III. Financial Stability


Financial Stability and Development Council and its Sub-Committee

The Financial Stability and Development Council (FSDC), set up in 2010, is assisted by a Sub-Committee, chaired by Governor, Reserve Bank, and its members include financial system regulators, the Finance Secretary and other key Ministry of Finance officials. In order to provide focused attention to the broad areas of functioning of the FSDC and its Sub-Committee, the Sub-Committee has set up two Technical Groups – a Technical Group on Financial Inclusion and Financial Literacy and an Inter-Regulatory Technical Group. The Technical Group on Financial Inclusion and Financial Literacy, headed by the Deputy Governor in charge of financial stability in the Reserve Bank, will include representatives from the regulators and from the ministries and associated departments of the Central and State Governments. The Inter-Regulatory Technical Group, chaired by the Executive Director in charge of the financial stability in the Reserve Bank, will include representatives from the four financial sector regulators, viz., the Reserve Bank, the SEBI, the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA) and will discuss issues relating to systemic financial stability risks and inter-regulatory co-ordination. Both Technical Groups will provide critical inputs to the Sub-Committee. The secretariat of the Sub-Committee (Financial Stability Unit at the Reserve Bank) will act as the secretariat for these two Groups.


Financial Stability Report

The first Financial Stability Report (FSR) was published by the Reserve Bank in March 2010. Subsequently, it was decided that the Reserve Bank would publish FSRs twice every year in June and December. The June 2011 FSR, which included contributions from the SEBI and the IRDA, reflected the deepening of inter-regulatory collaborative process for financial stability assessment and presented a more holistic position of risks and stress in the system. In order to further enhance the coverage of the FSR so that it adequately reflects the potential systemic risks facing the whole of the economy, it has been decided that beginning from the next FSR, the draft report will be discussed in a meeting of the Sub-Committee of the FSDC. The comments/suggestions of the members would be suitably incorporated in the Report before its final release. In addition to the half-yearly FSRs, an internal review of systemic risks facing the financial system is undertaken in the interim period through Systemic Risk Monitors. Financial Market Risk Monitors are also prepared on a monthly basis for internal surveillance of various markets. The tools and techniques used to assess the stability of the financial sector are being improved over time.


Assessment of Financial Stability

The June 2011 FSR observed that the Indian financial system remained stable in the face of some fragilities being observed in the global macro-financial environment. The macroeconomic fundamentals for India continued to be strong, notwithstanding the prevailing inflationary pressures and concerns on the fiscal front. The banking sector was resilient, though going forward stress tests pointed to the strains in profitability and asset quality. Under severe stress tests, banks might also face liquidity constraints.


IV. Credit Delivery and Financial Inclusion


Branch Authorisation Policy - Relaxation

Considering the requirement of penetration of banking in rural and semi-urban areas, domestic scheduled commercial banks [excluding regional rural banks (RRBs)] were permitted in December 2009 to open branches in Tier 3 to Tier 6 centres (with population up to 49,999 as per Census 2001) and in the rural, semi-urban and urban centres in North-Eastern States and Sikkim under general permission, subject to reporting. They were further mandated in July 2011 to allocate at least 25% of the total number of branches proposed to be opened during a year in unbanked rural centres (Tier 5 and Tier 6 i.e., population up to 9,999 as per Census 2001), so as to meet the targets set out for providing banking services in villages with population over 2,000 by March 2012, and thereafter progressively to all villages over a period of time. However, prior authorisation from the Reserve Bank is required for opening of branches in Tier 1 and Tier 2 centres, except in the case of North-Eastern States and Sikkim where general permission has been granted.


These initiatives have led to increased pace in the number of branches opened in Tier 3 to Tier 6 centres.


However, it is observed that branch expansion in Tier 2 centres has not taken place at the desired pace. To provide enhanced banking services in Tier 2 centres, it is proposed:

  • To permit domestic scheduled commercial banks (other than RRBs) to open branches in Tier 2 centres (with population 50,000 to 99,999 as per Census 2001) without the need to take permission from the Reserve Bank in each case, subject to reporting.

The opening of branches by domestic scheduled commercial banks (other than RRBs) in Tier 1 centres (centres with population of 1,00,000 and above as per Census 2001) will continue to require prior permission of the Reserve Bank. While issuing such authorisation, the Reserve Bank will continue to factor in, among others, whether at least 25% of the total number of branches to be opened during a year are proposed to be opened in unbanked rural centres.


Detailed guidelines in this regard will be issued separately.


Redefining the Priority Sector

Based on the Malegam Committee’s recommendations, and as proposed in the Monetary Policy Statement of May 2011, the Reserve Bank set up a Committee (Chairman: M. V. Nair) to re-examine the existing classification and suggest revised guidelines with regard to priority sector lending classification and related issues. The terms of reference of the Committee include revising the current eligibility criteria for classification of bank loans as priority sector; review of the definition of direct and indirect priority sector finance; classification of bank lending through financial intermediaries as priority sector lending; and the consideration of capping interest rate on loans under the eligible categories of the priority sector. The Committee first met on September 29, 2011 and it will submit its report within four months from that date.


Credit Flow to the Micro, Small and Medium Enterprises Sector

Based on the recommendations of the High Level Task Force on the micro, small and medium enterprises (MSMEs), the Reserve Bank issued guidelines in June 2010, advising scheduled commercial banks that the allocation of 60% of micro and small enterprises (MSEs) advances to micro enterprises was to be achieved in stages, viz., 50% in the year 2010-11, 55% in the year 2011-12 and 60% in the year 2012-13. Banks were also mandated to achieve a 10% annual growth in the number of micro enterprise accounts and a 20% year-on-year growth in credit to the MSE sector. The Reserve Bank has been closely monitoring the achievement of targets by banks on a half-yearly basis. The last review of the achievement of targets was done as on March 2011. It has been observed that 27 banks (10 public sector banks, 7 private sector banks and 10 foreign banks) have attained the target of 50% advances to the micro enterprises, and another 27 banks (9 public sector banks, 12 private sector banks and 6 foreign banks) have attained the target of 10% growth in the number of micro enterprises. Similarly, 38 banks (22 public sector banks, 11 private sector banks and 5 foreign banks) have attained the target of 20% growth in credit to the MSE sector. Meetings were held with all those banks which lagged behind in achieving the targets to agree on a plan of action for meeting the targets. The frequency of monitoring has been changed from half-yearly to quarterly with effect from the quarter ended June 2011.


Rural Credit Institutions


Licensing of Co-operatives

In terms of the recommendations of the Committee on Financial Sector Assessment (Chairman: Dr. Rakesh Mohan and Co-Chairman: Shri Ashok Chawla), and as proposed in the Annual Policy Statement of April 2009, the work relating to licensing of unlicensed state and central co-operative banks in a non-disruptive manner, in consultation with National Bank for Agriculture and Rural Development (NABARD), has been initiated. Subsequent to the issuance of revised guidelines on licensing of state co-operative banks (StCBs)/district central co-operative banks (DCCBs), 10 StCBs and 169 DCCBs were licensed, bringing down the number of unlicensed StCBs from 17 to 7 and unlicensed DCCBs from 296 to 127 by end-August 31, 2011.


Revival of the Rural Co-operative Credit Structure

The Government of India, based on the recommendations of the Task Force on Revival of Rural Co-operative Credit Institutions (Chairman: Prof. A. Vaidyanathan) and in consultation with the State Governments, had approved a package for revival of the short-term rural co-operative credit structure. As envisaged in the package, 25 States have entered into memorandum of understanding (MoU) with the Government of India and NABARD and 21 States have amended their respective State Co-operative Societies Acts. As on July 31, 2011, an aggregate amount of Rs. 9,000 crore was released by NABARD for recapitalisation of primary agricultural credit societies (PACS) in 16 States as the Government of India’s share under the revival package and as part of the operationalisation of the recommendations of the Vaidyanathan Committee.


Roadmap for Provision of Banking Services in Villages with Population of over 2000


In pursuance of the announcement made in the Monetary Policy Statement of April 2010, a roadmap to provide banking services in every village with a population of over 2000 was finalised by the state level bankers’ committees (SLBCs). In all, 74,386 villages as per 2001 Census have been identified. They have been allotted to various banks for provision of banking services by March 2012. Banking outlets have been opened in 32,144 villages across various States in the country. Of these, 809 villages are covered through branches, 30,882 villages through branchless banking, i.e., business correspondents (BCs) and 453 through other modes like automated teller machines (ATMs), mobile vans, etc., constituting 43% of the target. Of the total 32,144 banking outlets opened, public sector banks hold 85% share, followed by RRBs with 12% and private sector banks with 3%.


Financial Inclusion Plan for Banks


It was indicated in the Monetary Policy Statement of May 2011 that all public and private sector banks had prepared and submitted board-approved three-year financial inclusion plans (FIPs), containing targets for March 2011, 2012 and 2013, to the Reserve Bank. In order to review the progress of banks in the implementation of FIPs and making way for accelerated progress in future, the Reserve Bank has been conducting annual FIP review meetings with banks. Based on discussions with banks, some action points were conveyed to them.


Banks were advised to ensure close and continuous monitoring of BCs. They were also advised to focus, in future, on opening of some form of low cost brick and mortar branches between the base branch and BC locations. Further, banks were required to make efforts to increase the number of transactions in no-frill accounts. There should be seamless integration of the financial inclusion server with their internal core banking solution (CBS) systems and in the case of end-to-end solution, there should be a clear demarcation of the technology related activities and BC related activities of their service providers. Banks should initiate action for registering with the Unique Identification Authority of India (UIDAI) and start opening accounts on the basis of Aadhaar information. Public sector banks should formulate FIPs for all RRBs sponsored by them and develop an effective monitoring mechanism so that targets assigned to the RRBs were also achieved meticulously.



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