Second Quarter Review of Monetary Policy 2012-13

India Infoline News Service | Mumbai |

As the advanced economies (AEs) deal with these tensions and global demand conditions weaken, emerging and developing economies (EDEs) are also slowing down.

By Dr. D. Subbarao


Over the last quarter, policymakers around the world have confronted increasingly difficult challenges. Globally, even as the growth momentum has slowed, governments have had to manage the balance between fiscal consolidation and growth stimulus amidst visible signs that the two objectives are in conflict with each other. As the advanced economies (AEs) deal with these tensions and global demand conditions weaken, emerging and developing economies (EDEs) are also slowing down.

Liquidity infusions by central banks in AEs during the quarter have contributed to some stability in global financial markets. These measures cannot, however, substitute for robust structural solutions that can return the AEs to the path of recovery. At this stage, growth risks have risen and could well overwhelm the positive effects of enhanced liquidity. Moreover, with commodity prices still at elevated levels, notwithstanding some muted softening recently, risks of liquidity-driven price increases remain significant. Even as this process moves forward, the months ahead will be a period of heightened uncertainty for the global economy.

Amidst this global slowdown and uncertainty, the Indian economy remains sluggish, held down by stalled investment, weakening consumption and declining exports. However, recent policy initiatives undertaken by the Government have begun to dispel pervasive negative sentiments. As the measures already announced are implemented and further reforms are initiated, they should help improve the investment climate further.

Meanwhile, the persistence of inflationary pressures even as growth has moderated, remains a key challenge. In this respect, India is an exception to the global trend, which underscores the role of domestic structural factors. Of particular concern is the stickiness of core inflation, mainly on account of supply constraints and the cost-push of rupee depreciation. Consequently, managing inflation and inflation expectations must remain the primary focus of monetary policy. A central premise of monetary policy is that low and stable inflation and well-anchored inflation expectations contribute to a conducive investment climate and consumer confidence, which is key to sustained growth on a higher trajectory in the medium-term.

Accordingly, over the past few quarters, monetary policy had to focus on inflation, even as growth risks have increased. As recent policy initiatives by the Government start yielding results in terms of revitalising activity, they will open up space for monetary policy to work in concert to stimulate growth. However, in doing so, it is important not to lose sight of the primary objective of managing inflation and inflation expectations.

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 released yesterday by the Reserve Bank.

The 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 (Section V); and Institutional Developments (Section VI).

Part A. Monetary Policy

I. The State of the Economy

Global Economy

Notwithstanding modest improvement in growth performance in parts of the world in Q3 of 2012, the global economy remains sluggish. In the US, growth in Q3 picked up relative to the earlier quarter. In the UK, after three consecutive quarters of contraction, growth turned positive in Q3. The euro area continued to experience contraction in output in Q2, and recessionary headwinds have persisted in Q3. Growth decelerated significantly in Japan. High unemployment relative to trend persisted in all major AEs, although in September the US unemployment rate declined to below 8% for the first time in four years. As regards the other BRICS – Brazil, Russia, China and South Africa – they have also slowed in the first half of 2012, with China decelerating further in Q3. Reinforcing this perspective, the average level of the global composite PMI for Q3 remained nearly unchanged from the three year low in the previous quarter.

In September, additional quantitative easing measures were announced by the US Fed, the European Central Bank and the Bank of Japan to which financial markets responded positively as reflected in the prices of risky assets and narrowing of spreads. According to the October 2012 Global Financial Stability Report of the IMF, however, risks to financial stability have increased since April as confidence in the global financial system remains fragile, notwithstanding greater monetary accommodation by central banks.

Domestic Economy

The loss of growth momentum that started in 2011-12 has extended into 2012-13 though the pace of deceleration moderated in Q1. Nevertheless, growth remains below trend and persisting weakness in investment activity has clouded the outlook.

After decelerating over four successive quarters from 9.2% y-o-y in Q4 of 2010-11 to 5.3% in Q4 of 2011-12, GDP growth was marginally higher at 5.5% in Q1 of 2012-13. The slight improvement in GDP growth in Q1 of 2012-13 was mainly driven by growth in construction, and supported by better than expected growth in agriculture.

On the expenditure side, the growth of gross fixed capital formation decelerated from 14.7% in Q1 of 2011-12 to 0.7% in Q1 of 2012-13. The slowdown in growth of private consumption expenditure witnessed during Q4 of 2011-12 continued through Q1 of 2012-13. External demand conditions and crude oil prices have also remained unfavourable, adversely impacting net exports.

After declining for two consecutive months, the index of industrial production (IIP) posted a modest growth of 2.7% in August. The upturn was visible in mining and manufacturing sectors. However, over the period April-August, industrial activity was lacklustre at 0.4% as against 5.6% during the corresponding period last year. Most significantly, reflecting the retrenchment of investment demand, capital goods production declined by 13.8% during April-August.

The seasonally adjusted manufacturing PMI in September was unchanged relative to its August level, but was below its level in June. The headline services business activity index, seasonally adjusted, was marginally higher in September than in August.

Notwithstanding apprehensions earlier in the season, rainfall deficiency during the south-west monsoon was 8% of the long period average (LPA). However, the uneven temporal and spatial distribution of the monsoon this year is expected to adversely impact the Kharif output. According to the first advance estimates, production of Kharif foodgrains at 117.2 million tonnes (MT) in 2012-13 will be lower by 9.8% than the record output in the previous year.

According to the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS), capacity utilisation of the manufacturing sector in Q1 of 2012-13 declined from the preceding quarter and a year ago. For Q2, business confidence, as measured by the business expectations index of the Reserve Bank’s industrial outlook survey (IOS), dipped relative to the previous quarter.

Headline WPI inflation remained sticky at above 7.5% on a y-o-y basis through the first half of 2012-13. Furthermore, in September there was a pick-up in the momentum of headline inflation, driven by the increase in fuel prices and elevated price levels of non-food manufactured products. While this is in part attributable to some suppressed inflation in the form of earlier under-pricing being corrected, even after this, the momentum remains firm.

Even while y-o-y inflation of WPI primary food articles moderated since July due to the softening of prices of vegetables, prices of cereal and protein-based items such as pulses, eggs, fish and meat edged up. WPI food products inflation increased in September, mainly due to the firming up of the prices of sugar, edible oils and grain mill products.

Fuel group inflation registered a significant rise in September, primarily due to the WPI reflecting the sharp increase in prices of electricity effected from June, the partial impact of the increase in prices of diesel in mid-September and significant increase in non-administered fuel prices on account of rising global crude prices.

Non-food manufactured products inflation was persistent at 5.6% through July-September and continued to exhibit upside pressures from firm prices of metal products and other inputs and intermediates, especially goods with high import content due to the rupee depreciation. The momentum indicator of non-food manufactured products inflation (seasonally adjusted 3-month moving average annualised inflation rate) also remained high.

The new combined (rural and urban) CPI (Base: 2010=100) inflation remained elevated, reflecting the build-up of food price pressures. CPI inflation excluding food and fuel groups ebbed slightly during June-September, from double digits earlier. Inflation based on the CPI for industrial workers recorded an upturn, primarily due to higher food inflation. The y-o-y increase in rural wages, though showing some moderation, has remained high.

Reflecting some softening in inflation from the high levels observed in the last two years, urban households’ inflation expectations showed a marginal decline in Q2 of 2012-13, though they remained in double digits.

The Reserve Bank’s quarterly house price index suggests that house price inflation remained firm in Q1 of 2012-13. Notwithstanding the increase in house prices, the volume of housing transactions grew y-o-y at a faster pace than in the preceding quarter.

An analysis of corporate performance in Q1 of 2012-13, based on a common sample of 2,308 non-government non-financial companies, indicates that y-o-y sales growth decelerated sequentially over the last three quarters, but remained positive after adjusting for inflation. Earnings, however, contracted sharply due to higher increase in expenditure relative to sales, indicating a decline in pricing power. The early results for Q2 of 2012-13 indicate that the drop in sales growth and earnings may be bottoming out.

Money supply (M3) moderated y-o-y to 13.3% on October 5, 2012, lower than the indicative projection of 15% set out in the Monetary Policy Statement 2012-13. This essentially reflected the deceleration of growth in aggregate deposits. Non-food credit growth at 15.4% y-o-y was below the indicative projection of 17%, reflecting the growth slowdown. Disaggregated data show that barring agriculture, credit growth decelerated on a y-o-y basis across all the major sectors, particularly infrastructure.

The estimated total flow of financial resources from banks, non-banks and external sources to the commercial sector at around Rs. 4,700 billion in 2012-13 (up to October 5, 2012) was lower than Rs. 5,000 billion during the corresponding period of last year. Apart from the decline in the flow of resources from banks, the flow from external sources declined on account of lower external commercial borrowings (ECBs) and foreign direct investment (FDI) into India.

Following the cut in the policy repo rate in April and the cash reserve ratio (CRR) in September, several commercial banks reduced their deposit and lending rates. During H1 of 2012-13, the modal deposit rates of scheduled commercial banks declined by 13 bps across all maturities and the modal base rate of banks also declined by 25 bps.

Liquidity conditions, as reflected in the average net borrowing under the LAF at Rs. 486 billion during July-September remained within the comfort zone of (+/-) one% of NDTL. However, liquidity conditions tightened in October, mainly on account of the build-up in the Centre’s cash balances and the seasonal increase in currency demand, taking the average LAF borrowing to Rs. 871 billion during October 15-25, well above the band of (+/-) one% of NDTL.

During April-August, the Centre’s fiscal deficit was nearly two-thirds of the budget estimate for the year as a whole. In view of evolving patterns of revenues and non-plan expenditure, the revenue deficit (RD) and the gross fiscal deficit (GFD) for 2012-13 are expected to be higher than budgeted.

During Q2 of 2012-13, yields on government securities (G-secs) eased and have remained range-bound in October. Equity markets also improved in Q2 of 2012-13 on account of revival in sentiment and the turnaround in foreign institutional investor (FII) inflows.

The adverse external environment and, in particular, the slump in world trade took its toll on export performance. Exports declined in September for the fifth month in succession. However, with imports also declining, the trade deficit in H1 of 2012-13 remained broadly at the same level as a year ago. In terms of external financing, net inflows on account of FDI and ECBs were sizably lower than in the first half of the preceding year, but the shortfall was largely offset by a surge in non-resident deposits and a turnaround in FII flows in Q2. Reflecting these developments, the nominal exchange rate of the rupee vis-a-vis the US dollar moved within a relatively narrow range during Q2 compared with its behaviour in Q1. Overall, in H1 of 2012-13, the rupee depreciated in nominal terms by 7.8%. In real terms, it depreciated by 5.4%. The impact of real depreciation on net exports is being offset by global demand conditions.

II. Outlook and Projections

Global Outlook


Global growth prospects have deteriorated further and downside risks have increased, even as monetary policy in AEs remains supportive. Much depends on concrete policy actions in the euro area to ease the sovereign debt stress, balance growth-friendly structural reforms with fiscal consolidation, and carry forward integration at the area level, particularly in banking and fiscal domains. In the US, determined political resolve to agree on a credible medium-term fiscal consolidation strategy is critical to averting the fiscal cliff and to avoid once again encountering the debt ceiling deadline. In the absence of these efforts, the outlook for AEs appears bleak, with the risks of a prolonged downturn more real than before. Spillovers from AEs present a serious downside risk to the prospects for EDEs, notwithstanding their relatively stronger fundamentals and absence of financial strains.

In its October 2012 World Economic Outlook (WEO), the IMF scaled down its projection of world GDP growth for 2012 to 3.3% from its July projections of 3.5%, and for 2013 to 3.6% from its earlier projection of 3.9%. Since September 2011, the IMF has been scaling down its projection of global growth for 2012, evidencing persistent and more than anticipated weakness in the global economy.


According to the IMF (WEO, October 2012), consumer price inflation is likely to decline from 1.9% in 2012 to 1.6% in 2013 in AEs, and from 6.1% to 5.8% in EDEs. As a result of weakening of global economic activity, headline and core inflation are expected to ease. However, risks to this outlook remain as global commodity prices, particularly of crude oil, have corrected only marginally. Further accommodation in monetary policy in major AEs is likely to work in conjunction with supply constraints to keep commodity prices elevated and volatile.

Domestic Outlook


In its April 2012 Policy, the Reserve Bank projected GDP growth for 2012-13 at 7.3%. In the First Quarter Review (FQR) of July, this was revised downwards to 6.5% on an assessment that risks to domestic growth from the global slowdown, weak industrial activity and slower growth of services had materialised. By the time of the Mid-Quarter Review (MQR) of September, growth risks had heightened on account of worsening global macroeconomic conditions, decline in domestic industrial activity and service sector growth falling below trend.

Since then, global risks have increased further and domestic risks have become accentuated by halted investment demand, moderation in consumption spending and continuing erosion in export competitiveness accompanied by weakening business and consumer confidence. Although industrial output picked up marginally in August and the services PMI showed a modest improvement in September, the outlook remains uncertain. Notwithstanding the improvement in rainfall in the months of August and September, the first advance estimates of the 2012 kharif production are somewhat less buoyant in comparison to the previous year. Accordingly, even while prospects for agriculture appear resilient, the overall outlook for economic activity remains subdued. On these considerations, the baseline projection of GDP growth for 2012-13 is revised downwards to 5.8% (Chart 1).


Looking ahead, the path of inflation will be shaped by two sets of counteracting forces. On the downside, slower growth and excess capacity in some sectors will help moderate core inflation. Stable, or in the best case scenario, declining commodity prices will reinforce this tendency. An appreciating rupee will also help to contain inflationary pressures by bringing down the rupee cost of imports, especially of commodities. On the upside, persistent supply constraints may be aggravated as demand revives, resulting in price pressures. Rupee depreciation, which may result from global financial instability, will add to imported inflation. An important driver of inflation is the upsurge in both rural and urban wages, which is exerting cost-push pressures. Finally, as under-pricing in several products is corrected as part of the fiscal consolidation process, suppressed inflation is being brought into the open. As necessary a step as this is, it will result in higher inflation readings.

Taking into consideration the above factors, the baseline projection for headline WPI inflation for March 2013 is raised to 7.5% from 7.0% indicated in July (Chart 2). Importantly, it is expected to rise somewhat in Q3 before beginning to ease in Q4.

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

Money supply (M3), deposit and credit growth have so far trailed below the indicative trajectories of the Reserve Bank indicated in the April Policy and reiterated in the July Review. Deposit growth has decelerated with the moderation in interest rates, especially term deposits. Credit growth has ebbed with the slowdown in investment demand, especially with regard to infrastructure, and lower absorption of credit by industry, in general. Keeping in view the developments during the year so far and the usual year-end pick-up, the trajectories of the monetary aggregates for 2012-13 are projected at 14.0% for M3, 15.0% for deposit growth and 16.0% for growth of non-food credit. As always, these numbers are indicative projections and not targets.

The wedge between deposit growth and credit growth, in conjunction with the build-up of the Centre’s cash balances from mid-September and the drainage of liquidity on account of festival-related step-up in currency demand, have kept the system level liquidity deficit high, with adverse implications for the flow of credit to productive sectors and for the overall growth of the economy going forward.

Risk Factors

The projections of growth and inflation for the remaining part of 2012-13 are subject to several risks as detailed below:

i) Downside risks to growth emanating from the global macroeconomic environment are now adjudged to be more elevated than at the time of the FQR of July and the MQR of September. Weak growth momentum and policy uncertainties are impacting the macroeconomic outlook of EDEs. Spillovers to the Indian economy through trade, finance and confidence channels could increase. Domestically, a revival in investment activity, which is key to stimulating growth, depends on a number of factors. In particular, recent policy announcements by the Government, which have positively impacted sentiment, need to be translated into effective action to convert sentiment into concrete investment decisions.

ii) On the inflation front, despite recent moderation, global commodity prices remain high. While oil prices appear to have stabilised, balancing between weak demand prospects and abundant liquidity, upside risks from persistently high liquidity and geopolitical developments remain. Further, domestic prices of administered petroleum products do not reflect the full pass-through of global commodity prices, and under-recoveries persist. While corrections are welcome from the viewpoint of overall macroeconomic stability, their second-round effects on inflation will have to be guarded against. As regards food prices, drought conditions in important foodgrain producing areas of the world are likely to impart an upside and persistent bias to international food prices with adverse implications for all countries that have relatively high weights for food in their inflation indicators. The behaviour of food inflation will also depend on the supply response in respect of those commodities characterised by structural imbalances, particularly protein items. Finally, the persistent increase in rural and urban wages, unaccompanied by commensurate productivity increases, is also a source of inflationary pressures.

iii) The large twin deficits, i.e., the current account deficit and the fiscal deficit continue to pose significant risks to both growth and macroeconomic stability. A large current account deficit poses challenges for financing it in the current global environment. In a situation of volatile capital flows, the deficit could exacerbate downward pressures on the rupee. A persistently large fiscal deficit reduces the space for a revival in private spending, particularly investment spending, without quickly re-kindling inflationary pressures.

iv) Liquidity pressures pose risks to credit availability for productive purposes and could affect overall investment and growth prospects adversely. On the other hand, excess liquidity could aggravate inflation risks.

III. The Policy Stance

In response to rising inflation pressures in the period January 2010 - October 2011, the Reserve Bank started monetary tightening. This helped in moderating inflation from its peak of 10.9% in April 2010 to an average level of 7.5% over the period January-August 2012. Over this period, however, growth slowed down and is currently below trend. This slowdown is due to a host of factors, including monetary tightening.

Since April 2012, the monetary policy stance has sought to balance the growth–inflation dynamic through calibrated easing. The transmission of these policy impulses through the economy is underway, and in conjunction with the fiscal and other measures recently announced, should work towards arresting the loss of growth momentum over the next few months. As inflation eases further, there will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to mitigate the growth risks and take the economy to a sustained higher growth trajectory.

It is important, however, to note that inflation turned up again in September. To some extent, this reflected the partial pass-through of revisions of diesel and electricity prices which, notwithstanding their contribution to inflation, were absolutely necessary. Besides, underlying inflationary pressures reflected in non-food manufactured products inflation has remained stubbornly above comfort levels. Accordingly, it is critical that even as the monetary policy stance shifts further towards addressing growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised.

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

  • Manage liquidity to ensure adequate flow of credit to the productive sectors of the economy;

  • Reinforce the positive impact of government policy actions on growth as inflation risks moderate; and

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

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:

Cash Reserve Ratio

It has been decided to:

Reduce the cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.5% to 4.25% of their net demand and time liabilities (NDTL) effective the fortnight beginning November 3, 2012.

As as result of this reduction in the CRR, around Rs. 175 billion of primary liquidity will be injected into the banking system.

Repo Rate

The policy repo rate under the liquidity adjustment facility (LAF) has been retained at 8.0%.

Reverse Repo Rate

The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands at 7.0%.

Marginal Standing Facility (MSF) Rate

The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, stands at 9.0%.

Bank Rate

The Bank Rate stands at 9.0%.


The reduction in the CRR is intended to pre-empt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable to support growth. It anticipates the projected inflation trajectory which indicates a rise in inflation before easing in the last quarter. While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13. The above policy guidance will, however, be conditioned by the evolving growth-inflation dynamic.

Expected Outcomes

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

  1. Enable liquidity conditions to facilitate a turnaround in credit growth to productive sectors so as to support growth;

  2. Reinforce the growth stimulus of the policy actions announced by the Government as inflation risks moderate; and

  3. Anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation. 

Mid-Quarter Review of Monetary Policy 2012-13

The next Mid-Quarter Review of Monetary Policy for 2012-13 will be announced through a press release on Tuesday, December 18, 2012.

Third Quarter Review of Monetary Policy 2012-13

The Third Quarter Review of Monetary Policy for 2012-13 is scheduled for Tuesday, January 29, 2013.

Part B. Developmental and Regulatory Policies

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.

Since the Monetary Policy Statement of April 2012, risks to global financial stability have increased, despite some improvement in markets associated with exceptional liquidity operations. In advanced economies, significant fiscal challenges could morph into broader macro-financial concerns. For emerging and developing economies (EDEs), financial stability risks are embedded in potential spillovers, apart from those associated with domestic challenges of managing slowdown in growth, while countering lingering inflationary pressures in some. These unsettled conditions have nevertheless spurred movements towards globalised regulatory reforms intended to make financial systems safer, less complex and more transparent, and financial institutions less leveraged, better capitalised and thus able to effectively manage various risks. Many of these reforms are at various stages of implementation.

In India, in the face of a challenging global environment and a difficult growth-inflation dynamic, developmental and regulatory policies have focused on building a sound, efficient and vibrant financial system that ensures the effective provision of financial services to the widest sections of society. Financial sector reforms have moved in step with evolving international best practices, but with a country-specific orientation. Accordingly, financial market development, credit quality, credit delivery, customer service and financial inclusion within a participative and consultative approach with involvement of all stakeholders have been pursued.

This review of Developmental and Regulatory Policies for SQR of Monetary Policy 2012-13 focuses on certain key areas while assessing the progress made on the measures instituted in recent policy statements: reviewing interest rate policies and products; carrying forward financial market development and strengthening the market infrastructure, including payment and settlement systems; further improving credit delivery and financial inclusion; expanding customer service initiatives; upgrading the regulatory and supervisory framework in terms of progress towards Basel III, risk based supervision (RBS), non-performing assets (NPAs) management/restructuring and resolution frameworks; and strengthening currency management.

I. Interest Rate Policy

Fixed Interest Rate Products

In the Monetary Policy Statement of April 2012, it was noted that while interest rates on deposits are predominantly fixed, most of the retail loan products, especially home loans, are sanctioned on a floating interest rate basis, thereby exposing the borrowers to the uncertainties of interest rate movements and associated interest rate risk. In order to examine the issue, a Committee (Chairman: Shri K.K.Vohra) comprising external as well as internal experts has been set up to assess the feasibility of introduction of long-term fixed interest rate loan products by banks.

The draft report of the Committee will be put out on the Reserve Bank’s website by mid-November 2012 inviting views/suggestions from the public/stakeholders.

II. Financial Markets

Development of Trade Repository for OTC Derivatives

Pursuant to the announcement made in the Monetary Policy Statement of April 2010, the reporting platform for over-the-counter (OTC) inter-bank foreign exchange forwards, swaps and options was launched in July 2012. It has been decided to extend this arrangement, in phases, in terms of a well-defined roadmap, so as to cover: 

  1. Trades in foreign currency-rupee forwards and options, foreign currency-foreign currency forwards and options between banks and their clients under a suitable protocol to ensure confidentiality of client trades reported by banks to the repository.

  2. Currency swaps, interest rate swaps (IRS)/forward rate agreements (FRAs)/caps/floors/collars in foreign currency and client trades in rupee IRS.

Working Group on G-secs and Interest Rate Derivatives Markets

As announced in the Monetary Policy Statement of April 2012, the report of the Working Group (Chairman: Shri R. Gandhi) was put out on the Reserve Bank’s website for feedback from market participants. Based on the feedback received, the Group finalised its report on August 10, 2012. The Working Group has recommended measures to promote liquidity in the secondary market, to improve retail participation in the G-secs market, and to develop the market for interest rate derivatives. Its recommendations include consolidation of outstanding G-secs, gradually bringing down the upper limit on the Held to Maturity (HTM) portfolio, steps to promote the term repo market, centralised market makers for retail participants in G-secs in the long-run, and permitting cash-settled 10-year Interest Rate Futures (IRFs), subject to appropriate regulations. Some recommendations like truncating the time-window for bidding in the primary auction, and re-issuances of existing securities in State Development Loans have been implemented. Following the Group’s recommendations, it has been decided to: 

  1. Change the settlement cycle of the primary auction in Treasury Bills (T-Bills) from T+2 to T+1.

  2. Undertake reissuance/introduce fungibility of T-Bills/Cash Management Bills with identical maturity dates.

  3. Standardise IRS contracts to facilitate centralised clearing and settlement of these contracts.

Operational guidelines in this regard are being issued separately.

The remaining recommendations are being examined by the Reserve Bank in consultation with stakeholders.

Financial Market Infrastructure

Working Group on Export Reporting and Follow-up

Under the Foreign Exchange Management Act (FEMA) 1999, it is obligatory on the part of exporters to realise and repatriate the full value of exports to India, and monitoring and follow-up in this regard is done by Reserve Bank through the Authorised Dealer banks. It has been observed that there has been an increase in the number of unmatched export transactions between customs and bank reporting which, in turn, attenuates export realisation follow-up. Accordingly, a Working Group (Chairperson: Smt. Rashmi Fauzdar) was constituted to identify gaps/lacunae in the current export reporting and follow-up procedure and to recommend suitable re-engineering of the system. The Group submitted its report on September 27, 2012, recommending implementation of an IT - based solution using a secured website of the Reserve Bank to update the export database on a real time basis to facilitate quicker follow-up/data generation/policy formulation. It has been decided:

To put in place the envisaged architecture by September 2013.

III. Financial Stability

Assessment of Financial Stability

The fifth Financial Stability Report (FSR) of June 2012 observed that the domestic financial system remained robust, notwithstanding an increase in risks to stability. The Reserve Bank’s Second Systemic Survey Review reflected concerns about evolving global risks. On the domestic front, lower growth, elevated inflation and high fiscal and current account deficits were identified as posing risks to financial stability. Despite rising NPAs in the banking sector, simulations of shocks under different scenarios for banks as at end-June 2012 showed that the system-level CRAR remained above the required minimum of 9%. Banks also remained resilient to credit, market, and liquidity risks. However, distress dependencies between banks have risen, warranting closer monitoring. The Financial Stability Report reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on potential risks to financial stability.

Financial Stability and Development Council (FSDC) and its Sub-Committees

The Sub-Committee of the FSDC is assisted by two Technical Groups, viz., the Technical Group on Financial Inclusion and Financial Literacy and the Inter-Regulatory Technical Group. In addition, the Sub-Committee approved the creation of an Inter-Regulatory Forum under the Chairmanship of the Deputy Governor in charge of banking supervision in the Reserve Bank with Executive Director level membership from other regulatory/supervisory agencies to institutionalise the framework for supervision of financial conglomerates (FCs) and for monitoring and management of systemic risks emanating from their activities. This Inter-Regulatory Forum would have responsibility for framing policies for FCs such as identification, group-wide risk management, and corporate governance as well as for conducting high-level supervision. The Forum would also seek to strengthen the supervisory co-ordination/cooperation mechanism amongst domestic supervisors for effective supervision.

IV. Credit Delivery and Financial Inclusion

Roadmap for Provision of Banking Services in Unbanked Villages

The Monetary Policy Statement of April 2012 mandated State Level Bankers’ Committees (SLBCs) to prepare a roadmap covering all unbanked villages of population less than 2,000 and to notionally allot these villages to banks for providing banking services in a time-bound manner. Accordingly, detailed guidelines were issued to SLBC convenor banks on June 19, 2012. Furthermore, banks were advised to furnish details of allocation of villages to respective regional offices of the Reserve Bank by end-August 2012. Quarterly statements on district-wise and bank-wise progress in opening banking outlets are required to be submitted from the quarter ending September 2012 by the 10th of the following month to the Reserve Bank.

Constitution of Financial Inclusion Advisory Committee

Moving towards universal financial inclusion has been a national commitment as well as a policy priority for the Reserve Bank. In order to spearhead efforts towards greater financial inclusion, the Reserve Bank constituted a Financial Inclusion Advisory Committee (Chairman: Dr. K.C. Chakrabarty). The collective expertise and experience of the members will be leveraged to explore viable and sustainable banking services delivery models focusing on accessible and affordable financial services, developing products and processes for rural as well as urban consumers presently outside the banking network and suggesting the appropriate regulatory framework to ensure that financial inclusion and financial stability move in tandem. The first meeting of the Committee will be held in December 2012.

Redefining the Priority Sector

As indicated in the SQR of October 2011, the Reserve Bank constituted a Committee (Chairman: Shri M. V. Nair) to re-examine existing classifications and suggest revised guidelines with regard to priority sector lending. The Committee submitted its report in February 2012. Based on the discussion with various stakeholders and in the light of the comments/suggestions received, guidelines on priority sector lending were revised on July 20, 2012. The overall target under the priority sector for domestic scheduled commercial banks has been left unchanged at 40% of the Adjusted Net Bank Credit (ANBC) or Credit Equivalent (CE) amount of Off-Balance Sheet Exposure (OBE), whichever is higher, as on March 31 of the previous year. Targets under both direct and indirect agriculture have also been kept unchanged at 13.5 percent and 4.5 percent, respectively. Foreign banks with 20 or more branches have been brought at par with the domestic commercial banks in terms of the target/sub-targets under priority sector lending. The target under the priority sector for foreign banks with less than 20 branches has been set at 32% of ANBC or CE of OBE, whichever is higher, as on March 31 of the previous year, without any sub-target.

To address concerns raised by banks on the revised priority sector guidelines, discussions were held with the Chairman and Managing Directors (CMDs)/Chief Executive Officers (CEOs) and with operational heads of priority sector departments of select banks.

Foreign banks have to prepare roadmaps for meeting the targets over a period of five years and their performance vis-à-vis targets will be reviewed periodically.

Based on the feedback received, it has been decided that:

Loans up to Rs. 20 million to partnership firms, cooperatives and corporates directly engaged in agriculture and allied activities under partnership, rural cooperative and corporate categories will also be classified as direct finance to agriculture.

Bank loans to Housing Finance Companies (HFCs) for on-lending for housing up to Rs. 1 million per borrower, may be included under the priority sector, provided the interest rate charged to the ultimate borrower by the HFC does not exceed two percentage points above the lowest interest rate of the lending bank for housing loans.

Guidelines on additions/amendments have since been issued.

Urban Cooperative Banks (UCBs) -Repo in Corporate Bonds

In the SQR of October 2009, the Reserve Bank had announced the introduction of repo in corporate bonds and issued the ‘Repo in Corporate Debt Securities (Reserve Bank) Directions, 2010’ in January 2010. On the basis of requests received from Federations/Associations of UCBs, it has been decided:

To include scheduled UCBs with strong financials and sound risk management practices as eligible participants to undertake repo transactions in corporate bonds.

Detailed guidelines are being issued separately.

Licences for New Urban Cooperative Banks

Based on comments/feedback received from the public on the recommendations of the Expert Committee (Chairman: Shri Y. H. Malegam), it has been decided to initiate steps for setting up of new UCBs after issues relating to governance arrangements are resolved with the Government.

Licensing of Cooperatives

The Committee on Financial Sector Assessment (Chairman: Dr. Rakesh Mohan and Co-Chairman: Shri Ashok Chawla) had recommended that rural cooperative banks which failed to obtain a license by end-March 2012 should not be allowed to operate. The Reserve Bank, along with the National Bank for Agriculture and Rural Development (NABARD), implemented a roadmap for issuing licenses to unlicensed state cooperative banks (StCBs) and district central cooperative banks (DCCBs) in a non-disruptive manner to ensure the completion of licensing work by end-March 2012.After considering the NABARD’s recommendations for issuance of licenses, one out of 31 StCBs and 42 out of 371 DCCBs were unable to meet the licensing criteria by end-March 2012.

Subsequently, the StCB and 16 of the 42 DCCBs were recommended by the NABARD for issuance of licences, since these banks attained the licensing norms following release of funds by the State Governments. The remaining 26 DCCBs which have not met the licensing criteria within the extended period, i.e., before September 30, 2012 continue to be under directions. Task Forces set up by the Reserve Bank in these States for the purpose have observed that these DCCBs are unviable in their present form and their continued existence cannot be sustained. Various alternatives are being analysed to ensure that the cooperative structure in these States does not get adversely affected.

Streamlining Short-Term Cooperative Credit Structure

In order to examine issues of structural constraints and to explore strengthening of the rural cooperative credit architecture with appropriate institutions and instruments to fulfil credit needs, it was proposed to constitute a Working Group to review the Short-Term Cooperative Credit Structure (STCCS). Accordingly, the Reserve Bank constituted an Expert Committee (Chairman: Dr. Prakash Bakshi) to undertake an in-depth analysis of the STCCS and examine various alternatives with a view to reducing the cost of credit and the feasibility of setting up of a two-tier STCCS as against the existing three-tier structure. The report of the Committee is expected by end-December 2012.

Defining Sick, Micro and Small Enterprises (MSEs)

In recognition of the problem being faced by the Micro and Small Enterprises (MSEs) Sector, particularly with respect to rehabilitation of potentially viable sick units, the Reserve Bank had constituted a Working Group (Chairman: Dr. K. C. Chakrabarty), which recommended a change in the definition of sickness and in the procedure for assessing the viability of sick MSE units. It was decided that the Ministry of Micro, Small and Medium Enterprises (MSME), Government of India, would constitute a Committee to examine the proposal. Following the submission of the report by this Committee, it is proposed:

To modify the existing definition of sickness of micro and small enterprises (as defined in the MSMED Act, 2006) and lay down a procedure for assessing the viability of sick units in the sector.

Detailed guidelines in this regard are being issued separately.

Customer Service

Committee on Customer Service in Banks

Of the recommendations of the Committee on Customer Service in Banks (Chairman: Shri M. Damodaran) constituted by the Reserve Bank, 152 have been implemented, including 142 in respect of which the Indian Banks’ Association (IBA) issued guidelines to banks. They include spelling out Most Important Terms and Conditions (MITCs) for products and services that are of critical importance to consumers; strict adherence by banks to the time schedule prescribed under extant regulatory guidelines for disposing of loan applications; and issue of ATM cards only at the option of the customers on written request. Ten recommendations implemented by issue of regulatory guidelines include instructions to banks on abolition of foreclosure charges on floating rate home loans; introduction of Basic Savings Account; Unique Identification Number (UID) as Know Your Customer (KYC) for opening of No Frills Account; and differential merchant discount/fee for debit cards.

Banking Ombudsman Scheme (BOS) 2006

Drawing on the recommendations of the Committee on Customer Service in Banks and the suggestions given by the Rajya Sabha Committee on Subordinate Legislation in their 183rd report, a Working Group (Chairperson: Smt. Suma Varma) has been constituted in the Reserve Bank to review, update, and revise the BOS, 2006 in the light of the recommendations and suggestions. The Working Group is expected to submit its report by end-December 2012.

V. Regulatory and Supervisory Measures

Basel III Disclosure Requirements on Regulatory Capital Composition

As announced in the Monetary Policy Statement of April 2012, the Reserve Bank issued guidelines on implementation of Basel III Capital Regulations on May 2, 2012 to all scheduled commercial banks (excluding LABs and RRBs). The Basel Committee on Banking Supervision (BCBS) has finalised proposals on disclosure requirements in respect of the composition of regulatory capital, aimed at improving transparency of regulatory capital reporting as well as market discipline. As these disclosures have to be given effect by national authorities by June 30, 2013, it has been decided: 

  • To issue draft guidelines on composition of capital disclosure requirements by end-December 2012.

  • Banks’ Exposures to Central Counterparties (CCP)

The BCBS has also issued an interim framework for determining capital requirements for bank exposures to CCPs. This framework is being introduced as an amendment to the existing Basel II capital adequacy framework and is intended to create incentives to increase the use of CCPs. These standards will come into effect on January 1, 2013. Accordingly, it has been decided: 

  • To issue draft guidelines on capital requirements for bank exposures to central counterparties, based on the interim framework of the BCBS, by mid-November 2012.

Core Principles for Effective Banking Supervision



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