RBI Annual Report

RBI Annual Report 2014-2015 The RBI Annual Report for 2014-15 highlighted the three core work in progress areas for the RBI to restore macroeconomic stability to the economy - lower than potential economic growth, inflation projections for January 2016 at the upper limits of RBI's inflation objective and the muted willingness of banks to cut base rates. It stated that the short term macroeconomic priorities of the RBI were focus on bringing down inflation in line with the proposed glide path; work with the Government and banks on speeding up the resolution of distressed projects and cleaning up bank balance sheets; ensure banks have the capital to make provisions, support new lending, and thus pass on future possible rate cuts. The report elaborates the ground work done by the RBI during the year along with the government to build institutions for more transparent and independent monetary policy. Thus measures like the historic agreement between the RBI and the government spelling out RBI's inflation objective, shift in the liquidity management framework from a fixed rate one to auctioning of liquidity in the market has helped in greater transparency and also lower volatility in the weighted average call rate even during the regular quarter end volatile periods. Other than this, the conduct of regular term repo auctions is intended to facilitate the emergence of a market-based term money benchmark. The agreement between the government and the RBI represents a fundamental institutional reform in India as it mandates the RBI to pursue FIT (Flexible Inflation Targeting) with transparency, predictability and accountability. Along with these measures, the publication of the Monetary Policy Reports from September 2014 onwards providing medium-term outlook and the balance of risks have helped to enhance greater public understanding and accountability of monetary policy formulation and operations. The Report also highlighted the problem of rising NPAs of banks especially PSBs and the measures undertaken by the RBI to deal with such stressed assets. Factors like the stigma attached and provisioning required by banks for bad loans, lack of resolution by other stakeholders, undue advantage taken by existing promoters from banks to avoid NPA classification of their assets and the judicial process have acted as impediments to the resolution of the rising stressed asset crisis in banks. To remedy both the paralysis as well as the unfair distribution of losses, RBI has taken a number of actions. It has created a database of loans over `50 million (the CRILC database), and has advised banks and NBFCs to report regularly on the status of the loans, ensuring that all the creditors are on one forum. This has made it easier for the promoter and the creditors to reach a consensus on actions, even while making it harder for the promoter to play one creditor off against another. While restructured loans are classified as non-performing, RBI has allowed bankers to stretch repayment profiles for performing loans to infrastructure and the core sector subject to specific conditions. Further in case of restructuring, banks have been allowed to write in clauses that allow banks to convert loans to equity in case the project gets stressed again. The Report lauds Government's step to add to the recapitalisation fund for banks on the basis of level of cleaning of the balance sheet and generating healthy growth. The Report stresses that the real economy will not wait for the banking system, and a slow pace of reform could lead to greater, rather than lower risk residing in the banking system. 7

The Reports also brings out the changes wrought over the year in a move towards professionalising the operations of PSBs. It stressed on the need for appropriate pay compensation along with better accountability for middle and senior managers as well as Board members of PSBs for them to compete in the marketplace with private and foreign banks. As many PSBs have higher overall costs than private sector banks performing similar activities, there is some scope for cost rationalisation even while improving the pattern of compensation. The PSBs need to be fully compensated by the Government for the public interest activities undertaken by them in order to keep a level competitive playing field for them. The banking sector is expected to experience a substantial change in the nature of competition as two new universal banks start operations, and a number of payment banks and small finance banks have been approved for license. Payment banks are expected to offer bank accounts in every corner of the country, facilitating payments and cash transfers through new technologies and physical access points. The RBI has put out frameworks on the Leverage Ratio, Countercyclical Capital Buffer, Capital for Domestic Systemically Important Banks, the desirable extent of large exposures, and various liquidity ratios as per the new Basel norms. RBI plans to come out by January 1, 2016 with thoroughly revised master documents covering different regulatory issues, with real-time updation and will attempt to streamline and simplify regulations where possible. The RBI announced a number of initiatives and measures during the year to incentivise banks to improve pass through of rate reductions at their end. Some of these measures include greater operational flexibility to price credit with the freedom to revise the methodology every three years instead of every five years and also were issued directions to address the issue of arbitrary charging of spread. In its first bi-monthly monetary policy statement for 2015-16, the RBI stated that the base rate calculated on the basis of a marginal cost of funds should be more sensitive to changes in policy rate. Once the Financial Benchmark India Pvt. Ltd., an independent benchmark administrator, starts publishing various indices of market interest rates, the RBI will encourage banks to use the indices as an external benchmark for pricing bank products. RBI established Financial Market Regulation Department (FMRD) and The Financial Markets Operations Department (FMOD) to strengthen market regulation and surveillance. The FMRD was created with the objective of regulation and development of the money, G-secs, foreign exchange and related derivatives markets. RBI is proposed to set Market Intelligence Cell as part of FMRD. The FMOD's primary function of FMOD is to facilitate vibrant, efficient and stable financial markets to support a rapidly growing real economy. The first step towards transparent financial market benchmarks was taken with the launch of the FBIL overnight Mumbai interbank offer rate (FBIL- Overnight MIBOR) on July 22, 2015.RBI instituted public dissemination system at the Clearing Corporation of India Ltd. (CCIL) from April 13, 2015 for disclosing the price and volume information on major interbank over-the-counter (OTC) foreign exchange derivatives. RBI enhanced short sale limit and permitted short sale in OTC market. Re-repo of G-secs acquired under reverse repo has also been permitted. Foreign portfolio investors (FPIs) were permitted to acquire G-secs directly from any counterparty in the secondary market. Settlement of all FPI transactions in G-secs has been permitted on T+2 basis. FPIs were allowed to reinvest coupons, received on their investments in G-secs, outside the existing limit and also permitted to hedge the currency risk of the coupon receipts on debt securities falling due during the following 12 8

months. With the objective of introducing new products and expanding markets, 6-year and 13-year cash settled interest rate futures (IRFs) on Government of India (GoI) securities with residual maturity of 4-8 years and 11-15 years, respectively, were permitted on exchanges. In the currency market the focus of the RBI measures during the year was to ensuring robust and stable capital flows to finance the current account deficit and supplement savings in financing the investment needs of the economy. Partly paid equity shares and warrants issued by an Indian company were eligible instruments for FPI and FDI shares and they were also permitted to issue equity shares against any funds payable by them, remittances of which did not require prior permission of the government or RBI under FEMA, 1999.Following the changes announced by the Government in the FDI policy, regulations were amended to enable foreign investments: (a) up to 49% in the defence sector under the government approval route; and (b) up to 100% in railway infrastructure and manufacturing of medical devices under the automatic route. In addition, FDI in the insurance sector was increased to 49% from the earlier level of 26%. The scope of ECB was expanded and recognized non-resident lenders were allowed to extend loans in Indian rupees to eligible resident borrowers. The limit under the liberalised remittance scheme (LRS) was enhanced to US$ 2,50,000 per individual per financial year from the existing limit of US$ 1,25,000. The stance of monetary policy on the back of conducive supply management, the government's fiscal measures, favourable commodity prices, helped in achieving sustained and significant disinflation to levels well below the set trajectory. Average inflation at 5.90% during 2014-15 turned out to be significantly lower than 9.50% a year ago. Intra-year movements in inflation during 2014-15, however, exhibited three distinct phases - first, weather related vegetable price pressures till August; second, the subsequent fall in food prices and passthrough of declining global commodity prices into food, fuel and services prices, and finally the reversal of favourable base effect, which pushed inflation up to 5.30% in March 2015.In order to capture shifting consumption pattern of households, the Central Statistics Office (CSO) revised the base year of CPI to 2012 from its earlier base of 2010.During 2014-15, large divergence between the wholesale price index (WPI) and CPI inflation in the first half of 2015 also posed a major challenge for monetary policy communication, following the adoption of CPI-C as the inflation target against the backdrop of growing expectations of a highly accommodative monetary policy stance based on deflationary WPI. Monetary and credit conditions remained sluggish through 2014-15. The sizeable expansion in RBI's net foreign exchange assets driven by surges in capital inflows was largely sterilised by active liquidity management operations. Reserve money grew at a subdued pace, reflecting the slow pace of economic activity as well as the anti-inflationary monetary policy stance of the RBI. Credit demand was muted reflecting the slack in the economy; also increasing levels of nonperforming assets imparted an element of risk aversion across the banking sector, which inhibited credit supply. The money supply growth slowed down in 2014-15, mainly reflecting easing inflation which lowered the demand for money. Non-food credit growth decelerated sharply in 2014-15 to 9.30% (y-o-y), with incremental nonfood credit declining to `5.50 trillion from `7.30 trillion in 2013-14. A host of factors weighed down on credit off-take, including lower corporate sales, 9

softening of inflation rate, risk aversion by banks due to rise in non-performing loans, and procedural delays in debt recovery. In January 2015, the Central Statistics Office (CSO) released a new series of India's national accounts. As per the new series, real activity (at market prices) picked up in 2014-15, rising by 7.30% on top of a growth of 6.90% in 2013-14, driven mainly by private consumption and supported by fixed investment, even as government consumption and net exports slackened considerably. From the supply side, the quickening of activity in 2014-15 was largely led by industry and services. Within industry, higher growth was observed in manufacturing and electricity generation. On the other hand, the agriculture sector lost momentum, adversely impacted by the deficient southwest monsoon (SWM) which affected kharif sowing and by unseasonal rains and hailstorms at the time of Rabi harvesting. Gross domestic saving rate of households declined for the second consecutive year on account of a decline in physical assets as well as in valuables. Investment rate also declined in 2012-13 & 2013-14 respectively, largely reflecting the slackening in the non-financial corporations' investment rate on account of weak domestic and external demand and other structural factors such as delay in land acquisition and environment clearances, weak business confidence and policy uncertainties, as did household investment rate. Industrial production posted a growth of 2.80% during 2014-15. Excluding the consumer durables category, industrial production would have risen by 5.30% during 2014-15.The services sector is estimated to have grown by 9.40% during 2014-15 mainly driven by 'financial, real estate and professional services' and construction sector. The fiscal position of the general government deteriorated in 2014-15 (RE). The combined fiscal deficit stood at 6.90% of GDP as against 6.60% in 2013-14. In 2014-15 (provisional accounts), non-debt receipts were sluggish reflecting tepid domestic activity. While gross tax collection suffered a shortfall of 8.80% from the budget estimates (BE), net tax inflows turned out to be 7.70% lower than BE, mainly on account of subdued indirect tax receipts. Non-tax revenue was also lower than BE due to lower collections from general, economic, fiscal and social services. Non-debt capital receipts were significantly lower than the budgetary target, reflecting a large shortfall in disinvestment proceeds. The shortfall in non-debt receipts warranted a sharp cutback in plan expenditure by more than 20%, both on the revenue and capital accounts, in order to meet deficit targets. Global developments impacted India's external sector significantly in 2014-15. The collapse in international commodity prices, particularly of crude, delivered a positive shock, yielding a large measure of savings in imports. Export performance remained resilient to the commodity price plunge and large movements in G3 exchange rates for the greater part of the year. However, the conjunction of weak global demand, decline in crude prices affecting exports of petroleum products (POL) and persisting real appreciation of rupee, eventually took its toll, resulting in export contraction in the last quarter. With import prices falling faster than export prices, however, unexpected terms of trade gains accrued. Imports of gold remained subdued until the liberalisation of restrictions prompted a surge in volumes in the later part of the year. All these factors restrained the CAD within sustainable limits. Foreign investments, both direct and portfolio recorded substantial inflows. Consequently, the external financing requirement was comfortably met and there was large accretion to the reserves. The plunge in global prices of crude oil by nearly 50% between June 2014 and March 2015 compressed 10

India's POL import bill by 16% yielding a saving of US$26.50 billion in relation to the outgo on this account a year ago. With the decline in exports exceeding the fall in imports, the merchandise trade deficit widened marginally in 2014-15 from its level in 2013-14. While softening of oil prices compressed India's POL trade deficit, the non-pol trade deficit widened from US$34.20 billion in 2013-14 to US$55.70 billion in 2014-15.The Indian rupee depreciated only marginally against the US dollar, it gained strongly against other major currencies, reflecting the weak economic outlook for these economies and their ultra-accommodative monetary policies. Agenda for 2015-16 The focus of the RBI's monetary policy stance during 2015-16 will be on fostering a gradual and durable disinflationary process towards the target of below 6% by January 2016 in order to achieve the centrally projected rate of 4% by the end of 2017-18. Identifying the impediments in pass-through and implementing an alternative method, such as marginal cost based credit pricing or identifying an appropriate benchmark for the bank lending rate will be a priority for the RBI. In this regard, it is imperative to develop market based benchmarks by developing the term segment of the money market. Thus, liquidity support may have to be progressively provided through regular auctions of longer term repos with reduced dependence on overnight fixedrate liquidity support. While doing so, it will also be important to dampen deviations of WACR and other money market rates such as CBLO rates from the repo rate in a narrow range. The RBI would continue to explore and augment its instruments of liquidity management, including standing deposit facility for absorption of surplus liquidity, as recommended by the Expert Committee. www.rbi.org.in 11