Stance of Monetary Policy
36. The overall stance of monetary policy in 2001-02, as outlined in last year’s annual policy Statement, was as follows:
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.
The monetary management in 2001-02 was largely in conformity with the monetary policy stance announced in annual policy Statement of April 2001 and reiterated in the Mid-term Review of October 2001. However, the monetary management in 2001-02 was fraught with several challenges like overhang of liquidity, global slowdown, external developments after September 11 and the tense situation on the borders.
37. As spelt out in the Mid-term Review of October 2001, RBI has been able to maintain stable interest rate regime throughout the year with a bias towards further softening of the interest rates. The yields on government securities in the secondary market ruled much lower than the yields at the beginning of the financial year. The large market borrowing programme of the Government could be completed at a lower cost without unduly affecting the general interest rates.
38. Though there have been substantial lendable resources with banks due to reduction in the Cash Reserve Ratio (CRR) and prevalence of soft interest rate regime, as mentioned earlier, non-food credit off-take has not picked up to a desirable extent due to low level of economic activity in general, which is evident from the decelerated growth in industrial production.
39. During the last quarter of 2001-02, a pick-up in the non-food credit has been observed which is expected to continue. Further, benign inflation, good agricultural prospects, and signs of recovery, though incipient, in the US and euro-zone should help the process of recovery in our economy. Agricultural recovery should increase rural demand for both durable and non-durable goods. The global recovery should also help our exports, specifically in software and knowledge-based industries. As such, it is anticipated that the demand for credit is likely to increase in the current year.
40. During 2001-02, forex market showed considerable stability without any undue pressure on exchange rate. As pointed out in the previous Section, India’s exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way, has stood the test of time. Despite several unexpected external and domestic developments, India’s external situation has remained highly satisfactory. RBI will continue to follow the same approach of watchfulness, caution and flexibility in regard to the forex market. Barring major unforeseen global development, RBI will also continue to ensure that, leaving aside short-term variations in reserve levels, the quantum of reserves in the long-run is in line with the growth rate in the economy, the share of external sector in the economy, and the size of the risk-adjusted capital flows. It is heartening to note that our system of exchange rate and reserve management now commands increasing international acceptance.
41. The fiscal deficit of the Central Government which was budgeted at 4.7 per cent of GDP for 2001-02 was revised upward to 5.7 per cent. For the year 2002-03, the fiscal deficit was placed at 5.3 per cent of GDP and the market borrowing programme of the Centre at Rs.1,42,867 crore (gross) and Rs.95,859 crore (net). While the market 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.
42. The projection of overall growth rate for the year 2002-03 basically depends on the speed of recovery in the industrial sector and the expected growth in agriculture. The present indications show that agriculture is likely to grow at a higher rate than last year and there are positive indications of a quicker recovery in the industrial sector with good prospects for export sector. For the purpose of monetary policy formulation, for the year as a whole, growth rate of real GDP in 2002-03 is placed at 6.0 – 6.5 per cent. The rate of inflation is assumed to be slightly lower than 4.0 per cent. The projected expansion in broad money (M3) for 2002-03 is 14.0 per cent. Consistent with this order of growth in M3, an increase in aggregate deposits of scheduled commercial banks is set at Rs. 1,54,000 crore. Non-food bank credit adjusted for investments in commercial paper, shares/debentures/bonds of PSUs and private corporate sector is projected to increase by 15.0 – 15.5 per cent. This magnitude of credit expansion is expected to adequately meet the credit needs of all the productive sectors of the economy.
43. Against this background, RBI proposes to continue to ensure that all legitimate requirements for credit are met, consistent with price stability. Towards this end, RBI will continue its policy of active demand management of liquidity through OMO, including two-way sales/purchase of Treasury Bills and using the policy instruments at its disposal, whenever required. Unless circumstances change unexpectedly, RBI will continue to maintain current interest rate environment with a bias towards softer interest rate regime in the medium-term. Further, the long-term objective would be towards realignment of interest rates of all types of debt instruments, both the government and private sector, within a narrow band.
44. The monetary policy framework has also substantially changed during the past few years in moving from direct to indirect instruments and improved the transmission mechanism of monetary policy. This process is likely to accelerate with the operationalisation of the Real Time Gross Settlement (RTGS) system. The precursors for RTGS such as operationalisation of Negotiated Dealing System (NDS) and Clearing Corporation of India Ltd. (CCIL) have been put in place. There have been substantial improvements in the systems of regulation and supervision of banks and the proposal to set up a Credit Information Bureau (CIB) to collect, process and share credit information on the borrowers among banks and FIs within the existing legal framework attains importance in this regard.
45. The Bank Rate changes 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) has evolved as 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. With most of the procedural and technological constraints removed, RBI’s endeavour to make LAF much more efficient will continue. RBI will also continue its efforts to bring about development and smooth functioning of the financial market and pursue further financial sector reforms towards achieving a greater degree of financial stability.
46. In sum, under normal conditions and barring emergence of any adverse and unexpected developments in the various sectors of the economy, the overall stance of monetary policy for 2002-03 will be:
Provision of adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level.
In line with the above, to continue the present stance on interest rates including preference for soft interest rates.
To impart greater flexibility to the interest rate structure in the medium-term.