Mid-Term Review of the Annual Policy Statement for 2006-07, RBI Credit Policy: Banknet India

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Part II. Mid-term Review of Annual Statement on Developmental and Regulatory Policies for the Year 2006-07

I. Financial Markets

82. The Reserve Bank continues its efforts to develop various segments of financial markets in terms of operational flexibility, transparency and institutional structure. Concomitantly, orderly functioning and preservation of soundness of the market segments are ensured through effective monitoring and regulation.

83. The Technical Advisory Committee (TAC) on Money, Foreign Exchange and Government Securities Markets has provided valuable guidance to the Reserve Bank in the context of its developmental role vis-à-vis financial markets. The Reserve Bank reconstituted the TAC on Money, Foreign Exchange and Government Securities Markets in June, 2006. The TAC would meet as often as it is required but at least once in a quarter, to review and recommend measures for deepening and widening the money, foreign exchange and Government securities markets including those relating to participants, products, institutional and infrastructural arrangements.

Money Market

84. A number of measures have been undertaken in 2006-07 with a view to improving the functioning of various segments of the money market and enhancing smooth flow of funds across instruments and participants. These measures are intended to fortify the institutional architecture for the smooth play of money markets.

NDS-CALL

85. In pursuance of the announcement made in the Annual Policy Statement of April, 2006 a screen-based negotiatedquote-driven system for all dealings in call/notice and term money market (NDS-CALL) was operationalised with effect from September 18, 2006. The system has been developed by the Clearing Corporation of India Ltd. (CCIL) and is expected to improve ease of transactions and bring about greater transparency and efficient price discovery.

Government Securities Market

86. The implementation of the Fiscal Responsibility and Budget Management (FRBM) Act has necessitated several structural and developmental measures for the Government securities market to prepare it for the withdrawal of the Reserve Bank from the primary segment.

(a) ‘When Issued’ Market for Fresh Issuance of Securities: Extension

87. As indicated in the Annual Policy Statement of April, 2006 a ‘when issued’ (WI) market in Government securities was introduced and trading in this market has commenced from August, 2006. To begin with, WI trading has been permitted in reissuable securities. It is now proposed:

• to extend ‘when issued’ trading in the case offresh issues of Central Government securities on aselective basis.

(b) Allowing Short Sale beyond Intra-daySettlement Cycle

88. On the basis of the recommendations of the Technical Group on the Central Government Securities Market, intra-day short-selling in Central Government securities was permitted in February, 2006. On an assessment of the market feedback, it is now proposed:

• to allow eligible participants, viz., scheduled commercial banks (SCBs) and primary dealers (PDs) to cover their short positions within an extended period of five trading days.

89. As this arrangement may result in carrying short positions across settlement cycles, the participants would be allowed to deliver a shorted security by borrowing it through the repo market.

(c) Consolidation of Central Government Securities

90. The Annual Policy Statement of April, 2006 stated that there is a need to enlarge the number of actively traded Central Government securities in order to enhance liquidity and improve pricing in the market. The modalities of consolidation are being worked out in consultation with the Government of India.

Foreign Exchange Market

91. The Reserve Bank has taken several initiatives to liberalise the conduct of foreign exchange business. A key consideration has been the rationalisation and simplification of procedures with a view to facilitating prompt and efficient customer service in external transactions.

(a) Follow-up of Recommendations of the Committee on Fuller Capital Account Convertibility

92. The Reserve Bank, in consultation with the Government of India, had appointed a Committee on Fuller Capital Account Convertibility (FCAC) (Chairman: Shri S.S. Tarapore) on March 20, 2006. The Committee submitted its report to the Reserve Bank in July, 2006 which has been placed on the Reserve Bank’s website. Keeping in view the recommendations of the Committee, the following measures are proposed:

(i) Setting up of Internal Task Force for Procedural Rationalisation and Simplification

93. The Reserve Bank has constituted an Internal Task Force to review the exchange and payments regime. The Task Force has suggested some rationalisation and procedural simplifications in areas related to trade and miscellaneous remittances and, accordingly, a circular is being issued separately.

(ii) Liberalised Remittance Scheme:Enhancement of Limit

94. Resident individuals would henceforth be free to remit up to US $ 50,000 per financial year for any current or capital account transaction or a combination of both, as against the earlier limit of US $ 25,000. The existing facilities for gifts, donations and investment by resident individuals in overseas companies would be subsumed under this revised limit. The existing facility for private travel up to US $ 10,000 per financial year will continue to be available on a self-declaration basis.

(iii) Exchange Earners’ Foreign Currency Accounts: Liberalisation

95. All categories of foreign exchange earners may henceforth retain up to 100 per cent of their foreign exchange earnings in their Exchange Earners’ Foreign Currency (EEFC) accounts with a view to providing the facility uniformly to all eligible residents.

(iv) Project and Service Exports: Liberalised Procedures

96. With a view to facilitating project exporters and exporters of services and providing greater flexibility in conducting their overseas transactions, it is proposed that:

• large turnkey/project exporters/service exporters with satisfactory track record may operate one foreign currency account with inter-project transferability of funds/machinery in any country, subject to specified reporting requirements;

• large turnkey/project exporters/service exporters with good track record may deploy their temporary cash surpluses either in investments in short-term bank deposits or AAA-rated short-term paper abroad, subject to monitoring by the authorised dealer bank(s); and

• the stipulation regarding recovery of market value of machinery from the transferee project is withdrawn; however, such transfer of machinery should be reported to and monitored by the authorized dealer bank(s)/approving authority.

(v) Banks’ Borrowings from Overseas: Enhancement

97. With a view to providing further flexibility to authorised dealer banks in seeking access to funds overseas, the following liberalisation is proposed:

• authorised dealer banks may henceforth borrow funds from their overseas branches and correspondent banks (including borrowings for financing export credit, ECBs and overdrafts from their Head Office/Nostro account) up to a limit of 50 per cent of their unimpaired Tier I capital or US $ 10 million, whichever is higher, as against the earlier overall limit of 25 per cent (excluding borrowings for financing export credit). Short-term borrowings up to a period of one year or less, however, should not exceed 20 per cent of unimpaired Tier I capital within the overall limit of 50 per cent;

• all borrowings in the form of subordinated debt placed by head offices of foreign banks with their branches in India as Tier II capital, capital funds raised/augmented by issue of innovative perpetual debt instruments (IPDI) and other overseas borrowing with the specific approval of the Reserve Bank would, however, continue to be outside the limit of 50 per cent; and

• in order to phase in these limits in a non-disruptive manner, banks whose overseas borrowings exceed the revised prudential limit may approach the Reserve Bank with a proposed road-map for complying with these limits.

(vi) External Commercial Borrowings: Increased Access

98. Borrowers currently eligible for accessing external commercial borrowings (ECBs) can avail of an additional amount of US $ 250 million with average maturity of more than 10 years under the approval route, over and above the existing limit of US $ 500 million under the automatic route, during a financial year. Other ECB criteria such as end-use, all-in-cost ceiling, recognised lender and the like would continue to apply. Prepayment and call/put options, however, would not be permissible for such ECBs up to a period of 10 years.

99. With a view to providing greater flexibility to the corporates in managing their liquidity and interest costs, prepayment of ECB up to US $ 300 million, as against the earlier limit of US $ 200 million, will now be allowed by authorised dealer banks without prior approval of the Reserve Bank subject to compliance with the stipulated minimum average maturity period as applicable to the loan.

(vii) Establishment of Offices Abroad 100. In order to provide greater flexibility to Indian corporates in establishing overseas offices, authorised dealer banks may now allow remittances on behalf of their customers up to 15 per cent of the average annual sales/income or turnover during the last two financial years or up to 25 per cent of their net worth, whichever is higher, for initial expenses. For recurring expenses, authorised dealer banks may allow remittances up to 10 per cent of the average annual sales/income or turnover during the last two financial years. Authorised dealer banks may also permit remittances for acquisition of immovable property for the overseas office, within these limits.

(viii) FIIs’ Investment in Government Securities

101. It is proposed to permit FIIs to invest in securities issued by the Central and State Governments by an incremental amount of 5 per cent of total net issuance in the previous financial year. This would be over and above the current stipulation of investment up to US $ 2 billion. Accordingly, the existing limit of US $ 2 billion will be enhanced in phases to US $ 2.6 billion by December 31, 2006 and further to US $ 3.2 billion by March 31, 2007. The extant limit of US $ 1.5 billion for investment in corporate debt would, however, continue.

(ix) Overseas Investment by Mutual Funds: Enhancement of Ceiling

102. The extant ceiling of overseas investment by mutual funds of US $ 2 billion is enhanced to US $ 3 billion with a view to providing greater opportunity to mutual funds to invest overseas.

(x) Liberalisation of Forward Contract Regulations

103. Customs authorities use a fixed exchange rate for a month for the purpose of levying import duty. In order to provide the facility of hedging economic exposure, importers will henceforth be permitted to book forward contracts for their customs duty component of imports.

104. As per the extant guidelines, FIIs are allowed to hedge the market value of their entire investment in equity and/or debt in India as on a particular date. Furthermore, these forward contracts, once cancelled, cannot be rebooked but may be rolled over on or before maturity. It is proposed to allow FIIs to rebook a part, say, 25 per cent of the cancelled forward contracts, provided such contracts are supported by underlying exposure. The modalities would be finalised in consultation with market participants.

105. Authorised dealer banks are currently permitted to allow importers and exporters to book forward contracts on the basis of a declaration of an exposure and based on past performance up to the average of the previous three financial years’ actual import/export turnover or the previous year’s actual import/export turnover, whichever is higher. Furthermore, contracts booked in excess of 25 per cent of the eligible limit have to be on deliverable basis and cannot be cancelled. In order to provide greater flexibility to exporters and importers, it is proposed to enhance this limit to 50 per cent.

(xi) Data Collection and Monitoring

106. The Internal Task Force set up by the Reserve Bank would review the data collection/compilation system in pursuance of a recommendation of the Committee on FCAC. A ‘Working Group on Data Related Issues’ is also proposed to be set up.

(b) Other Measures

(i) Bank Guarantees and/or Letters of Credit to cover Temporary Trade Related Credits – Delegation of Powers to Authorised Dealer Banks

107. Authorised dealer banks are permitted to allow advance remittances for import of services up to US $ 100,000 without the counter-guarantee of a bank of international repute situated outside India. As a measure towards further liberalisation, it is proposed to permit authorised dealer banks to issue guarantees/letters of credit for import of services up to US $ 100,000 where the guarantee is intended to secure a direct contractual liability arising out of a contract between a resident and a non-resident.

(ii) Remittances out of NRO Accounts

108. The existing regulations permit NRIs and persons of Indian origin (PIOs) to remit up to US $ one million per calendar year for any bonafide purpose out of the balances in their Non-resident Ordinary (NRO) accounts. The amounts credited to the NRO accounts would also represent the sale proceeds of immoveable property acquired by the non-resident concerned out of her/his resources in India, or proceeds of property received by way of inheritance or gift. The sale proceeds of the immoveable property are at present subject to a lock-in period. On a review, it is proposed to eliminate the lock-in period, provided the amount being remitted in any financial year does not exceed US $ one million.

(c) Advisory Group on FEMA Regulations Relating to Services

109. An Advisory Group (Chairman: Shri Mohandas Pai) was constituted, as indicated in the Annual Policy Statement of April, 2006 to review all foreign exchange regulations relating to services and prepare a compendium of all foreign exchange regulations that apply to the services sector. The Group is expected to submit its report shortly.

(d) Working Group on Cost of NRI Remittances

110. The Working Group (Chairman: Shri P.K. Pain) constituted by the Reserve Bank to examine various cost aspects of NRI remittances submitted its report in August, 2006. This report has been placed on the Reserve Bank’s website for wider dissemination and comments. On the basis of the recommendations of the Group, it is proposed:

• to dispense with the existing restrictions on the number of tie-ups by banks with exchange houses and the number of drawee branches for rupee drawing arrangements in respect of those banks having sound risk management systems. Guidelines in this regard would be issued separately; and

• to put in place an ‘Awareness Programme’ to sensitise NRIs on options to minimise cost of remittances; PSBs to identify remittances as an independent business segment and resort to latest technology for handling large volume at lower cost and explore tie-ups with more correspondent banks; to review the existing scale of charges, both at the foreign and domestic end; large PSBs in India to examine the feasibility of setting up Centralised Remittance Receiving Centres for efficiency and better service; improvements in infrastructure and extending the scope of real time gross settlement (RTGS) for inter-city settlement between the banks in India.