I. Mid-Term Review of Macro-economic and Monetary Developments in 2000-01
II. Stance of Monetary Policy for the second half of 2000-01;
III. Financial Sector Reforms and Monetary Policy Measures.
2. On the basis of the meteorological reports available upto September 2000, it has been observed that the south-west monsoon was active and the quantum and distribution of rainfall were fairly satisfactory at the aggregate level. Of the 35 meteorological sub-divisions, 28 sub-divisions received excess or normal rainfall, which was the same as that of the last year. As some sub-divisions were affected by deficient rainfall or floods, the agricultural out-turn in 2000-01 remains somewhat uncertain. As of now, the output of foodgrains during the year is expected to remain close to that of last year. The total buffer stock of foodgrains stood at 40.8 million tonnes at the end of August 2000, which is higher by 38.3 per cent over the stock level of 29.9 million tonnes at the end of August 1999. The stocks of rice at 13.56 million tonnes are higher by 57.5 per cent, and those of wheat by 27.9 per cent. Overall, therefore, the outlook for agricultural supplies is comfortable during the year.
3. The industrial outlook presents a mixed picture. The increase in industrial production during the first four months of the current financial year was lower at 5.4 per cent than 5.9 per cent recorded during the corresponding period of the previous year. Manufacturing sector recorded a growth rate of 5.7 per cent upto July 2000 as compared with 6.7 per cent in the same period of last year. According to the use-based classification, basic goods production registered an accelerated growth rate of 4.7 per cent in comparison with 3.8 per cent during the same period of the previous year. Production in consumer goods sector also showed a better performance at 8.3 per cent compared with 2.5 per cent during the previous year. The intermediate goods sector recorded a lower growth of 5.2 per cent against 9.6 per cent during the previous year. The capital goods sector showed a negative growth of 0.3 per cent so far. The general deceleration observed in the Index of Industrial Production is partly attributable to the Central Statistical Organisation (CSO) incorporating the revised Wholesale Price Index (1993-94=100) as the deflator.
4. The CSO, in their recent release, has placed the real GDP growth in the first quarter (April-June) of 2000-01 at 5.8 per cent as against 6.9 per cent observed in the first quarter of 1999-2000. Taking the first quarter estimates into account, as per present indications, the real GDP growth during 2000-01 can be placed in the range of 6.0 – 6.5 per cent as against the projection of 6.5 – 7.0 per cent indicated in the April policy statement.
5. The rate of inflation on a point-to-point basis as on September 23, 2000 was 6.06 per cent as against 3.20 per cent a year ago. On an average basis, the annual inflation rate was at 4.96 per cent as against 4.37 per cent in the last year. Inflation as measured by rise in Consumer Price Index (CPI) for the month of August 2000 was 3.99 per cent as compared with 3.15 per cent in August 1999. On an average basis, the annual CPI inflation was, however, substantially lower at 3.25 per cent as against 10.16 per cent in the same period of last year.
6. The contribution to inflation has primarily arisen from the 'fuel, power, light and lubricants' group, the index of which recorded an increase of 25.9 per cent as on September 23, 2000 over the previous year. The increase in particular was in 'mineral oils'. This is a consequential impact of the substantial rise in international oil prices since September 1999. The increase in prices of other items among both the primary articles and the manufactured products, excepting fertilizers, were subdued. The inflation rate, excluding the effect of price increase in the fuel and petroleum group, works out to only 2.44 per cent on a point-to-point basis. While a close watch has to be kept on the inflation front, and the international oil prices continue to be a matter of particular concern, the overall demand/supply conditions in respect of sensitive commodities and manufactured goods remain comfortable. On the whole, as of now, the rate of inflation for the year as a whole is likely to be close to the average of last two years.
7. Growth of money supply during the current financial year upto September 22, 2000 was 6.6 per cent as against 6.8 per cent observed in the same period last year. On an annual basis (September 22, 2000 over September 24, 1999), M3 growth was lower at 13.6 per cent than 16.3 per cent observed in the comparable period of the preceding year. Aggregate deposits of scheduled commercial banks in the current financial year so far increased by Rs.59,603 crore (7.3 per cent) as compared with Rs.51,680 crore (7.2 per cent) in the same period last year. Assuming that the strong deposit accretion will continue, the increase in aggregate deposits during the current year will be of the order of Rs.1,25,000 crore as envisaged in the April policy statement. The monetary expansion during 2000-01 so far, is in the expected trajectory as indicated in the April policy statement, and the projected growth in M3 for 2000-01 is likely to remain around 15.0 per cent.
8. Reserve money in the current financial year upto September 29, 2000 increased by Rs.688 crore (0.2 per cent) as against an expansion of Rs.3,617 crore (1.4 per cent) in the comparable period of last year. Currency in circulation increased by 1.9 per cent as against 3.8 per cent in the corresponding period of the last year. On an annual basis, currency expansion was 9.9 per cent as against 14.8 per cent in the previous year. There has been a shift in the sources contributing to the reserve money expansion during this year. During 1999-2000, the reserve money expansion was mainly due to increase in net foreign exchange assets and RBI credit to commercial sector whereas during this year so far, it has been mainly due to increase in net RBI credit to the central government. There is a sharp decline in the RBI credit to commercial sector in the current year. Net foreign exchange assets of RBI in the current financial year have also declined by Rs.2,799 crore as against an increase of Rs.5,219 crore during the same period last year. Net RBI credit to the Government, however, increased substantially by Rs.10,588 crore as against Rs.308 crore in the corresponding period of last year. On the components side, bankers' deposits with RBI declined substantially by Rs.4,124 crore (primarily due to reduction in CRR). On the whole, the reserve money expansion is expected to remain moderate and significantly lower than last year.
9. There has been a significant pick up in the bank credit and other flows to the commercial sector from the banking system during the current year. Scheduled commercial banks' credit expanded by Rs.30,867 crore (7.1 per cent) upto September 22, 2000 as against an increase of Rs.11,821 crore (3.2 per cent) in the previous year. Food credit increased by Rs.6,398 crore as against Rs.3,716 crore in the previous year. Non-food bank credit increased by Rs.24,469 crore (6.0 per cent) as against an increase of Rs.8,105 crore (2.3 per cent) in the previous year. Together with the provisional data on investments in commercial paper, investments in bonds / shares / debentures of PSUs and private corporate sector, the flow of resources from scheduled commercial banks to the commercial sector increased by Rs.26,471 crore (5.6 per cent) as against Rs.13,647 crore (3.4 per cent) in the previous year. Banks' investments in instruments issued by financial institutions and mutual funds this year increased by Rs.171 crore as against Rs.1,773 crore last year. Total resource flow to the commercial sector including capital issues, GDRs and borrowings from financial institutions increased by Rs.58,838 crore as compared with Rs.34,235 crore in the previous year.
10. The significant expansion in resource flow from banks to the commercial sector has occurred despite some evidence of deceleration in the growth rate of industrial output in the past few months of the current year. The feedback received from select bankers indicates that there have been positive increases in stocks of fertilizers, sugar, petroleum and automobiles. There has been some pick up in infrastructure sector and working capital growth in financing bills receivables. Export growth has also been higher resulting in higher export credit. Data collected internally by RBI on additional limits of Rs.150 crore and above show a high year-on-year growth in limits for manufacture of silk and synthetic fibres, drugs and pharmaceuticals, fertilizers, light engineering, leasing and hire purchase, etc.
11. The Union Budget for 2000-01 placed the net market borrowings of the Central Government at Rs.76,383 crore and gross borrowings at Rs.1,17,704 crore. Upto October 6, 2000, the Central Government, keeping the normal pace, completed net borrowings of Rs.47,026 crore, and gross borrowings of Rs.77,183 crore. RBI continued to combine auction issues with acceptance by private placement of dated securities of the Government consistent with market conditions. In the current financial year so far, devolvement and private placements with RBI amounted to Rs.31,977 crore. However, the reserve money impact of this remained moderate due to decreases in RBI credit to commercial sector and net foreign currency assets. The commercial banks' investment in government securities this year showed an increase of Rs.23,934 crore against an increase of Rs.35,766 crore in the corresponding period of the previous year. However, in the aggregate, banks continued to hold government securities in excess of SLR prescription by a sizeable margin.
12. Government of India's fiscal deficit upto August 2000 this year is reported to be significantly lower at Rs.36,447 crore representing an improvement by 24.3 per cent compared to last year. This has been contributed by a substantial increase in revenue receipts of Rs.64,523 crore, an increase of 27.5 per cent over last year, and a marginal increase of 2.7 per cent in expenditure. This is encouraging. However, two major uncertainties which may finally affect the budgetary outlook are: the pace of progress in realising the projected receipts from disinvestments, and the budgetary outgo to meet the shortfall in the oil pool account. Notwithstanding these uncertainties, it is absolutely essential to contain the borrowing programme within the budgeted levels. In fact, a reduction in the borrowing programme would be desirable as it would make a positive contribution to keeping the interest rate outlook positive and stable.
13. Several initiatives have been taken recently in regard to the internal debt management policy. Consequently, there has been a lengthening of the maturity structure in the last two years. Reissues and price based auctions were also introduced in order to enable consolidation of securities. Combining private placement with strategic open market operations whenever appropriate, has enabled the conduct of the government borrowing programme without being unduly disrupted by unanticipated external and domestic developments. An internal debt management policy, however deft, cannot continuously handle a widening deficit without serious adverse consequences in the debt market. It is, therefore, necessary that a strong framework is put in place to build up positive expectations on the fiscal front and it is hoped that the proposed Fiscal Responsibility Legislation will address this issue.
14. There have been marked changes in the external environment since April 2000 when the annual monetary and credit policy statement was presented. During the year 1999-2000, despite a sharp increase in oil prices, the foreign currency assets of India had increased by US $ 5.54 billion, and forex markets were generally stable. In the month of March 2000 alone, the increase in foreign exchange reserves was US $ 2.1 billion, and both exports and capital flows had registered substantial growth. The subsequent period, from about mid-May to early August 2000, however, proved to be difficult for management of the external sector. Forex markets were affected by considerable uncertainty with the rupee depreciating against the US dollar by 3.2 per cent between May 31 and September 29, 2000, and overall foreign exchange reserves declining by US $ 1.8 billion. Since the middle of August 2000, the situation has shown some improvement, and forex markets and reserve levels have been relatively stable.
15. As is well-known, in the very short-run, "expectations" about the likely behaviour of a currency next day or over a week or fortnight can play a major role in determining its movement against foreign currencies, particularly the US dollar. Given the "bandwagon" effect of any adverse movements, and the herd behaviour of market participants, expectations can often become self-fulfilling. This is particularly true of thin developing country market, where net volumes are relatively small. The day to day movement in currency markets is further complicated by volatility in private capital flows, which are highly sensitive to short-term domestic and international developments as well as future expectations. In view of these and other imponderables, it is not possible to come to a definitive conclusion about the relative role of different factors in explaining the behaviour of forex markets in India during May – August 2000. Some of the factors which had a bearing on developments during this period were:
The increase in US interest rates by 50 basis points in May 2000, which was followed by hikes in the European interest rate by 50 basis points in June and 25 basis points in August 2000. The increase in US interest rate in May coming on top of several earlier increases, significantly reduced the interest differential in respect of holdings in US dollars vis-a-vis Indian rupees.
In April 2000, there was considerable uncertainty about the prospects of the US economy. This was reflected, among other things, in the sharp drop in equity prices. In April, the NASDAQ index fell by nearly 25 per cent, which in turn affected equity prices, in all major stock exchanges, including the Sensex in India. The US outlook, however, changed dramatically in June/July with an increasing consensus that the US economy was "soft landing" and US growth rates were likely to be sustained at a relatively high level.
In view of the continuing uncertainty about recovery in Japan and the outlook for European economies, the US dollar appreciated sharply against most major currencies. US dollar appreciated by 5.7 per cent, 2.2 per cent and 0.8 per cent against Euro, Pound-Sterling and Japanese Yen, respectively, during the period end-May to end of September 2000. US dollar also appreciated by 7.8 per cent against Thai Baht, 1.7 per cent against Indonesian Rupiah, 8.5 per cent against Philippines Peso, and 0.4 per cent against Singapore dollar during the same period. (It may be noted that, as depreciation of the rupee against the US dollar was less than that of several other currencies, the rupee also appreciated against the Euro and Pound Sterling from end-May to mid-September by 4.4 per cent and 3.4 per cent, respectively. However, rupee depreciated by 1.8 per cent against the Japanese Yen during the same period.)
The price of crude oil imported by India increased further during the year, on top of the sharp increase recorded in the previous year. Average prices of Brent crude in September 2000 were US $ 32.97 per barrel as compared with US $ 25.55 in December 1999 and US $ 22.51 in September 1999. As a result, there was a substantial increase in the volume of demand for foreign currency by Indian Oil Corporation (IOC) and other bulk importers of crude oil.
For various reasons, including some uncertainty about the prospects of the equity market in India, there was a sharp reversal in capital flows on account of Foreign Institutional Investors (FIIs). In the months May to August, 2000, there was a net outflow of US $ 505 million as against a net inflow of US $ 948 million during the first quarter of the calendar year.
16. In order to cope with the adverse effects of the above factors, which persisted for several weeks, the Reserve Bank had to adopt a combination of measures. These included: (a) use of foreign exchange reserves to partially meet the excess demand in currency markets, particularly on account of oil imports and government debt servicing; (b) increasing the cost of bank financing for imports and overdue export bills; (c) allowing the exchange rate to move in response to the prevailing demand/supply situation; (d) increasing the Bank Rate to pre-April level in order to partially reverse the narrowing of interest differential between dollar/rupee holdings in order to improve inflows. In order to mop up some excess liquidity in the system, CRR was also increased by 0.5 percentage point. The very short-term Repo and reverse Repo rates were also increased in order to make it less attractive to hold daily long positions in US dollars; and (e) repatriation of 50 per cent of balances held in EEFC accounts, along with reduction in entitlement in respect of further accretions to these accounts.
17. It may be argued that a recourse to one or two measures more intensively would have been more appropriate, or alternatively the rupee exchange rate could have been allowed to depreciate much more sharply and "find its own level". Under certain circumstances, depending on availability of firm information on what exactly was causing the turbulence in forex markets, either of these positions could be valid. However, while at times the underlying causes of exchange market volatility are easy to diagnose (e.g. effects of contagion, sanctions or hostilities at the border), often the precise cause and the degree of volatility as well as its duration are difficult to estimate or forecast. Multiplicity of factors, which can also change from time to time, and which are often self-fulfilling can influence forex market outcomes (e.g., uncertainty of economic outlook, changes in oil prices, behaviour of equity markets abroad or movements in the exchange rate of US dollar vis-a-vis Euro, or rumours about central bank actions, etc.). In the situation prevailing in our exchange markets during May-August 2000, based on a continuous analysis of the evolving situations, recourse to a combination of measures was preferred so that the adverse impact on the rest of the economy could be minimised. A reliance on one or two measures (e.g., sharp monetary tightening or unchecked depreciation of the exchange rate, and/or unlimited use of reserves) could have had unacceptable longer term consequences for the economy and the financial system, including a much greater risk of non-reversible destabilisation.
18. A related issue that has figured in the recent debate on the management of the external sector is that it would be appropriate if, during periods of excess capital flows or capital surge (as experienced during some months in 1999-2000, and also earlier), the rupee was allowed to appreciate substantially (rather than the RBI absorbing part or whole of the excess supply). From a theoretical point of view, this argument has some merit. If there were sharp two-way movements in the exchange rate, market operators would be subject to two-way risks rather than being able to take "one-way" bet during periods of excess demand for foreign currency. In reality, however, the situation is somewhat more complicated. It is not clear whether greater volatility in exchange rates, and continuing sharp depreciation within a very short period during periods of excess demand, would stabilise expectations or destabilise currency markets beyond the levels of tolerance. The world-wide experience of emerging markets is that there is always a greater rush to "get out" (when exchange rate is falling sharply) than to "get in" (when exchange rate is rising). In countries with a current account deficit, like India, a build-up of reserves is also essential to take into account various types of "liquidity risks" associated with different types of flows and other requirements. As pointed out in the April policy statement, the recent international experience particularly during the period of East Asian crisis, has highlighted the fact that emerging market economies have to largely rely on their own resources during external exigencies as there is no "lender of the last resort" to provide additional liquidity at short notice. While two-way movements in currency are certainly desirable and no attempt should be made to provide a "floor" when there are excess capital inflows, it is necessary to keep the above considerations in view in order to guard against unexpected contingencies.
19. A lesson of experience, not only in India but also in other countries, is that, given the nature of foreign exchange markets and uncertainty in the direction of capital flows in a floating rate environment, the situation and outlook can change dramatically within short periods and extreme caution and care need to be exercised in the management of the exchange rate and foreign exchange reserves.
20. Looking ahead to the second-half of the current year, there is need for continued caution and vigilance on the external front in view of several uncertainties. Despite the action by OPEC in early September to increase supplies and the action by the United States to release some oil from strategic reserve, international prices of crude oil continue to be very high and cast a substantial burden on oil. Internationally, while growth/inflation outlook in industrialised countries as a whole remains favourable, the exchange markets continue to be characterised by sharp volatility and unpredictable movements (as revealed, for example, by the sudden depreciation of Euro and Pound Sterling vis-a-vis US dollar in early September). The behaviour of equity markets world wide, which in turn influences inflows of foreign capital for portfolio investment, is also far from stable, and an unexpected turnaround in such investments cannot be ruled out.
21. In coping with these uncertainties, the favourable factors for India are: continued good performance of exports, particularly software exports; a comfortable level of foreign exchange reserves; a favourable outlook for foreign direct investment in certain important sectors (such as, Information Technology and Telecommunications); a relatively low level of external commercial debt, particularly short-term debt; and a positive outlook for sustained economic growth. No effort should be spared to take maximum advantage of these positive factors, and to further accelerate the process of growth with particular emphasis on exports.
22. Exports have done well during the current year and capital inflows have also increased in the very recent period. India's exports during the first four months of the current financial year at about US $ 13.9 billion recorded an increase of over 25.0 per cent over the exports during the corresponding period of the preceding year. During the same period, imports at US $ 17.6 billion, also increased by about 25.0 per cent compared to 1.1 per cent in the preceding year. Of the total imports, oil imports increased by US $ 5.5 billion (or nearly 100 per cent) impacted by higher prices. Trade deficit in the first four months of the current financial year was US $ 3.7 billion as against US $ 3 billion in the same period last year. However, despite the substantial increase in the oil import bill, increase in exports and invisible receipts is expected to keep the current account deficit for the year 2000-01 at less than 2.0 per cent of GDP, which is considered reasonably satisfactory.
23. In the last two years, as pointed out in the April policy statement, several measures have been introduced to ensure timely delivery of credit to exporters and remove procedural hassles. These measures included provision of 'On Line credit' to exporters, extension of 'Line of Credit' for longer duration for exporters with good track record, peak/non-peak credit facilities to exporters, permission for interchangeability of pre-shipment and post-shipment credit and meeting the term loan requirements of exporters for expansion of capacity and modernisation of machinery and upgradation of technology. Improvements were also made in the procedure for handling of export documents and fast track clearance of export credit at specialised branches of banks. Similarly, new simplified guidelines were issued for sanction of credit facilities for software services, project services and software products and packages.
24. In order to ensure that the above procedural and other improvements in the credit delivery system were actually reaching the exporters, the Reserve Bank had also set up a Bankers' Group at the operational level (comprising senior officials from commercial banks and the Reserve Bank). The Group held a number of interactive sessions with exporters as also base-level officials of the commercial banks at 21 major export centres in the country in addition to discussions with industry associations. In order to further improve the credit delivery system, the Reserve Bank had invited exporters, particularly those who were located in non-metropolitan centres, to send their reactions on whether the new system was working satisfactorily. They were also requested to send their suggestions for improvement in procedures, particularly those which were designed to reduce paper work without diluting accountability.
25. In response to this request, a number of suggestions, mainly of a procedural nature, were received from export organisations and exporters. These have recently been examined by the Bankers' Group. Banks are being advised separately to implement the recommendations of the Group to further simplify the procedures for export credit.
26. The action taken by the Reserve Bank to reduce accumulated balances and further accretions to EEFC account in August 2000 has no doubt caused some disappointment among exporters. It may be recalled that this account was essentially meant for use by exporters for certain specified purposes to facilitate mostly current account and other permissible payments. While most exporters were using the scheme for the intended purposes, in the recent period, it was noticed that balances in these accounts were being increased, which added to the magnitude of "leads" and "lags" in external receipts. The Reserve Bank has reviewed the scheme in the light of previous experience and feedback received from premier export organisations. It is desirable to persevere with the positive feature of the scheme, viz., the reduction in the "transaction" and banking costs for exporters for making current account and other permissible payments, while at the same time ensuring that the scheme is not used for unintended purposes. The details of the revised EEFC scheme are given in Part III.
27. In the last two years, a number of changes have also been introduced in various schemes for remittances, investment and maintenance of bank accounts by Non-Resident Indians (NRIs) in order to make these special facilities procedurally simple. In April, Reserve Bank had also invited responses from NRIs on the actual working of these simplified procedures, and suggestions for further improvement. It is gratifying to note that most of the responses have been highly positive, and no special problems in the operation of these schemes have been reported.
28. In recent months, the Government has taken several initiatives to encourage the flow of Foreign Direct Investment (FDI) on mutually beneficial basis. Thus, new foreign investment proposal in the IT sector will now be entitled to automatic approval irrespective of whether the investor has an existing joint venture or technical collaboration in the country. IT companies with an existing joint venture or a technical collaboration need not henceforth seek "no objection certificate" from existing joint venture partners/associates to float new business. Government has also permitted foreign equity investment in micro credit/rural credit activities. FDI upto 100 per cent has been allowed for business-to-business e-commerce subject to certain conditions. The upper limit of Rs.1,500 crore for FDI in projects of electricity generation, transmission and distribution (other than atomic reactor power plants) has been removed. The level of FDI in oil refining sector under automatic route has also been raised from the existing 49 per cent to 100 per cent. It may be mentioned that "in principle" or prior approval of the Reserve Bank is no longer required for any FDI proposal as long as it is in conformity with Government guidelines.
29. Recently, the Government has delegated powers to the Reserve Bank to approve External Commercial Borrowings(ECB) upto US $ 50 million under the automatic route, and upto US $100 million on a case-by-case basis. In order to avoid recourse to short-term or high-cost ECBs, Government has also laid down certain conditions regarding minimum maturity period and acceptable spreads for such borrowings. In respect of ECB proposals under the automatic route, which conform to Government guidelines, prior approval of RBI will not be required. The procedure for proposals requiring specific approval of RBI is also being simplified.
Click here to read AnnexureI for :
Summary of Guidelines for Issue of
Commercial Paper (CP)
Click here to read AnnexureII for:
Summary of Guidelines on Categorisation
& Valuation of Banks'Investments
Click here to read AnnexureIII for:
Guidelines on Bank Financing of Equities and Investments in Shares