DYNAMICS OF MONETARY POLICY FRAMEWORK IN INDIA

Transcription

1 DYNAMICS OF MONETARY POLICY FRAMEWORK IN INDIA Manoel Pacheco and Pryanka Shraly Monetary polcy framework n Inda has evolved Indan economy has moved from a regulated over tme wth a shft n focus from a controlled economy to a market-based economy as expanson n the ntal years to an antnflatonary polcy n the recent years. The ndcated by the gradual changes n monetary management n terms of objectves, nstruments developments n the government securtes and operatonal procedures. market and money market brought about by The monetary polcy n Inda presently pursues fnancal sector reforms have led to several the objectves of mantanng prce stablty, changes n the operatng procedure of monetary provdng adequate credt for economc growth polcy. In the process, the lqudty management and ensurng fnancal stablty. The mportance faclty (LAF) has emerged as the prncpal of prce stablty as a key objectve of monetary operatng procedure of monetary polcy, wth polcy ntally ganed momentum wth the onset repo rates as the key ndcators for sgnalng the of fnancal lberalzaton when strong captal monetary polcy stance, supported by other flows nudged nflaton nto double dgts. The nstruments such as open market operatons mportance of prce stablty was once agan (OMO), cash reserve rato (CRR) and statutory renforced n when the country had to lqudty rato (SLR), among others. Aganst ths face sharp ncreases n nternatonal commodty backdrop, the followng artcle hghlghts the prces. More recently, from to , monetary polcy framework and nstruments RBI had followed a contractonary monetary used by the Reserve Bank of Inda (RBI), and the polcy stance to ren n a surgng nflaton manly evoluton and the recent developments of the nduced by supply sde factors. Whle the three monetary polcy n Inda. objectves are complementary to one another n 1. MONETARY POLICY FRAMEWORK the long run, the RBI has persstently had to AND INSTRUMENTS: address the tradeoff arsng n the short run. The dlemma of provdng credt at vable rates to Monetary management, whch comprses of support economc growth wthout fuellng assessng the lqudty needs of the bankng nflaton s a constant tussle faced by the Central system and accordngly supplyng or absorbng Bank. Further, n a rapdly globalzng world, the approprate amount of lqudty through fnancal stablty has also ganed mportance n varous nstruments, plays a central role n monetary polcy decson makng, more so, after mplementaton of the monetary polcy. The the global fnancal crses. Mr. Manoel Pacheco and Ms. Pryanka Shraly are Senor Executve Offcers, Economc Research and Survellance Department, CCIL January 2014 CCIL Monthly Newsletter 7

2 CCIL Monthly Newsletter January 2014 Monetary Polcy Targets Central banks seek to acheve the fnal objectves of monetary polcy through ntermedate targets. Lke n other countres, n Inda too, these targets have evolved over tme from broad money to a multple ndcator approach. The RBI dd not have a formal ntermedate target tll the 1980s, and bank credt served the purpose of both the operatng and ntermedate targets. However, due to the hgh level of government borrowngs there was a shft to a new polcy framework n 1985 n the form of monetary targetng wth feedback. Broad money (M3) became the ntermedate monetary aggregate, reserve money remaned the man operatng target, and the short-term nterest rate proxed by overnght call money rate emerged as the supplementary operatng target. The process of fnancal lberalzaton, whch gathered momentum n the 1990s, necesstated a relook nto the monetary polcy and the effcency of broad money as an ntermedate target of monetary polcy. The Reserve Bank, therefore, formally adopted a multple ndcator approach n Aprl Instruments of Monetary Control Hstorcally, RBI employed a range of drect nstruments such as cash and lqudty reserve ratos, drected credt (targets prescrbed for allocaton of credt to preferred sectors/ndustres) and admnstered nterest rates (depost and lendng rates). However, n consonance wth nternatonal experences and the fnancal sector reforms ntated n the early 1990s, the monetary polcy framework n Inda also wtnessed a transformaton, nducng a shft from drect to ndrect nstruments of monetary control. The ndrect nstruments nclude bank rate, margnal standng faclty (MSF), market stablzaton scheme (MSS) and open market operatons, ncludng outrght and repurchase agreement (repo) Cash Reserve Rato CRR s the cash balances whch a bank s requred to hold wth the RBI. The RBI whch was earler empowered to mpose and alter the CRR anywhere between 3% to 15% of the net demand and tme labltes (NDTL) has been gven the flexblty to fx the CRR wthout any celng rate as per the RBI (Amendment) Act, Pursung ts medum term objectve of reducng the CRR, the RBI has reduced the CRR progressvely n phases from the peak of 15% n 1992 to around 5% n the recent years. Currently, the CRR stands at 4% Statutory Lqudty Rato SLR, another nstrument of monetary polcy control was frst mposed on banks n 1949 and was fxed at 20%. It remaned at ths level for almost 15 years tll September 1964, when t was rased to 25%. The next change n SLR was n February Snce then the SLR has stepped up successvely and frequently untl t was rased to 38.5% n September Subsequently, phased reducton of the SLR was desgned and efforts were made to make banks and fnancal nsttutons hold government securtes voluntarly. As a part of ths polcy, SLR was reduced from 38.25% at the begnnng of 1993 to 25% n Currently, the SLR stands at 23%. 8

3 Bank Rate Bank rate, the rate at whch the RBI buys or redscounts blls of exchange or other commercal paper presented by a scheduled bank, was hstorcally algned wth short-term nterest rates. The Bank rate was fxed at 3.5% n 1935 and after a few occasonal changes t was ncreased to 12% n The bank rate whch was dysfunctonal was reactvated n Aprl 1997, and was sharply used between 1998 to 2003, wth the rate varyng from 11% n Aprl 1997 to 6% n Aprl However, wth the ntroducton of LAF, the bank rate began losng ts sgnfcance, as monetary polcy sgnalng was done through modulatons n the reverse repo rate and the repo rate under the LAF. But n February 2012, as a part of money market operatons, the RBI algned the bank rate wth margnal standng faclty rate, whch n turn s lnked to the polcy repo rate under the LAF. Currently, the bank rate stands at 8.75% Lqudty Adjustment Faclty LAF, ntroduced n June 2000, conssts of daly nfuson or absorpton of lqudty on a repurchase bass, through repo (lqudty njecton) and reverse repo (lqudty absorpton) aucton operatons, usng government securtes as collateral. An Interm Lqudty Adjustment Faclty (ILAF) was ntroduced n Aprl 1999, whch was gradually converted nto a full-fledged LAF from June 5, 2000 n phases. The LAF was operated through overnght fxed rate repo and reverse repo from November 2004, whch provded an nformal corrdor for the call money rate. However, there were two major drawbacks, one s the lack of a sngle polcy rate and second was lack of a formal corrdor. To overcome these shortcomngs, a new operatng procedure for LAF was put n place n May 2011 (table 4). Table 1 : Changes n Monetary Polcy Rates and Reserve requrements Year Bank Rate CRR SLR No. of tmes Range (%) No. of tmes Range (%) No. of tmes Range (%) * * up to Dec'13 January 2014 CCIL Monthly Newsletter 9

4 Table 2: Evoluton of LAF Aprl 1998 Aprl 21, 1999 June 5, 2000 May 8, 2001 March 29, 2004 August 16, 2004 October 29, 2004 November 1, 2004 November 28, 2005 May 3, 2011 The Narasmham Commttee II on Bankng Sector Reforms recommended the ntroducton of a Lqudty Adjustment Faclty (LAF). Introducton of an Interm Lqudty Adjustment Faclty (ILAF) through repos and lendng aganst collateral of Government of Inda securtes. ILAF was replaced by full - fledged Lqudty Adjustment Faclty (LAF) operatng through varable rate repo/reverse repo auctons wth same day settlement. Changes n the operatng procedures of LAF. Mnmum bd sze was reduced from `10 crore to `5 crore. Aucton format for LAF was changed from the unform prce aucton method to the multple prce aucton. The tmng for LAF auctons was advanced by 30 mnutes. Repo operaton on an overnght bass was retaned but 1-day reverse repos was phased out, and n ts place the 7-day fxed rate reverse repo on a daly bass and the 14-day varable rate reverse repo on a fortnghtly bass were ntroduced. 1-day fxed rate reverse repo was re-ntroduced. The nomenclature of repo and reverse repo was nterchanged as per nternatonal usage. 7-day fxed rate and 14-day varable rate reverse repos were phased out and the LAF was operated through overnght fxed rate repo and reverse repo. Second LAF (SLAF) was ntroduced on a daly bass, provdng market partcpants a second wndow to fne-tune ther management of lqudty. Revsed Operatng Procedure for LAF was ntroduced. Table 3: Mechancs of Operaton of LAF Mechancs of Operaton - LAF CCIL Monthly Newsletter January 2014 Tenor Rate of Interest Partcpants Overnght repo auctons and reverse repo auctons are conducted on a daly bass (Monday to Frday, except on holdays). Repo and reverse repo operatons are conducted at a fxed rate determned by RBI. Scheduled Commercal Banks (excludng Regonal Rural Banks) and Prmary Dealers (PDs) havng Current Account and SGL Account wth RBI. Bd Sze Mnmum amount of `5 crore and n multples of ` 5 crore thereafter. Tmngs of LAF operatons Elgble Securtes Settlement LAF Repo s conducted between 9.30 A.M. and A.M., LAF Reverse Repo operatons are conducted n the afternoon between 4.30 P.M. and 5.00 P.M. SLR-elgble transferable Government of Inda dated Securtes, Treasury Blls and SDL s. Settlement of transactons n the aucton wll take place on the same day. 10

5 Table 4: New Operatng Procedure of LAF Key features - LAF Explct operatng target Independent varable polcy rate Insttuton of new MSF Revsed Corrdor Weghted average call money rate Repo rate Lnkng of MSF to repo rate Scheduled commercal banks can borrow overnght at 100 bass ponts above the repo rate up to 1% (currently rased to 2%) of ther respectve net demand and tme labltes (NDTL). Bank Rate s algned to the MSF rate. Defned wth a fxed wdth of 200 bass ponts Repo rate s placed n the mddle of the corrdor Reverse repo rate at 100 bass ponts below repo rate MSF rate as well as the Bank Rate at 100 bass ponts above repo rate Table 5 : Changes n LAF Rates Year Repo Reverse Repo No. of tmes Range (%) No. of tmes Range (%) * * up to Dec' Margnal Standng Faclty excessve surplus or shortage of lqudty n the market, thus refutng the very purpose of the Before the new operatng procedure of LAF was corrdor. Thus, the MSF was ntroduced n May ntroduced, the repo rate and the reverse repo rate 2011 to serve as an upper bound of the corrdor were nformally supposed to be the boundares of and was fxed as 100 bps above the repo rate. It s a the LAF corrdor so as to enable the call rate to knd of safety valve whch market partcpants settle n between. However, there were several can approach when ther fundng from the LAF nstances n the past years when the call rates repo wndow s exhausted. Currently, the MSF have breached the corrdor on ether sde due to rate stands at 8.75%. January 2014 CCIL Monthly Newsletter 11

6 Open Market Operatons Wth the progressve phasng out of the admnstered nterest rate structure and the evoluton of a regme of market determned mantan nterest rates at reasonable levels. Snce , on account of lqudty defct there has been an ongong ncrease n open market purchases by RBI. CCIL Monthly Newsletter January 2014 Table 6: Open Market Operatons (` crores) Year Purchase Sale Net Purchase (+) / Net Sales (-) * 3320 * -3320* * * 4508 * * 2679 * -2674* ** * OMO's of T-blls ** ncludes data up to July 2013 nterest rate on Government securtes, OMO's Market Stablzaton Scheme (MSS) has ganed ground and emerged as an mportant Post 1990 reforms, Inda wtnessed a sgnfcant tool of lqudty management. OMO's have ncrease n captal flows whch posed serous come nto sharper focus snce and n challenges to the conduct of monetary polcy treasury blls of varyng maturtes were The foregn nvestment flows surged from to US$ ncluded n OMO. On account of large captal 4161 mllon n to US$ mllon nflows from onwards, RBI conducted a n The reserve accreton of a hgh seres of open market sales durng 2001 to end of magntude due to massve captal flows led to March-2007 to absorb excess lqudty and substantal excess lqudty n the economy. 12

7 Intally, the lqudty mpact of large captal nflows were sterlzed through OMO sales and LAF. Subsequently, there was a need to ntroduce an addtonal nstrument to absorb the lqudty of an endurng nature and thus based on the recommendatons of the Workng Group on Instruments of Sterlzaton, MSS was ntroduced n Aprl Under the MSS scheme, the Reserve Bank ssues treasury blls/dated Government securtes by way of auctons on behalf of the Government and the money rased s mpounded n a separate cash account mantaned and operated by RBI. The amounts credted nto the MSS account are approprated only for the purpose of redempton and/or buyback of T-blls and/or dated securtes ssued under the MSS. maturtes, ncludng dated government securtes. Generally, snce the ntroducton of MSS, the preference has been for short-term nstruments, partcularly 91-day T-blls. In , on account of favorable lqudty condtons n the market there were large addtonal ssuances of government securtes under the MSS, wth total ssuances of dated securtes and T-blls amountng to ` crore. Table 7: Cost of Sterlzaton to the Government (as % to GDP) Year Interest Payments on MSS ` Crore Chart 1: MSS Issuances G-sec day bll day bll day bll Source: CCIL, `RBI MSS has been used effectvely by RBI n absorbng surplus lqudty by nstruments of short-term maturtes, such as 91-day, 182-day and 364-day T-blls, and medum-term ( ` Crore) Sterlzaton operatons through MSS, OMOs/LAF and ncrease n CRR nvolve fscal and monetary costs, whch are borne by the government, the RBI, and bankng system, respectvely. The T-blls and dated securtes ssued for the purpose of MSS have an mpact on revenue and fscal balances of the government to the extent of nterest payment on the outstandng under the MSS. Table 7 shows the nterest payments on MSS borne by the government. January 2014 CCIL Monthly Newsletter 13

8 Durng , the foregn nvestment flows to Inda fell sgnfcantly from ther peak n Thus, n order to provde adequate lqudty, RBI had to ease the monetary polcy. Accordngly, RBI ceased fresh bond ssuances under MSS after September 2008 and also bought back exstng MSS securtes amountng to `47544 crore wth effect from November 2008 n order to nject lqudty nto the system. Reflectng these operatons, MSS balances declned sgnfcantly and the RBI unwound all the remanng MSS balances amountng to `317crore on July 23, Cash Management Blls (CMB) The RBI has used CMBs ntroduced n May 2010 as a tool to manage lqudty n the system by auctonng CMBs to dran out excess lqudty from the bankng system and check volatlty n the forex market. Durng , n order to Table 8: Issuance of Cash Management Blls (` crores) Issue Year Tenor Range (Days) Amount to to * 6 to * up to Sep'13 Crore ` Chart 2: MSS Outstandng Amount (as of March-end) * tackle the volatle rupee, the RBI resorted to lqudty tghtenng measures and ncreased the aucton amounts to `22000 crore of CMB's every week startng md-august wth shorter maturtes. 2. THE RESERVE BANK OF INDIA'S OPERATIONAL FRAMEWORK: CCIL Monthly Newsletter January 2014 MSS Amount * MSS Bal Outstandng as on July 23, 2010 Monetary Condtons (a) Hghly regulated nterest rates n the fnancal markets. (b) Increase n government borrowngs and deteroraton n the government s fscal balance n the 1980 s. (c) Increase n reserve money and money supply, contrbuted prmarly by the RBI s credt to the government. Table 9: Hghlghts of Monetary Polcy n the Pre-reform Perod Technques of Monetary Control RBI used drect nstruments of monetary control, n partcular the CRR and SLR. (a) SLR: progressvely ncreased from the statutory mnmum of 26% n February 1970 to 36% n September 1984 as dspensaton of credt to the government took place va SLR. (b) CRR: ncreased from ts statutory mnmum of 3% snce September 1962 to 5% n June 1973 and then hked to 15% n July 1989 to neutralze the nflatonary mpact of defct fnancng Monetary and Lqudty Management n the Pre-Reform Perod Sgnfcant Monetary Polcy Developments (a) Shft to monetary targetng as the framework of monetary polcy based on the recommendatons of the Chakravarty Commttee (1985). (b) In order to support the process of monetary targetng, money market nstruments such as 182 day T-blls, CD s, CP s and nter-bank partcpaton certfcates were ntroduced based on the recommendatons of Vaghul Commttee (1987). 14

9 Durng ths perod, money market lacked depth and the nterest rates were hghly regulated n the credt market. As a result, banks were forced to set asde a substantal porton of ther NDTL for nvestments n government securtes and the SLR reached a peak of 38.5% n September These developments along wth the balance of payments crss agan called for necessary changes n the framework of the monetary polcy Monetary and Lqudty Management n the Post-Reform Perod up to 2000 Monetary polcy assumed greater sgnfcance n the 1990's and was manly guded by the recommendatons of the Narasmham commttee wth the man objectve of deepenng the fnancal markets. Table 10: Hghlghts of Monetary Polcy n the Post-reform Perod upto 2000 Focus of Monetary Sgnfcant Monetary Polcy Technques of Monetary Control Polcy Developments (a) Lberalzaton of nterest rates (b) Phased reducton n the reserve requrement ratos of CRR and SLR. (c) Inter-lnkages across varous segments of fnancal markets. (d) Actvaton of OMO by the RBI to nfluence lqudty. (e) Restoraton of the Bank Rate as a sgnalng nstrument for monetary polcy. (a) Introducton of aucton system n Aprl 1992 for new central government borrowngs at market nterest rates, whch n turn helped n development of government securtes markets. (b) OMO s ganed ground and was used by the RBI to moderate excess lqudty on account of surge n foregn captal nflows. (c) To support OMO operatons RBI developed repos (repurchase agreements) between RBI and commercal banks. The frst such aucton of repos wth perods rangng from overnght to 14 days, collateralzed by central government securtes were ssued n December (d) The RBI reduced the CRR to around 10% n (e) Reactvaton of the bank rate n Aprl 1997 lnkng t to the RBI refnance rate. (f) Introducton of ILAF n Aprl (a) Greater relance on ndrect nstruments and reactvaton of the bank rate. (b) The use of CRR was progressvely brought down. (c) The RBI swtched from a monetary targetng framework to a multple ndcator approach from Table 11: Changes n the Monetary Polcy Framework n Inda Perod Monetary Polcy Framework Key Features to to to current Monetary Targetng wth feedback Multple Indcators Approach Augmented Multple Indcators Approach Nomnal Anchor: Broad money (M3) Operatng Target: Reserve Money Man Operatng Instrument: Bank Reserves Use of Quantty and rate varables Informaton Varable: Broad money (M3) Other multple ndcators: nterest rates n fnancal markets, currency, credt, captal flows, nflaton, GDP and BOP. Use of forward ndcators (varables from ndustral outlook, capacty utlzaton, professonal forecasters and nflaton expectatons survey) n addton to quantty and rate varables January 2014 CCIL Monthly Newsletter 15

10 2.3. Monetary and Lqudty Management durng 2001 to 2008 Lqudty management was complex durng ths perod on account of surge n captal flows and varatons n cash balances of the government. Aganst ths background, the full-fledged LAF was ntroduced to manage lqudty condtons on a daly bass. Further, lqudty management snce was clearly focused on managng surplus lqudty, smultaneously operatng through LAF, OMO and ssuances under MSS. Durng ths perod, although RBI reduced ts relance on CRR for lqudty management operatons, t was used by RBI as an mportant nstrument for regulatng lqudty n the economy, and SLR was used to provde suffcent lqudty buffer Chart 3: LAF volumes for the perod of to Amount n ` Crore Date Net LAF +1% of NDTL -1% of NDTL Table 12: Monetary and lqudty management operatons durng to Lqudty Condtons Monetary polcy developments and measures by RBI CCIL Monthly Newsletter January 2014 Easy lqudty condtons Comfortable lqudty condtons () Wth a vew to achevng ts medum term objectve of reducng the CRR to ts statutory mnmum level of 3%, RBI gradually reduced the CRR from 11% n August 1998 to 7.5% n May 2001 and to 5.5% effectve from November () Repo rate was reduced four tmes durng the perod from 7% to 5.75%. () Owng to sharp fall n ndustral actvty and exports, the Bank Rate was reduced to 6.50% wth effect from October 22, 2001, ts lowest level snce May (v) Mostly outrght open market sales were conducted to neutralze the monetary mpact of prvate placement of government securtes and to sterlze foregn captal nflows. However, due to adverse reactons n the fnancal markets n the wake of the terrorst attack on September 11, 2001 open market purchases were made durng September 18 to October 3, ) LAF was actvely used durng to manage the njectons of lqudty due to large captal nflows. (Chart 3) ()OMO sales were hgher durng the perod to sterlze large nflows of foregn captal. () Bank Rate was reduced n stages to 6.25% n October

11 Comfortable lqudty condtons Lqudty condtons moderated durng May - July 2004, but bounced back n the 2 nd half of the year as captal nflows to Inda resumed. Lqudty condtons remaned mostly stable durng the perod, whle t tghtened n the last quarter of Complex lqudty condtons due to varatons n government cash balances & captal flows. Lqudty condton remaned volatle throughout the year () Durng Aprl December 2003, RBI contnued to absorb lqudty emanatng from captal flows by an even mx of OMO sales and LAF. CRR reduced from 4.75% to 4.50% effectve August 25, Bank Rate was reduced to 6% effectve Aprl 30, () Durng January March 2004, sterlzaton was manly through LAF repo () Durng Aprl to May 2004, there was ample lqudty on account of captal nflows, whch was absorbed through LAF and MSS. () Durng May to October 2004, captal outflows, rsng mport demand, hke n crude ol prces and buld up of the center s surplus wth RBI brought down the surplus lqudty. Thus, to ease lqudty condtons, RBI manly njected lqudty through repos. () Durng November to March 2005, there was a dversfed trend n lqudty management through LAF and MSS. (v) Wth the ntroducton of MSS n Aprl 2004, the pressure on the LAF wndow gradually reduced and the outstandng reverse repo amount fell from `89,435 crore (md-aprl 2004) to only `15,820 crore by December 10, () Durng Aprl July 2005, the lqudty surplus was absorbed through contnued ssuances under MSS accompaned by reducton n absorpton through reverse repos under LAF. () Lqudty n the system ncreased durng July 23 August 12, 2005, manly due to the spurt n foregn exchange nflows (followng the revaluaton of the Chnese currency) and a further reducton n the Centre s surplus nvestment balances wth RBI. Ths was absorbed through LAF reverse repos whch rose from `10,485 crore as on July 22, 2005 to a peak of `50,610 crore as on August 3, () Towards the end of 3 rd quarter and n the 4 th quarter, lqudty condtons tghtened and balances under LAF transted from absorpton to njecton mode and auctons of T- Blls under the MSS were dscontnued effectve November 16, 2005 to nject lqudty () LAF reverse repo and repo rates were ncreased twce by 25 bass ponts each to 6.0% and 7.0%, respectvely LAF shfted from an absorpton mode to njecton mode from December 2006 onwards and agan shfted back to absorpton mode from February () CRR was hked by a cumulatve of 100 bass ponts n four equal phases of 25 bass ponts each durng December March st () In addton to LAF, RBI also used MSS to mop up excess lqudty n the economy () Polcy rates remaned unchanged throughout the year. () Celng of `3000 crores was mposed by RBI on the reverse repo wndow of RBI st ( `2000 crores n case of the 1 LAF and `1000 crores n case of the 2 nd LAF) untl August 6 th 2007 on account of surplus lqudty whch emanated on account of easng central government deposts wth RBI. () Followng a hke n the CRR rate, the lqudty condtons tghtened. January 2014 CCIL Monthly Newsletter 17

12 2.4. Monetary and Lqudty Management durng 2008 to 2013 The effcacy of RBI's monetary polcy was truly tested from to , wth dppng growth due to the onset of the global fnancal crses, a spralng nflaton and a sharp deprecaton n the rupee n % Chart 4: Movement of Call Rates wthn the LAF corrdor Date Reverse Repo Rate Repo Rate Call Rate MSF Rate CCIL Monthly Newsletter January 2014 Amount n ` Crore Chart 5: Net LAF volumes for the perod to Date Net LAF MSF vol +1% of NDTL -1% of NDTL 18

13 Table 13: Hghlghts of Monetary Polcy durng Macro-economc and Lqudty Condtons Monetary Polcy Acton Surge n nflaton durng the frst half of the year. Economc growth tumbled due to the fallout of the global fnancal crses. RBI rased the repo rate on 3 occasons to 9% n the frst 6 months of the year. The CRR rate was ncreased on 6 occasons to 9%. The repo rate was reduced by a cumulatve of 400 bps to 5%, whle the reverse repo was cut on 3 occasons to 3.5%. The CRR was also cut 3 tmes by 350 bass ponts from 9% to 5.50% As a consequence of the crses, mutual funds began to face large redempton pressures and began to wthhold ther lqudty from money markets. Other market partcpants such as NBFCs that reled on Mutual funds for meetng ther fnancng needs began to take a ht. These market partcpants turned to commercal banks to shoulder ther fundng requrements. v The wedge between bank credt and aggregate deposts started wdenng. RBI began to conduct a second LAF on a daly bass. A specal fxed rate term repo of 14 days tenor under LAF was ntroduced on a daly bass Inda s GDP grew from 5.7% n Q1 to 11.2% n Q4. RBI mantaned an accommodatve monetary polcy by reducng the repo and reverse repo rate by 4.75% and 3.25% and thereafter left the rates unchanged for nearly 12 months. By keepng the overnght nterest rates low, there was a hgher pressure among banks to reduce ther lendng rates. The contnuance of low polcy rates transmtted across the maturty spectrum, albet rather slowly to the long term lendng rates of banks. Mountng nflaton pressures manly nduced from supply sde factors. To complete the central and state government borrowngs smoothly. The specal term repo faclty was dscontnued by the end of October RBI rased the CRR of scheduled banks n two stages from 5% to 5.75% of ther NDTL by February By md -March 2010, the RBI rased the repo rate to 5% and the reverse repo rate to 3.5%. RBI added prmary lqudty through OMOs and the unwndng of MSS balances January 2014 WPI nflaton rate ranged from 8.20% to 10.88% through the year. Lqudty pressures due to an ncrease n the government balances wth the RBI produced from the 3G/BWA spectrum auctons n May and June RBI ncreased the repo rate by a cumulatve of 175 bps to 6.75% and the reverse repo rate by 225 bps to 5.75%. The CRR was also adjusted upwards to 6%. RBI extended the addtonal lqudty support to SCBs under the LAF to the extent of up to 0.5% of ther NDTL. RBI began conductng Second LAF on a daly bass up to July 16 th CCIL Monthly Newsletter 19

14 Table 13: Hghlghts of Monetary Polcy durng CCIL Monthly Newsletter January 2014 The Net LAF surpassed RBI s comfort zone of +/-1% of the NDTL n October 2010 due to a sgnfcant buld -up of government cash balances as a result of hgher than antcpated tax recepts. The Net LAF touched a record ( -) `1,70,485 crores n December Headlne WPI nflaton rate remaned at elevated levels. Inda s GDP rate started deceleratng. The US soveregn credt ratng downgrade and the deepenng of the Euro area crses led to an apprecaton of the USD aganst major emergng market currences as the US dollar was consdered to be a safe haven. RBI ntervened through the sale of USD along wth stern captal account measures whch consequently began to stran the rupee lqudty n the system. The Net LAF breached the comfort zone of RBI and exceeded (-) `1,00,000 crores n November Domestc growth remaned at one of ts weakest post crses levels. The RBI conducted a specal Second LAF and specal two -day repo aucton. The RBI allowed waver of penal nterest on shortfall n mantenance of SLR to the extent of 1% of NDTL. RBI ntroduced a daly Second LAF. The RBI purchased government securtes through OMOs Repo rate was ncreased by a cumulatve of 175 bps to 8.5%. A seres of OMO purchase auctons were ntated by RBI RBI reduced the repo rate on 3 occasons, by a cumulatve of 100 bps, to 7.5%. The borrowng lmt of SCBs under MSF was also ncreased f rom 1% to 2% of ther NDTL (up to Dec 2013) To curb the mountng nflatonary pressures. RBI rased the repo rate to 7.75%. Sharp deprecaton n the rupee due to a growng market percepton of a possble taperng n the quanttatve easng programme of the Untes States. The rupee strengthened by the September -end along wth a reducton n volatlty. The RBI rased the MSF rate to 10.25%, capped the overall allocaton of funds under the LAF to 1% of the NDTL of the bankng system and announced open market sales of government securtes of `12,000 crore on July 15 th The RBI put a lmt on the overall access to LAF by each ndvdual bank at 0.5% of ther outstandng NDTL and mandated a mnmum daly CRR balance of 99% of the requrement on July 23 rd On August 8 th 2013, the RBI announced the aucton of cash management blls for a notfed amount of `22,000 crore once every week on Mondays. v RBI announced a specal swap wndow for ol marketng companes to shft ther dollar requrements out of the nter - bank market on August 28 th v RBI offered a wndow to the banks to swap the fresh FCNR dollar funds, moblzed for a mnmum tenor of three years and over at a fxed rate of 3.5% per annum for the tenor of the depost. Further, Banks were allowed to swap the overseas borrowng moblzed by banks at a concessonal rate of 100bps below the ongong swap rate prevalng n the market. MSF rate was reduced n phases back to 8.75%. The mnmum daly mantenance of the CRR was brought down to 95% of the NDTL. 20

15 Concludng Remarks: Over the years, the RBI's monetary polcy framework has evolved by leaps and bounds wth dverse tools beng ntroduced n the process to steer market lqudty n the desred trajectory. However, the role of RBI n formulatng ts monetary polcy has turned more complex wth a persstent tussle to satsfy prce stablty, boost economc growth and mantan fnancal stablty as seen n the recent months. The LAF framework of RBI has progressed as a flexble monetary polcy tool that has not only helped n stablzng the money market rates, but also helped strke a comfortable lqudty poston among market partcpants. The ntroducton of the MSF rate has further provded leeway to the central bank to maneuver lqudty management n Indan money markets. References: 1. Deepak Mohanty (2013) 'Effcacy of Monetary Polcy Rules n Inda' 2. Deepak Mohanty (2011); 'How does the Reserve Bank of Inda Conduct ts Monetary Polcy?' 3. Rakesh Mohan (2006) 'Copng Wth Lqudty Management n Inda: A Practtoner's Vew' 4. Reserve Bank of Inda (2011); 'Report of the Workng Group on Operatng Procedure of Monetary Polcy'. 5. Reserve Bank of Inda; 'Annual Reports'(Varous Issues) 6. Reserve Bank of Inda; 'Notfcatons and Press Releases' (Varous Issues) 7. Reserve Bank of Inda ( ); 'Report on Currency and Fnance'. 8. Reserve Bank of Inda: Report on Currency and Fnance : Fscal-Monetary Coordnaton. CCIL Monthly Newsletter January

16 Annexure 1- Snapshot of Inda's Macro Economc Indcators: Y-o-Y growth n Inda's WPI and CPI Inflaton Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Inflaton Rate (%) Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Month WPI CPI 1, , Central Government Deposts wth RBI 02-Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec-2013 Central Government Deposts wth RBI 12.0 Trend of Inda's GDP Growth Rate CCIL Monthly Newsletter January 2014 GDP growth Rate (%) Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Quarter Inda's GDP Growth Rate 22