Central Bank Policy Mix: Reserve Bank of India s Experience. Anand Prakash Reserve Bank of India April 11, 2018

Transcription

1 Central Bank Policy Mix: Reserve Bank of India s Experience Anand Prakash Reserve Bank of India April 11, 2018

2 Presentation Structure A brief description of salient features of major policies employed by the Reserve Bank of India (RBI), viz., Monetary Policy RBI s financial stability role Exchange Rate policy Capital Flows Management Macro Prudential Policies Policy responses during episodes of heightened market volatility (e.g., global financial crisis, taper tantrum episode, etc.) Current Issues and challenges facing the Reserve Bank of India Some concluding observations

3 Introduction RBI is a full function Central Bank. Its main functions include: Monetary authority Regulator and supervisor of the financial system Manager of foreign exchange Issuer of currency Banker to Government including public debt management Banker to Banks Developmental role including financial inclusion and financial literacy

4 Monetary Policy-Evolution From 1985 to 1998, RBI adopted monetary targeting framework From 1998 to 2016, RBI adopted multiple indicator approach Initially, the objectives of monetary policy included maintaining price stability and ensuring adequate flow of credit to the productive sectors of the economy With progressive liberalization and increasing globalization of the economy, maintaining orderly conditions in financial markets (financial stability) emerged as an additional policy objective Thus, monetary policy in India evolved to have multiple objectives of price stability, financial stability and growth

5 Current Monetary Policy Framework- Inflation Targeting In 2016, RBI shifted to a flexible Inflation Targeting Framework through amendment to RBI Act Primary objective of monetary policy in India has been defined explicitly to maintain price stability while keeping in mind the objective of growth Monetary Policy Committee (MPC) has been constituted with the task of setting the benchmark policy rate MPC has 6 members, 3 internal and 3 external with Governor as exofficio chairperson CPI inflation to serve as nominal anchor Inflation target set by Government for 5 years, valid till 2021 Target set at 4% +/- 2% (between 2 to 6 %)

6 Monetary Policy: Operating Procedure Policy rate (repo rate) is the only instrument and weighted average call rate (WACR) is the operating target of the monetary policy. Liquidity operations to ensure WACR remains closely aligned with policy rate and fluctuates within the policy rate corridor of 50 bps for efficient transmission of monetary policy signals Instruments to manage structural liquidity: Open Market Operations, Market Stabilization Scheme (Dated Securities/T-Bills/Cash Management Bills), Cash Reserve Ratio Instruments to manage frictional liquidity: repo/reverse Repo/MSF at fixed rate,14-day Term Repo at variable rate, variable rate repo/reverse repo of varying tenors for fine tuning liquidity operations Forex Swaps (Will reflect in dip/ accretion in Reserves)

7 Financial Stability: RBI s Role-1 Prior to the crisis, no agency was explicitly granted a mandate for financial stability Reserve Bank acted as the implicit systemic regulator for the country RBI s mandate for ensuring financial stability arises mainly from its mandated functions of regulator of the banking system, regulator and supervisor of the payment and settlement systems, regulator of the money, forex, government security and credit markets, banker to the banks, as also the lender-of-the last resort. In 2004, RBI formally added financial stability as a policy objective, in addition to price stability and growth Over the years, RBI attempted to address both aspects of systemic risks time and cross-sectional within a macroprudential framework Two separate Committees of the RBI s Central Board, viz., the Board for Financial Supervision (BFS) and the Board for Payment and Settlement Systems (BPSS), responsible for financial supervision and payment and settlement infrastructure

8 Financial Stability: RBI s Role-2 Co-ordinated approach to supervision of financial system: High Level Coordination Committee on Financial Markets (HLCCFM) was functional since 1992 HLCCFM replaced by a Sub-Committee of the Financial Stability and Development Council (FSDC) in 2010 FSDC is an inter agency forum set up in the wake of the crisis with a specific mandate, inter alia, for systemic financial stability The sub-committee of the FSDC, headed by Governor, Reserve Bank, functions as the primary operating arm of the FSDC The sub-committee has set up a dedicated Crisis Management Framework to facilitate the handling of crisis situations An Early Warning Group having representatives from various financial regulators is headed by Deputy Governor with Financial Markets Operations Department of RBI as its secretariat

9 Financial Stability Unit in RBI In July 2009, Financial Stability Unit (FSU) set up in RBI FSU s mandate is to, inter alia, conduct effective macro-prudential surveillance of the financial system on an ongoing basis to enable early detection of any incipient signs of instability FSU started publishing half-yearly Financial Stability Report (FSR) FSRs are presented to Sub-committee of FSDC and incorporate views from various regulators on risks to systemic stability FSRs present holistic assessment of the risks to the stability of the Indian financial system Number of initiatives to improve financial stability analytics and indicators, viz., stability indicators and maps, network analysis, stress test, banking stability measures and expected shortfall, etc.

10 Macro-prudential policy (MPP) The Reserve Bank used macroprudential tools much before they became popular in the aftermath of the Global Financial Crisis Even after the change in institutional set up for MPP (setting up of FSDC), RBI still plays a dominant role in setting macroprudential policies (FSB Peer Review of India, 2016) A notable feature of macroprudential policy at the RBI is that it has developed organically from microprudential regulation and supervision. RBI s stance is more of principle based than that of a strictly rule based approach The desired objective of differentiated risk weights and provisioning norms during was to build resilience of the banking system while containing sectoral exuberance

11 India Use of MPP Differentiated risk weights, especially for sensitive sectors Provisions on standard assets LTV Ratio Domestic Systemically Important Banks Countercyclical capital buffer Sectoral approach was followed in implementation of risk weights during December 2004 to December imposition of higher risk weights and provisioning norms during Same tool used in the reverse direction when the boom conditions turned adverseused as a countercyclical tool Sectoral approach was followed in implementation of provisions during December 2004 to December 2010 For the first time a cap on LTV ratio was prescribed at 80 per cent in December 2010 for loans above INR 20 lakh and 90 per cent for loans upto INR 20 lakh. The framework was implemented in At present, three banks viz., SBI ICICI Bank and HDFC Bank have been identified as D-SIBs The framework is in place since February Activation of CCCB will take place when circumstances warrant. 11

12 Effectiveness of Measures: Interaction of MPP with Monetary Policy The Reserve Bank deployed both interest rates and prudential instruments during to ensure both price stability and financial stability. While the sectoral exuberance was dealt through countercyclical prudential policies, generalised exuberance in the economy was dealt through monetary tightening. Thus, monetary policy and macroprudential measures complemented each other. Such a coordinated response was facilitated as the Reserve bank has a wide mandate it has the mandate to conduct monetary policy and also to regulate and supervise the banking sector. Monetary Tightening Phase (Sept Aug 2008) Monetary Easing Phase Monetary Tightening Phase (Oct Apr (November ) Mar 2012) Monetary measures (Change in basis points) repo rate Risk Weights ( Change in basis points) Capital Markets 25 Nil Nil Housing -25 (priority sector) and 50 (others) Nil Nil (priority sector) and 25(others) Retail loans Nil Nil Nil CRE Nil Provisioning Norms ( Change in basis points) Capital Markets Nil 0 (priority sector) Housing and 160 (others) Retail loans Nil CRE

13 Exchange Rate Management Broad principals that have guided exchange rate management Careful monitoring and management of exchange rates without a fixed target or a pre-announced target or a band. Flexibility in the exchange rate together with ability to intervene, if and when necessary A policy to maintain a level of foreign exchange reserves which takes into account not only anticipated current account deficits but also liquidity at risk arising from unanticipated capital movements A judicious policy for management of the capital account In the post-crisis era virtues of larger FX reserves for EMEs recognized, earlier considered wasteful Forex market intervention to dampen appreciation is no longer a sin and reserves are a new virtue Robust, easily accessible and equitable global financial safety net (GFSN) for EMEs still elusive Need for improved access to swap lines for EMEs: Governor RBI

14 Exchange Rate Management-2 RBI intervenes in the forex market in order to: maintain orderly conditions prevent the emergence of destabilising and self-fulfilling speculative activities even out lumpy demand or supply RBI conducts operations in the spot, forward, swap and in, the recent years, in currency futures market Exchange rate policy not used for meeting monetary objective like controlling inflation At times of heightened volatility in FX market like taper tantrums, FX intervention used in conjunction with other policy instruments, including a macro-prudential/capital flow management toolkit, to restore stability

15 Why Manage Capital Account in India? large volatility in capital flows pose significant risks to EMEs like India Sharp rise in capital flows has Implications for macro and financial stability Abrupt reversals in capital flows also cause significant problems India has experienced both floods and sudden stops of capital flows Trade-offs between liberalization and maintaining capital controls Large capital flows a potential source of disequilibrium, important to monitor capital account to minimise external vulnerability.

16 Capital Account Management in India Capital account liberalization began in 1991 following balance of payments (BoP) crisis Analytical foundations for reforms provided by three RBI reports Capital account liberalization is a process rather than an event Sequencing of the process conditional on macroeconomic fundamentals and sustainability of the BoP Considerable progress made but moderate capital controls still there Non-residents provided considerable extent of convertibility but greater restrictions for residents

17 Capital Account Management in India-2 The overall approach has been to liberalize FDI Policy levers on the debt side of the flows used to manage volatility Ceiling on the extent of FII investment in sovereign and corporate debt ECBs and NRI deposits have interest rate ceilings

18 Phase of Large Capital inflows India witnessed large capital inflows prior to the global crisis of (Charts 1 & 2) RBI used a number of instruments in combination to manage the surplus; Allowed some degree of appreciation in the exchange rate, Excess liquidity due to regular intervention managed through a mix of instruments Macro prudential measures also employed

19 * US$ billion Chart 1: Current Account Balance, Capital Account Balance and change in Forex Reserves Current Account balance Capital Account balance Change in forex reserves * April-December 2017

20 * Chart 2: Net Capital Flows as Per cent of GDP (%) * April-December 2017

21 Experience during the Global Financial Crisis and RBI s Policy Response During capital flows decelerated sharply CAD increased Reserves declined Volatility in capital flows translated into sharp volatility in the exchange rate. Drying up of forex liquidity, RBI took several measures to ease FX liquidity

22 Management of Taper Tantrums The period from to saw steady growth in capital flows Chairman Bernanke s testimony on May 22, 2013 triggered large selloffs by the FIIs in most EMEs, including India (Charts 3-7) India resorted to a mix of policy measures including: Currency intervention Monetary policy Trade policy measures Capital flow management measures Measures helped in stabilizing the financial markets An important lesson from taper tantrums episode was that EMEs with better domestic fundaments were more resilient The flows normalized from onwards

23 to (average) * * P Percent Percent Chart 3: Select Macroeconomic Indicators in India on the Eve of Tapering 10 9 Lower GDP Growth than potential 12,0 Inflation was high since 2008 High Inflation Period 8 10, , , ,0 1 2,0 0 0,0

24 Percent of GDP Percent of GDP Chart 4: Issue of Twin Deficit CAD above the Sustainable Level Above sustainable level -4,2-4,7 7,0 6,0 High Government Deficit during Post-Crisis Period Period of fiscal rules -3-2,8-2,8 5, ,6-2,3-1,2-1,3-1 -0,3-1,7-1,7 4,0 3,0 Postcrisis 1 0,7 1,3 2,0 2 2,3 1,0 3 0,0

25 Percent Chart 5: Movement in spread of 10-year India and US G- Sec Yields 6,50 6,30 6,10 5,90 5,70 5,50 Taper talk period 5,30 5,10 4,90 4,70 4,50 3-Jan-13 3-Feb-13 3-Mar-13 3-Apr-13 3-May-13 3-Jun-13 3-Jul-13 3-Aug-13 3-Sep-13 3-Oct-13 3-Nov-13 Source: Reuters. 25

26 US$ billion Chart 6: Net FII investment in India s Equity and Debt Market Fed s taper talk Jan/12 Apr/12 Jul/12 Okt/12 Jan/13 Apr/13 Jul/13 Okt/13 Jan/14 Apr/14 Jul/14 Okt/14 Jan/15 Apr/15 Jul/15 Source: SEBI Equity Debt Total 26

27 01/01/ /01/ /02/ /03/ /04/ /05/ /06/ /07/ /08/ /09/ /10/ /11/ /12/ /01/ /02/ /03/ /04/ /05/ /06/ /07/ /07/ /08/ /09/ /10/ /11/ /12/ /01/ /02/ /03/ /04/ /04/ /05/ /05/ /06/ /07/ /08/ /09/ /10/ /11/ /11/ /12/ /01/ /02/ /03/ /04/ /05/ /06/ /07/ /08/ /09/ /09/ /10/ /11/ /12/ /01/ /02/ /03/ /04/2015 S.D (Percent) Rs. per US dollar Chart 7: Impact on currency market Rupee depreciated to Lowest level in August ,8 1,6 Volatility in Daily Movements in Indian Rupee (30 days-moving average) 54 1,4 56 1, ,0 0,8 0,6 66 0,4 68 0,2 70 0,0

28 Recent Developments in Capital flows India s fundamentals and vulnerability indicators have improved significantly in the recent years, though some deterioration in external debt, current account deficit in Good growth prospects and sound fundamentals driving capital inflows Strong domestic fundamentals low Fiscal/Current account deficit/inflation High GDP growth (one of the fastest growing large economies) and stable political environment & outlook. Stable Domestic Currency (Rupee one of the less volatile EM currencies) The comparative returns in India remains high for FPI flows. Reform measures and political factor aiding market sentiment Further Liberalization of FDI & FPI Norms Implementation of GST, demonetization, etc. FPI flows have picked up in FDI flows have been resilient (Chart 8) FPI flows have been influencing domestic equity market (Chart 9)

29 * US$ billion Chart 8: Trends in Foreign Direct Investment & Foreign Portfolio Investment Foreign Direct Investment to India Net Foreign Portfolio Investment * Foreign Direct Investment data is upto January 2018 and Foreign Portfolio Investment data is upto March 2018

30 Mar/16 Apr/16 Mei/16 Jun/16 Jul/16 Agu/16 Sep/16 Okt/16 Nov/16 Des/16 Jan/17 Feb/17 Mar/17 Apr/17 Mei/17 Jun/17 Jul/17 Agu/17 Sep/17 Okt/17 Nov/17 Des/17 Jan/18 Feb/18 Mar/18 Chart 9: FPI and Indian Equity Markets (Sensex) Sensex vs FPI Equity Flows Avg. Sensex Level Net FPI Equity Flows - RHS (US $ Mio)

31 Unhedged Corporate Exposure Large swings in capital flows to EMEs like India could expose corporates with large unhedged forex exposure to significant interest rate and currency risks This, in turn, could increase vulnerabilities for both local banks and the financial system more broadly. RBI has been monitoring and sensitizing the corporate and the banking system about the need for hedging and RBI has devised appropriate regulations like introducing incremental provisioning and capital requirements for bank exposures to entities with unhedged foreign currency exposures. Overseas corporate borrowings (ECBs) in the Indian case have exhibited declining trend in the recent years (Chart 10)

32 Chart 10: Corporates Borrowing Offshore ECB-Inflows (US $ Mio) * * April-December 2017

33 Some Observations on India s CFM Experience Considerable lessons drawn from past currency crises: Countries with sound fundamentals are more resilient Change in views on capital account management large capital movements (both inflows and outflows) driven by both domestic and global factors India adopted policy of cautious opening of capital account. Composition shifted almost entirely from debt to predominately equity FX intervention, capital control as well as macro prudential measures used in tandem to manage volatile capital flows Use of measures have been contextual and have been rolled back once the pressures abated

34 Policy Mix: Key issues and challenges Better co-ordination between various policies to maximize benefits Within the central bank Asset Quality Review (AQR) and monetary policy, need for co-ordination Between various departments of the Bank during episodes of heightened volatility, e.g., Monetary Policy Department and Financial Markets Operations Department Need for better management of unintended impact of polices, e.g. impact of LCR on operating target of monetary policy,

35 Policy Mix: Key issues and challenges-2 Better Co-ordination with fiscal policy Better co-ordination with government necessary as government s fiscal profligacy could make inflation targeting difficult and could also impact bond yields During taper tantrums, large expenditure by government nullified the initial impact of monetary tightening by the RBI. Good co-ordination required for interest rate defense of exchange rate RBI managed big events like demonetisation and introduction of GST having temporary impact on growth and inflation- required good coordination between Government and RBI. During demonestisation, RBI ran out of stock of G-secs to absorb surplus liquidity. Additional market stabilization bonds (MSBs) issued by Government for liquidity management by the RBI. Standing deposit facility (SDF) expected to be introduced shortly. Need to withstand pressure from government to cut rates to promote growth when other indicators point otherwise: independence of monetary policy`

36 Key Risks Going Forward and Outlook Pace of US Fed s rate hikes and pruning of its balance sheet Financial market volatility Trade war concern Crude Oil Prices Reversal of downward trend? Geopolitical Risks? Abrupt changes in sentiment or global liquidity conditions India better placed than during the 2013 taper tantrums episode to weather any externally induced volatility Capital flows to India likely to continue on the back of sound macro-economic fundamentals, good growth prospects, reforms and large liquidity overhang in the international financial system

37 Concluding Observations RBI like other EM central banks uses a mix of policy measures to meet multiple objectives: price stability. Growth and financial stability There has been considerable focus on macro-prudential measures (MPMs) in the recent period Use of a mix of monetary policy, MPMs, exchange rate policy and CFMs along with other ad-hoc measures have been made for managing episodes of crisis Legitimacy of MPMs well established but use of capital controls is a bit controversial despite an explicit endorsement by the IMF for selective use of CFMs Amid global financial cycles and trilemma (impossible trinity), soft capital account management becomes a necessity for an EME like India as corner solutions are not considered feasible Keeping external debt within practicable limits and prudence regarding the external sector would help strengthen financial and macroeconomic stability

38 Thank You