Part I. Annual Statement on Monetary Policy for the Year 2008-09
Developments in the Global Economy
46. Global economic activity decelerated somewhat in relation to earlier expectations, mainly on account of the slowdown in the US economy. During the first quarter of 2008, the unfolding of the subprime mortgage crisis coupled with growing concerns about a contraction of economic activity in the US in 2008 appears to be feeding into a deterioration in the outlook for global growth which has remained relatively resilient so far. There are some signs that the slowdown in the US may spill over to the euro area, China and Japan with potential implications for the emerging market economies (EMEs) through trade, financial markets and other linkages. According to the World Economic Outlook (WEO) of the International Monetary Fund (IMF) released in April 2008, the forecast for global real GDP growth, on a purchasing power parity basis, is expected to slow from 4.9 per cent in 2007 to 3.7 per cent in 2008 as compared with the projection of 4.1 per cent published in January 2008 and 3.8 per cent in 2009. World real GDP growth, on the basis of market exchange rates, is estimated to decelerate from 3.7 per cent in 2007 to 2.6 per cent in 2008 and 2009.
47. In the US, real GDP grew by 0.6 per cent in the fourth quarter of 2007 as compared with 2.1 per cent a year ago and 4.9 per cent in the previous quarter. In the first quarter of 2008, labour markets weakened with the unemployment rate rising to 5.1 per cent in March 2008. Household and consumption demand is likely to be affected with home prices having fallen by 10.7 per cent in the year ending January 2008, bank seizures having more than doubled in March 2008 over the level a year ago and the year-on-year monthly foreclosure continuing to increase in March 2008 for the 27th consecutive month. US real GDP growth is expected to slow further during 2008 as the housing market downturn deepens and the financial market turmoil spreads across the financial system with macroeconomic implications as apprehended by the IMF in its April 2008 Global Financial Stability Report. The index of leading indicators increased marginally in March after a continuous decline up to February 2008. However, consumer sentiment was at its lowest level in 26 years in April 2008. The US economy is expected to show some improvement in the second half of 2008, when tax rebates in the fiscal stimulus package could lift growth. The IMF's April 2008 update of its WEO expects the US economy to grow at a slower pace of 0.5 per cent in 2008 as against 2.2 per cent in 2007, but projects some recovery to 0.6 per cent in 2009.
48. Real GDP in the euro area grew by 2.3 per cent in the fourth quarter of 2007 on a year-on-year basis as compared with 3.3 per cent a year ago. Real activity appears to have strengthened in the first quarter of 2008. Unemployment fell in January-February 2008 to a record low of 7.1 per cent notwithstanding currency appreciation, surging oil prices and the US slowdown. Growth in European service industries has accelerated above projections with optimism on export prospects. However, European retail sales fell in March after rising for the first time in five months in February. Retailers continue to lack pricing power with consumer spending held down by inflation at its highest level in 14 years. The April 2008 update of the IMF's WEO has placed real GDP growth of the euro area at 1.4 per cent in 2008 and 1.2 per cent in 2009 as against 2.6 per cent in 2007.
49. The Japanese economy grew by 3.7 per cent in the fourth quarter of 2007 as compared with 2.2 per cent a year ago. In the first quarter of 2008, lead indicators point to some slackening of momentum while consumer and business sentiment has weakened. Japan's factory production fell in January-February 2008 as a deepening US slowdown weakened demand for cars and electronics. Exports and production are slowing and wages remain subdued. Consumer sentiment in Japan has been worsening with higher crude oil prices and the rising prices of daily necessities. The April 2008 WEO of the IMF has projected that Japan's economy, the world's second largest, will grow by 1.4 per cent in 2008 and by 1.5 per cent in 2009 as compared with the estimated growth of 2.1 per cent in 2007.
50. These unusual developments in global economy indicate heightened uncertainties and emerging challenges for the conduct of monetary policy, especially for EMEs. The IMF has forecast that the emerging and developing economies growth will slow to 6.7 per cent in 2008 from 7.9 per cent in 2007 and further to 6.6 per cent in 2009. Developing Asia will slow by 1.5 percentage points to a still-rapid 8.2 per cent. However, downside risks are emerging to the extent EMEs' growth has depended heavily on external demand and also due to the possibility of capital inflows drying up in the present risk-averse scenario. Rise in risk aversion has already dampened private bond issuance in several EMEs. Most importantly, inflation has raised its head in several EMEs and this might complicate monetary policy decision-making even further, particularly in view of the greater weight for food in consumer prices as well as inflation perceptions in EMEs.
51. The Chinese economy grew by 11.9 per cent in 2007 as compared with 11.1 per cent in 2006 in spite of measures to cool down the pace of growth, including reduction of export rebates and restrictions on processing exports. In the first quarter of 2008, however, growth has moderated to 10.6 per cent as compared with 11.7 per cent a year ago. Reflecting the slowdown in export growth, China's trade surplus fell year-on-year by 10.8 per cent in March 2008 to US $13.4 billion. The total foreign exchange reserves, however, increased to US $ 1.7 trillion in March 2008 as compared with US $ 1.2 trillion in March 2007. In 2008, the Chinese economy is expected to moderate to a growth of 9.3 per cent as tightening policies take effect. The CSI 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, has fallen by 28.8 per cent to 3803.1 on April 25, 2008 after increasing six-fold in the two years through 2007. The Chinese authorities are making efforts to resolve problems such as overheated growth in fixed asset investment, excessive supplies of money and credit and a huge trade surplus.
52. Among other major Asian economies, the Korean economy grew by 5.0 per cent in 2007, decelerating marginally from 5.1 per cent in 2006 despite higher exports to emerging markets such as China. Economic activity is expected to slow down further to 4.2 per cent in 2008 before accelerating to 4.4 per cent in 2009. In Thailand, economic activity is expected to grow by 5.3 per cent in 2008 and further to 5.6 per cent in 2009 as against 4.8 per cent in 2007, as stronger domestic demand growth and expansionary public expenditures offset slowing export growth.
53. Continuing strong demand and dwindling stocks are reflected in a tight supply-demand food situation globally, leading to the emergence of food price inflation as a key risk to global stability. The FAO's global food price index, which rose by 40 per cent in 2007 to the highest level on record, has continued to increase in the first quarter of 2008 as well, as world food stocks have fallen to their lowest levels in 25 years. Food import bills in the low-income food-deficit countries are likely to rise by 35 per cent for the second consecutive year in 2008. Shortages and high prices for all kinds of food have caused social tensions around the world in recent months in Haiti, Indonesia, Pakistan and several African countries. China has imposed price controls on cooking oil, grain, meat, milk and eggs. In Egypt, the Government has significantly raised food subsidies and signed a bilateral agreement with Kazakhstan for 1 million tonnes of wheat at a preferential price to be delivered during 2008. Indonesia has removed the 5 per cent duty on wheat import and suspended a 10 per cent duty on imported soybeans. In April 2008, the global food crisis appears to have intensified with Kazakhstan one of the world's biggest wheat exporters curbing exports, alongside restrictions in Russia, Ukraine and Argentina. These curbs are likely to trigger similar moves in other foodgrain exporting countries in the face of rising domestic prices worldwide.
54. In the global foodgrains market, prices of major crops such as corn, soyabeans and wheat have increased by 58.2 per cent, 86.3 per cent and 56.5 per cent, respectively, by April 25, 2008 from a year ago in response to surging demand. The increase in overall foodgrain prices has gained momentum from higher energy and fertiliser prices, low levels of inventories, shortfalls in certain crops mainly caused by weather-related factors such as the ongoing drought in Australia and strong increases in the demand for crops. Higher rice prices are also contributing to inflation in many developing countries as the price of rice, a staple in the diets of nearly half the world's population, has almost doubled on international markets in the last three months. Drawing down of costly stockpiles of rice in recent years has removed an effective price dampener in the face of adverse demand-supply imbalances. Rising prices and a growing fear of scarcity have prompted some of the world's largest rice producers India, Vietnam, Egypt and Cambodia at end-March 2008 to announce drastic limits on the amount of rice they export which have driven prices on the world market even higher. Philippines has started to track down rice hoarders. Rice prices in Thailand have trebled over their level in the beginning of 2008. With Indonesia joining other major rice exporters in banning exports, international near-month futures price of rice on Chicago Board of Trade (CBOT) has risen to a high of US $ 23.8 per hundredweight on April 25, 2008 _ up by 71 per cent since January 2008. On the same day, futures prices were quoted higher at US $ 24.18 for July 2008, but the quotes moderated for September 2008 to US $ 22.09 and for May 2009 to US $ 22.38.
55. Wheat prices remained generally firm and volatile since October 2007 on account of repeated downward revisions of production forecasts in a number of major exporting countries, most notably Australia. World wheat output is now estimated to have risen by only 1.6 per cent in 2007. Trade is expected to contract because of high and volatile prices, coupled with soaring freight rates. One month wheat futures at the CBOT rose from US $ 9.15 per bushel on January 2, 2008 to US $ 12.8 on February 27, 2008 before falling to US $ 8.01 on April 25, 2008. On the same day, futures prices for wheat were quoted higher for July 2008 at US $ 8.16, for December 2008 at US $ 8.49 and for May 2009 at US $ 8.68.
56. Strong demand for animal feed as well as for ethanol is the main driver in global coarse grain markets, but supply tightness in several exporting countries is also providing support to prices. The futures prices of corn on CBOT, which had moderated somewhat up to July 2007, started moving up thereafter and reached US $ 5.77 on April 25, 2008. On the same day, futures prices for corn were quoted higher for July 2008 at US $ 5.90, for September 2008 at US $ 6.00 and for May 2009 at US $ 6.25.
57. Metal prices have increased by 23.7 per cent during first three months of 2008 after declining by 8.1 per cent during 2007 following increases of 53.6 per cent in 2006 and 36.3 per cent in 2005. In the futures markets, aluminium, zinc and lead prices are showing a downward trend since October 2007. Copper prices have been buoyed up by the depreciating US dollar and high demand. Futures price of copper on the New York Mercantile Exchange (Nymex) increased to a record level of US $ 4.03 per pound on April 9, 2008. As on April 25, 2008 the May 2008 futures prices for copper which stood at US $ 3.96 per pound were quoted lower for July 2008 at US $ 3.91, at US $ 3.89 for September 2008 and at US $ 3.78 for May 2009. Spot gold rose to US $ 1000.10 an ounce on March 13, 2008 the highest since January 1980 as the dollar fell to a record low against the euro and on concerns about declining supply on mine shutdowns in South Africa, before declining to US $ 885.15 an ounce on April 25, 2008.
58. Prices of crude oil, which have rebounded since July 2007, increased by 83.2 per cent up to April 25, 2008 from their level a year ago and near-month futures prices have ruled at the record level of US $ 119.64 per barrel on April 25, 2008 the highest since trading began on the Nymex in 1983. On the same day, oil futures ruled at a lower level of US $ 115.77 for September 2008 and US $ 114.06 for December 2008 and US $ 111.6 for May 2009. According to the Energy Information Administration (EIA), tight fundamentals, reflected by low available crude oil surplus production capacity, combined with supply concerns in several oil exporting countries, have continued to put upward pressure on world crude oil prices. The outlook over the next two years points to some easing of the oil market balance due to increased production outside of the Organization of the Petroleum Exporting Countries (OPEC) and planned additions to OPEC capacity. However, delays to capacity additions in both OPEC and non-OPEC nations could alter the outlook, as could OPEC production decisions. According to the EIA, the price of West Texas Intermediate (WTI) crude oil is expected to be at US $ 100.61 per barrel in 2008 and US $ 92.50 per barrel in 2009. Surplus production capacity is projected to decelerate from its current level of a little over 2 million barrels per day (bbl/d) to more than 1 million bbl/d by the end of 2009.
59. In the US, consumer prices increased from 2.8 per cent in March 2007 to 4.0 per cent in March 2008. In the euro area, inflation increased to 3.6 per cent in March 2008 the highest level since the introduction of the euro from 1.9 per cent a year ago. In Japan, inflation increased to a decade-high rate of 1.2 per cent in March 2008 from (-) 0.1 per cent a year ago on account of rising oil and food costs. In the UK, CPI inflation decelerated to 2.5 per cent in February-March 2008 from 2.8 per cent a year ago. At the retail level (in terms of retail prices index or RPI), inflation rose to 4.8 per cent in the UK in March 2007 the highest since 1991 but declined thereafter to 3.8 per cent in March 2008 with some fluctuations in between. Inflation pressures have also raised concerns in some of the EMEs such as China, Malaysia, Indonesia and Chile.
60. Core CPI inflation in the US increased to 2.4 per cent in March 2008 from 2.3 per cent in February 2008. In the UK, core CPI inflation has been declining in tandem with the headline rate and stood at 1.2 per cent in February-March, down from 1.3 per cent in January 2008. In the euro area, core CPI inflation increased to 2.0 per cent in March 2008 from 1.8 per cent in February 2008. Core inflation in Japan turned positive (0.1 per cent) in March 2008 as compared with -0.1 per cent in February 2008. The increase in producer prices has been sharper than in consumer prices, reflecting increased input costs. In the US, producer prices increased from 3.1 per cent in March 2007 to 6.9 per cent in March 2008. In the euro area, producer prices increased from 2.8 per cent in March 2007 to 5.3 per cent in March 2008. In the UK, producer prices increased to 6.2 per cent in March 2008 from 2.7 per cent in March 2007. Wholesale price inflation in Japan increased from 1.2 per cent in February 2007 to 3.4 per cent in February 2008. Overall, the persistence of high food and oil prices sustained at elevated levels and continued high prices of other commodities pose significant inflation risks for the global economy and challenges for monetary policy worldwide.
61. In the EMEs, the recent jump in headline inflation caused by higher energy and food prices are of concern since this requires a balanced response in controlling inflation while being alert to decelerating impulses from the slowdown in the developed countries and the possibilities of a prolonged global financial market turmoil. Even though higher headline inflation may be driven initially by rising food and energy prices, it could quickly lead to broader price and wage pressures in the EMEs which are witnessing rapid growth. In China, inflation accelerated to 8.7 per cent in February 2008 before easing to 8.3 per cent in March as compared with 3.3 per cent in March 2007 despite the central bank's repeated efforts to rein in inflation through monetary tightening policies. At end-March 2008, the Chinese State Council decided to increase budgetary subsidies for grain production and the government's minimum grain procurement prices to address the potential shortfall in grain production. Farmers' interest in grain production has been declining as raw material costs were rising faster than grain prices. Consumer price inflation in Korea accelerated to 3.9 per cent in March 2008 from 2.2 per cent in March 2007 which is causing concern. Inflation increased to 5.3 per cent in March 2008 in Thailand from 2.0 per cent in March 2007.
62. Concerns about a US slowdown and the uncertainty surrounding the financial health of some of the biggest US financial entities have imparted considerable volatility in the US equity markets since January 2008. On January 21, 2008 equity markets across the world experienced sharp declines with fall in Asian stocks as well. The volatility and bearishness in equity markets have continued in February-April 2008 on account of weak US economic data and substantial write-offs by financial institutions. The Dow Jones Industrial Average, Standard and Poor's (S&P) 500 and Nasdaq Composite exhibited considerable volatility and posted declines of 1.5 per cent, 6.5 per cent and 4.9 per cent, respectively, by April 25, 2008 over their levels a year ago. In the fixed income segment, Government bond yields in the major economies, which had firmed up in the first half of 2007, have softened thereafter since demand for government debt has increased as investors shifted their funds to the treasuries acknowledging the likelihood that the economy is already in a recession and seeking safety. The US 10-year bond yield increased from 4.70 per cent at end-December 2006 to 5.29 per cent on June 12, 2007 before falling to 3.87 per cent on April 25, 2008. The 10-year bond yield in the euro area increased from 3.95 per cent at end-December 2006 to 4.68 per cent on July 9, 2007 before falling to 4.18 per cent on April 25, 2008. The Japanese 10-year bond yield has increased from 1.68 per cent at end-December 2006 to 1.97 per cent on June 13, 2007 before falling to 1.61 per cent on April 25, 2008. These recent developments are indicative of evolving uncertainties in international financial markets with implications for EMEs.
63. On a trade-weighted basis, the US dollar has been depreciating since 2006 with intermittent fluctuations. After the cuts in the Fed funds rates since September 2007, the US dollar has weakened against other currencies. The pound sterling moved to the level of US $ 1.99 on April 25, 2008 close to the 26-year high of US $ 2.11 reached on November 8, 2007 amidst concerns relating to the US subprime mortgage market. The euro, which has also been strengthening against the US dollar since June 2007, rose to a peak of US $ 1.60 on April 22, 2008 before declining to US $ 1.56 on April 25, 2008. The Canadian dollar appreciated against the US dollar to a 33-year high to reach US $ 1.09 on November 6, 2007 before declining to US $ 1.01 on April 25, 2008. Turkey experienced a sharp appreciation in its currency vis-a-vis the US dollar to reach the level of 86.95 cents on January 10, 2008 before moving to 77.95 cents on April 25, 2008. The New Zealand dollar had appreciated to 81.10 cents to reach a 22-year peak against the US dollar on July 24, 2007 before declining to 78.07 cents on April 25, 2008.
64. Since the beginning of the turbulence in August 2007, central banks of advanced economies have responded with both conventional and unconventional measures to ease liquidity stress in financial markets and solvency issues among large financial institutions. There has, however, been several aspects that differentiate the approaches of the central banks. Some central banks, notably the ECB, the Reserve Bank of Australia and the Swiss National Bank have responded by providing liquidity to inter-bank markets, implicitly viewing the financial turmoil as essentially a problem of liquidity tightness. These central banks have provided liquidity through fine-tuning operations aimed at assuring orderly conditions in their respective money markets. On the other hand, some central banks like the US Fed, the Bank of England and the Bank of Canada have responded in a more diverse fashion, regarding the market stress as reflecting both liquidity seizure as well as broader threats to financial stability, coupled with dangers of the slowdown in economic activity becoming protracted. Accordingly, they have moved to inject liquidity into money markets through normal and special facilities. They have also relaxed the class of eligible securities for liquidity availment from the central bank. Furthermore, they have also cut policy rates substantially amid fears that the subprime crisis could turn into a major credit crunch with adverse implications for the real sector. The US Fed has also been involved in resolution of problems arising in non-bank entities like investment banks and insurance companies. The Bank of England has provided generalised and institution-specific emergency liquidity and facilities for swapping securities.
65. In the second phase of central bank intervention in December 2007 (the first phase being spread over August-September), major central banks such as the Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank (SNB) injected liquidity in a coordinated manner. Actions taken by the Federal Reserve included the establishment of a temporary Term Auction Facility (TAF) against a wide variety of collateral that can be used to secure loans at the discount window; the establishment of foreign exchange swap lines with the ECB and the SNB which will provide dollars in amounts of up to US $ 20 billion and US $ 6 billion to the ECB and the SNB, respectively, for use in their jurisdictions; a Term Securities Lending Facility announced on March 11, 2008; and a Primary Dealer Credit Facility (PDCF) on April 22, 2008. The Fed has also conducted nine auctions amounting to US $ 340 billion having 28-day maturity and an auction of US $ 20 billion having 35-day maturity.
66. Since December 2007, the ECB has conducted seven US dollar TAF auctions amounting to US $ 85 billion up to April 24, 2008 for 28 days maturity each. The Bank of Canada has conducted five 28-day auctions amounting to US $ 10 billion till April 17, 2008. The SNB has conducted four auctions amounting to US $ 20 billion for 28 days each up to April 22, 2008. The Bank of England increased liquidity injections from £2.85 billion to £11.35 billion for its operations in December 2007-January 2008 of which £10 billion was offered for 3-month maturity. It also announced that long term repo operations would be held against a wider range of high quality collateral. In April 2008, the Bank of England launched a scheme to allow banks to swap temporarily their high quality mortgage-backed and other securities for UK Treasury Bills. It has so far allotted amounts of £44.9 billion (three months), £2.95 billion (six months), £1.6 billion (nine months) and £ 0.8 billion (12 months) in four long-term repo auctions since December 2007.
67. Some central banks have cut policy rates since the third quarter of 2007 when the financial market turmoil surfaced. During September 18, 2007 to March 18, 2008 the US Federal Reserve cut its policy rate by 300 basis points to 2.25 per cent after seventeen increases to 5.25 per cent between June 2004 and June 2006. The Bank of England reduced its repo rate to 5.0 per cent by 25 basis points each in February and April 2008. The Bank of Canada reduced its rate to 3.0 per cent by 25 basis points reductions each in December 2007 and January 2008 and 50 basis points each in March and April 2008. Central banks of several countries, including the euro area, New Zealand, Japan, Korea, Malaysia, Thailand and Mexico have not changed their rates since the last quarter of 2007. Some central banks that have tightened their policy rates in recent months include the Reserve Bank of Australia (Cash Rate raised by 25 basis points in February-March 2008 to 7.25 per cent); the People's Bank of China (lending rate raised to 7.47 per cent in December 2007 from 7.29 per cent in September 2007); the Banco Central de Chile (benchmark lending rate raised to 6.25 per cent in January 2008 from 5.75 per cent in October 2007), and Banco Central do Brasil (overnight Selic rate raised by 50 basis points to 11.75 per cent in April 2008).
68. Large capital flows to EMEs have elicited various responses from central banks for managing and stabilising these flows including monetary tightening involving either hikes in policy rates or in reserve requirements or both. In China, the required reserve ratio was raised from 8 per cent in July 2006 to 16.0 per cent on April 25, 2008. After a gap of 17 years, the Bank of Korea raised reserve requirements from 5 per cent to 7 per cent for local currency deposits and short-term foreign currency deposits in November and December 2006, respectively. Meanwhile, in several EMEs including China and Korea, central bank bonds have continued to absorb liquidity from the banking system.
69. Measures directly aimed at managing capital flows are also in evidence in many EMEs. On December 18, 2006 Thailand imposed unremunerated reserve requirements (URR) of 30 per cent on most capital inflows, requiring them to be deposited with the central bank for one year. However, with effect from March 3, 2008 the Bank of Thailand has lifted the URR on short-term capital inflows and said it would introduce three supporting measures to temper the impact of the change. These measures involve (a) an increase in the foreign investment limit to US $30 billion to allocate to securities companies, mutual funds and individual investors, (b) an improvement in measures to prevent baht speculation and (c) a revision to the structure of non-residential baht accounts so as to help monitor fund flows of non-residents. In May 2007, Colombia introduced a package of measures, including a 40 per cent URR on external borrowing to be held for six months in the central bank. Additionally, a new ceiling on the foreign exchange position of banks, including gross positions in derivative markets, was stipulated to limit circumvention of the URR and banks' exposure to counterparty risk. The PBC raised the amount of foreign currencies that lenders must keep as reserves to 5 per cent from 4 per cent of their foreign-currency deposits from May 15, 2007. The Bank of Korea is investigating large volume trading of currency forward contracts by exporters and financial companies to limit gains in the won, which appreciated to a 10-year high in 2007. Chile and Brazil's central bank have bought up substantial amount of inflows from the spot market to add to reserves and also conducted sizeable operations in the forward markets.
70. Over the year gone by, global developments have brought forward several new realities that pose severe challenges to monetary policy globally. First, concerns relating to the US slowdown and its intensity have mounted in view of the potential spillover on to the global economy. Second, threats to the global economy are emanating from advanced economies in sharp contrast to earlier crises which stemmed from the emerging world. Third, there are indications that protectionist tendencies have increased around the world in anticipation of the growing possibilities of slower growth in advanced economies. In several key commodity-producing economies, policy measures are in place and are being intensified to restrict the availability of supplies to the international markets. Fourth, linkages between financial sector developments and the real sector have become more worrisome than before, with apprehensions that financial turmoil may spillover to the real sector with adverse implications for employment and growth. With financial institutions reporting tightening in lending standards, deterioration in asset quality and deceleration in consumer loan demand, there are signals that events in the financial markets are beginning to have a persisting impact on other dimensions of the real economy as well. Fifth, higher and more volatile prices of food, energy and other commodities have imparted a significant upside bias to inflation and inflation expectations across the world, complicating the conduct of monetary policy at a time of severe financial stress. In several countries, there are threats to food availability with consequent social tensions. Sixth, terms-of-trade losses due to soaring commodity prices and exchange rate appreciation are reducing the capacity of the euro area and Japan to contribute to a re-balancing of the world economy. Seventh, EMEs are exhibiting resilience so far in the face of the global financial turmoil reflecting relatively stronger macroeconomic framework and sustainable macroeconomic balances. Thus, there is so far some divergence in terms of growth performance between mature economies and EMEs but whether, how long and to what extent it will persist is uncertain. On the other hand, inflationary pressures appear to be common to mature economies and EMEs but the latter are under heavier pressure.
71. There are several issues emerging out of recent financial developments that are interacting with global macroeconomic changes and carry implications for the conduct of monetary policy globally. First, financial markets are currently at the heart of the turmoil and are regarded as sources of higher potential instability going forward. Despite sizeable central bank action over a wide spectrum, market interest rates and policy rates continue to be widely divergent. Second, there are renewed concerns about the gaps in the financial architecture and its limited capability for withstanding shocks or for preventing spillovers. Third, the effectiveness of financial regulations and supervision has come under scrutiny, especially in the context of appropriately assessing capital adequacy in large financial institutions, complex financial products and vehicles and risk management practices. In this context, it is important to note that even the Basel II and related processes are being reviewed in their granularities. Fourth, the role of credit rating agencies is being subjected to critical reassessment, particularly in view of their envisaged role under Basel II. There is active discussion on the need for credit rating agencies to clearly differentiate the ratings for structured products, improve their disclosure of rating methodologies, and assess the quality of information provided by originators, arrangers, and issuers of structured products. Fifth, current practices relating to transparency and disclosure are being subject to careful appraisal in view of their inadequacy in the context of structured financial products and special purpose vehicles. Sixth, the role of investment banks and their adequacy of capital needs to be reviewed, along with stipulation of separate yet complementary sets of best practices for hedge fund investors and asset managers to increase accountability for participants in this industry.
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