Monetary Policy in India Deepak Mohanty Executive Director Reserve Bank of India September 16, 2013 1
I. Objective(s) An Outline II. III. IV. Policy Framework Operating Procedure Outcome V. Conclusion 2
I. Multiple Objectives The Preamble to the RBI Act (1934) delineates its basic functions as: to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage. From this, the broad objectives have evolved as: Price stability : low and stable inflation Growth : credit to productive sectors.and more recently, financial stability 3
II. Monetary Policy Framework Significant changes in monetary policy framework Driven by: - Financial market developments - Institutional setting - openness of the economy - Shifts in monetary transmission mechanism No formal targets till mid-1980s - Credit planning in mid-1960s Monetary Targeting : 1985-86 to 1997-98 Multiple Indicators Approach : 1998-99 onwards 4
Monetary Targeting Framework (1986-1998) Key features - Relatively closed economy - Fiscal dominance - Underdeveloped financial markets: interest rate regulation Broad money (M 3 ) growth : the nominal anchor Reserve money : the operating target Bank Reserves: the operating instrument Stable relationship between money, output and prices Flexible approach allowing for feedback effects 5
Transition to the Multiple Indicators Approach (MIA) Key features - Relatively open economy - Fiscal consolidation, eventually fiscal rule - Financial market integration : through interest deregulation - Problems in targeting money, rate channels gained importance Use of multiple indicators High frequency data - interest rates/rates in financial markets Medium frequency data - currency, credit, banking data, inflation Low frequency data - fiscal, trade, capital flows and BoP, GDP For drawing policy perspectives 6
Percent of GDP Increasing Depth in the Financial Markets 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 G-sec (Central Govt) Foreign Exchange Market Money Market (including CP & CD Excl. T Bills ) 7
Evolution of Multiple Indicators Approach Multiple indicators approach - Use of both quantity and rate variables - Broad money continues to be an information variable Augmented multiple indicators approach - Forward looking indicators (mid-2000s) - Panel of models 8
Augmented Multiple Indicators Approach Monetary Policy Action Panel of Time Series Models Growth and inflation outlook with risks; Liquidity conditions Augmented Multiple Indicators Approach Monetary Projections Broad Money, Aggregate Deposits, Credit to the Private Sector Forward Indicators Relevant variables from industrial outlook survey, capacity utilization survey, professional forecasters survey and inflation expectations survey Quantity Variables Money, credit, fiscal deficit, rainfall index, industrial production, service sector activity, exports and imports, balance of payments and capital flows Rate Variables Interest rates in money, government securities and credit markets; various inflation rates; asset prices and exchange rate 9
III. Operating Procedure Shift to indirect instruments of monetary control Money market the focal point for liquidity management Liquidity Adjustment Facility (LAF) - Repo and Reverse repo rate defines the corridor - Primary instruments of interest rate signaling - Primary instrument of managing day-to-day liquidity Open Market Operations (OMO) - Outright purchases/sales of G-Sec Market Stabilisation Scheme (MSS) - to absorb liquidity of more enduring capital flows Flexible use of multiple instruments LAF, OMO, CRR, SLR 10
Moving to a New Operating Procedure Limitations of Extant LAF Lack of single policy rate lack of a firm corridor Therefore, new operating procedure in May 2011. Key Features of New LAF: Weighted average call rate as the explicit operating target Repo rate: only independently varying policy rate New Marginal Standing Facility (MSF): linked to repo rate The revised corridor with a fixed width of 200 basis points 11
New operating procedure Rate of interest X+100 bps [This standing facility is available unlimited against collateral of government securities from excess SLR and up to 2 per cent of banks NDTL from required SLR]. Bank Rate / Marginal Standing Facility Rate (Ceiling) X [Liquidity against excess SLR securities and export credit refinance facility for banks and liquidity facility for PDs] Policy Rate (Repo Rate) Overnight Call Rate (Target Rate) X-100 bps Reverse Repo Rate (Floor) [Liquidity absorption by the Reserve Bank of India against government securities] Liquidity MSF rate recalibrated at 300 basis points above the policy repo rate on July 16, 2013 as part of measures to address exchange rate volatility. 12
May/13 May/13 May/13 Jun/13 Jun/13 Jul/13 Jul/13 Aug/13 Aug/13 Sep/13 Oct/09 Dec/09 Feb/10 Apr/10 Jun/10 Aug/10 Oct/10 Dec/10 Feb/11 Apr/11 Jun/11 Aug/11 Oct/11 Dec/11 Feb/12 Apr/12 Jun/12 Aug/12 Oct/12 Dec/12 Feb/13 Apr/13 Jun/13 Aug/13 Rate (Percent) Liquidity (Rs. Trillion) Transmission Generally Stronger Under Liquidity Deficit 16 2 16 0 14 12 10 8 6 4 1.5 1 0.5 0-0.5-1 -1.5 14 12 10 8 6-0.5-1 -1.5 2 0-2 -2.5 4 2-2 0-2.5 Repo Rate Weighted Call Rate Liquidity (RHS) 13
Rate (Percent) 02/Jul/10 02/Sep/10 02/Nov/10 02/Jan/11 02/Mar/11 02/May/11 02/Jul/11 02/Sep/11 02/Nov/11 02/Jan/12 02/Mar/12 Call Rate More Stable Under the New Procedure 02/May/12 02/Jul/12 02/Sep/12 02/Nov/12 02/Jan/13 02/Mar/13 02/May/13 02/Jul/13 02/Sep/13 02/May/13 16/May/13 30/May/13 13/Jun/13 27/Jun/13 11/Jul/13 25/Jul/13 08/Aug/13 22/Aug/13 05/Sep/13 14 12 Average (AV) = 6.32 Standard Deviation (SD) = 0.74 Coefficient of variation (CV) = 11.72 Average (AV) = 8.07 Standard Deviation (SD) = 0.74 Coefficient of variation (CV) = 9.15 14 10 12 8 10 6 8 6 4 4 Call rate(on) Average call rate Recent volatilities largely due to pressure in foreign exchange market. 14
2-May-13 16-May-13 30-May-13 13-Jun-13 27-Jun-13 11-Jul-13 25-Jul-13 8-Aug-13 22-Aug-13 5-Sep-13 2-Apr-09 2-Jun-09 2-Aug-09 2-Oct-09 2-Dec-09 2-Feb-10 2-Apr-10 2-Jun-10 2-Aug-10 2-Oct-10 2-Dec-10 2-Feb-11 2-Apr-11 2-Jun-11 2-Aug-11 2-Oct-11 2-Dec-11 2-Feb-12 2-Apr-12 2-Jun-12 2-Aug-12 2-Oct-12 2-Dec-12 2-Feb-13 2-Apr-13 2-Jun-13 2-Aug-13 Rate (Percent) Call Rates Highly Correlated with Other Money Market Rates 14.0 12.0 14.0 12.0 10.0 10.0 8.0 8.0 6.0 4.0 6.0 2.0 4.0 0.0 2.0 Weighted Money Market Rate (Call+CBLO+MR) 0.0 Weighted Call Rate 91 Day T-Bill (secondary market) Weighted call rate explicitly recognised as the operating target 15
IV: Outcome Improved Macroeconomic Performance Under MIA albeit Some Recent Deterioration Indicator GDP Inflation (%) Call Rate Growth (%) WPI CPI-IW (%) 1 2 3 4 5 Monetary Targeting 1985-86 to1997-98 5.5 8.1 9.1 11.7 (2.2) (3.0) (2.1) (4.0) Multiple Indicators Approach Pre-crisis 1998-99 to 2008-09 6.9 5.4 5.7 6.7 (1.9) (1.6) (3.0) (1.5) Post-crisis 2009-10 to 2012-13 7.3 7.4 10.4 6.3 Projection (latest) 2013-14 5.5 5.0 Post-crisis: Inflation has remained high 16
April May June July August September October November December January February March Y-o-Y Per Cent Inflation Pressures Emerge, though the level is lower 11.0 10.0 9.0 WPI Inflation (Y-o-Y) 8.0 7.0 6.0 5.0 4.0 2011-12 2012-13 2013-14 17
Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Y-o-y * per cent Inflation Pressures from Food and Fuel Persist 25 20 15 10 5 0 All Commodities Food Articles Fuel & Power Non food manufacturing * Three month moving average 18
per cent Second-round Impact on CPI is visible WPI, CPI New (Combined) YoY Trends 12 11 10 9 8 7 6 5 4 WPI- All Commodities New CPI (Combined) New CPI (Combined)- ex. Food, Fuel and housing (Weight 33.2) 19
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 Per cent of GDP Demand Pressures from Fiscal Deficit are Significant 11 Gross Fiscal Deficit- Budget Estimate vs Outcome 10 9 8 7 6 5 4 3 2 GFD - Centre BE GFD - Combined BE GFD - Centre Outcome GFD - Combined Outcome 20
1970-71 1972-73 1974-75 1976-77 1978-79 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2010-11 2012-13 Percent of GDP CAD Risks Remain 6.0 Both Oil and Non-oil current account balance deteriorated Significantly since 2008-09 4.0 2.0 0.0-2.0-4.0-6.0 Non-oil CAB CAB 21
Monetary Policy: Changes in Key Policy Rate Period Inflation Phases and Changes in Key Policy Rates Repo (bps) CRR (bps) WPI Overall NFMP Fuel Food I. Oct-09 to Mar-10 25 75 7.1 1.6 4.6 18.1 II. Apr to Jul-10 75 25 10.4 5.6 13.8 15.4 III. Aug to Nov-10 50-8.8 5.4 11.2 10 IV. Dec-10 to Dec-11 225-9.5 7.6 13.1 8.1 V. Jan-12 to Aug-13 (-)125 (-)200 6.9 4.5 10.7 8.4 Inflation rates in last row are till July 2013 MSF rate increased by 200 bps from 8.25% to 10.25% w.e.f July 15, 2013 22
Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Monetary Policy Witnessing Calibrated Easing After a Tightening Cycle 12 11 10 9 8 7 6 5 4 3 2 1 0-1 Repo Rate CRR WPI Inflation 3m-MA 23
V. Conclusion Monetary policy in India : more eclectic Multiple Objectives: price stability, growth and financial stability Multiple instruments : provides flexibility Role of other factors: Fiscal consolidation & Globalisation Post-crisis: - Some worsening in growth and inflation More-recent: - Currency market pressure - Stability? Pass-through? 24
Thank You 25