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39. During March 2001, the equity markets experienced considerable
turbulence and uncertainty leading to problems in certain stock exchanges
as well as liquidity/insolvency problems in some co-operative banks, which
in turn affected certain commercial banks also. An important priority of
the Reserve Bank during this difficult period was to try and minimise the
"contagion" spreading from equity markets to money and
government securities markets or to the banking system as a whole. In
order to achieve this objective, it was necessary to provide assurance of
sufficient collateralised liquidity to banks, and to take early action to
prevent the problem affecting particular co-operative banks in one region
from spreading to other financial institutions. By and large, so far,
money market as well as government securities market have continued to
function normally. Further, there has been no reduction in market
liquidity in spite of some cases of payment delays/defaults. There has
also been no immediate adverse impact of stock market turbulence on
interest rates. 40. The recent experience in equity markets, and its
aftermath, have thrown up new challenges for the regulatory system as well
as for the conduct of monetary policy. It has become evident that certain
banks in the co-operative sector did not adhere to their prudential norms
nor to the well-defined regulatory guidelines for asset-liability
management nor even to the requirement of meeting their inter-bank payment
obligations. Even though such behaviour was confined to a few relatively
small banks, by national standards, in two or three locations, it caused
losses to some correspondent banks in addition to severe problems for
depositors. In the interest of financial stability, it is important to
take measures to strengthen the regulatory framework for the co-operative
sector by removing "dual" control by laying down clear-cut
guidelines for their management structure and by enforcing further
prudential standards in respect of access to uncollateralised funds and
their lending against volatile assets. In the light of recent experience,
some corrective steps to prevent commercial banks from taking undue risks
in their portfolio management are also outlined in Part III of this
Statement. 41. The overall macroeconomic indicators, despite
recent developments in the equity market, continue to be favourable for
growth with price stability. As mentioned earlier, GDP growth is likely to
be about 6.0 per cent in 2000-01 in line with the projection indicated in
the Mid-term Review. The "headline" inflation rate at 4.9 per
cent turned out to be lower than expected in the Mid-term Review.
Excluding the petroleum sub-group, the inflation rate was 2.6 per cent as
on March 31, 2001. The external sector was also comfortable during the
year as a whole with exports doing well and current account deficit
expected to be considerably lower than 2.0 per cent of GDP. Money supply
growth was also by and large in line with projected trajectory and the
recent Budget has signalled a firm commitment towards fiscal consolidation
and reduction in fiscal deficit. The interest rates, after some hardening
in mid-year, had softened in the later part of 2000-01. The primary yields
in Treasury Bills of various maturities which had risen from a range of
7.0-9.2 per cent in April 2000 to close to 11.0 per cent in August 2000
have since declined to a range of 8.8-9.1 per cent by March 2001. The
primary yield on 10-year government securities has fallen from a peak of
11.7 per cent in October 2000 to 10.7 per cent in January 2001. The
secondary market yields have also moved in tandem with the primary market. 42. While there is still considerable uncertainty, it
is widely expected that the world GDP growth would be substantially lower
in 2001 compared with a high growth of about 5.0 per cent in the previous
year, driven by the slowdown of the US economy. A favourable factor this
year is that the international inflationary environment is reasonably
benign. Low inflationary expectations have facilitated substantial
reduction in international interest rates in order to revive economic
activity in major industrial countries. India cannot but reckon the impact
of these global developments though for several reasons, including its
relatively small share of trade, GDP growth in India is unlikely to be as
seriously affected by these developments, as in many other countries.
While merchandise exports growth may slightly moderate, software exports
with more diversified destinations and private remittances may still be
maintained. The size of current account deficit is, therefore, expected to
continue to be well within 2.0 per cent of GDP. 43. The fiscal deficit of the Central Government is
budgeted at 4.7 per cent of GDP for 2001-02 and the borrowing programme of
the Centre at Rs.1,18,852 crore (gross) and Rs.77,353 crore (net). While
the borrowing programme in respect of some States has come under stress,
RBI expects to conduct debt management without serious pressure on overall
liquidity and interest rates. 44. Against this background, the Reserve Bank proposes
to continue to ensure that all legitimate requirements for credit are met
consistent with price stability. Towards this objective, the Reserve Bank
will continue its policy of active demand management of liquidity through
OMO, including two-way sale/purchase of Treasury Bills, and further
reduction in CRR as and when required. Unless circumstances change
unexpectedly, or current problems in some segments of the market are not
resolved soon, on the present reckoning, it should also be possible to
maintain the current interest rate environment, and explore the
possibility of some further softening in medium and long-term rates over
time, following the stance of interest rate flexibility announced in the
recent Budget. However, as emphasized last year as well as in Part I of
this Statement, in formulating their business plans, banks and financial
institutions should be prepared for a reversal or tightening of monetary
policy in case the underlying inflationary situation turns adverse or
there are unfavourable and unexpected external developments. 45. A realistic projection of the overall growth rate
for the current year 2001-2002 is presently difficult in view of
uncertainties pertaining to the outlook for industrial growth. As
mentioned above, the objective conditions for revival of growth are
favourable, but the trend in growth of output and investment demand in the
last quarter of the previous year has not been very encouraging. Assuming
revival of the industrial sector from the next quarter, reasonable
monsoon, and good performance of exports, for purposes of monetary policy
formulation, for the year as a whole, growth rate of real GDP may be
placed at 6.0 to 6.5 per cent. The rate of inflation is assumed to be
close to that in the previous year, i.e., within 5.0 per cent; the
projected expansion in broad money (M3) for 2001-02 is about 14.5 per
cent. Consistent with prevailing elasticities, this order of growth in M3
would lead to an increase in aggregate deposits of scheduled commercial
banks at about the same rate (or about Rs.1,34,000 crore). Non-food bank
credit adjusted for investment in commercial paper,
shares/debentures/bonds of PSUs and private corporate sector is projected
to increase by 16.0 to 17.0 per cent. This magnitude of credit expansion
is expected to adequately meet the credit needs of the productive sectors
of the economy. 46. The Mid-term Review of October 1999 underlined the
need to undertake concrete steps to remove certain inherent rigidities so
that the interest rate structure can be made more flexible during
different phases of the business cycle. Since then, there has been some
easing of constraints on the flexibility of interest rates in the
financial system as a whole. Assuming a continued positive outlook for
inflationary expectations, further flexibility would be facilitated if
consistent progress is made in certain directions. As emphasised in the
Budget, there is urgent need for consistent and credible fiscal adjustment
combined with flexibility in administered interest rates. The financial
system should also improve its operational efficiency and aim at further
reduction in cost of intermediation. In this regard, there is a need to
improve the debt recovery system so that the burden of NPAs on the
financial system is eased. Although banks have been given the freedom to
quote flexible and variable rates on deposits, the bulk of the deposits
are still at fixed rates which become unsustainable when lending rates are
lowered. It is necessary for banks to undertake further improvements in
operational efficiency and active liability management for interest rate
flexibility in line with changes in the inflationary outlook. A reduction
in fiscal deficit and overall government borrowing programme could
facilitate easing the regulatory burden in the banking system by reducing
the relatively high level of CRR. There is also a need to rationalise the
tax regime so that tax-induced distortions in effective rates of return
between different instruments and markets are avoided. 47. The Bank Rate changes by RBI combined with CRR and
repo rate changes have emerged as signalling devices for interest rate
changes and important tools of liquidity and monetary management. The
Liquidity Adjustment Facility (LAF) introduced since June 2000 has proved
to be an effective mechanism for absorbing and/or injecting liquidity on a
day-to-day basis in a more flexible manner and, in the process, providing
a corridor for the call money market. The experience with LAF has been
satisfactory and RBI’s endeavour will be to make it more efficient, by
removing some of the existing institutional, procedural and technological
constraints. The Reserve Bank will also continue with its effort to bring
about orderly development and smooth functioning of financial markets and
takes further steps in financial sector reforms. 48. In sum, under normal circumstances and barring
emergence of any adverse and unexpected developments in domestic or
external sectors, the overall stance of monetary policy for 2001-02 will
be: Provision of adequate liquidity to meet credit growth
and support revival of investment demand while continuing a vigil on
movements in the price level. Within the overall framework of imparting greater
flexibility to the interest rate regime in the medium-term, to continue
the present stable interest rate environment with a preference for
softening to the extent the evolving situation warrants. |
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