Highlights of Second Quarter Review of Monetary Policy 2009-2010
-Announced on the 27th October 2009
Banks generally welcomed the Reserve Bank’s policy stance. They agreed with the Reserve Bank’s emphasis on credit flows, particularly to agriculture and micro, small and medium enterprises to support the revival of growth. They indicated that while underlying economic activity has picked up, credit demand remains muted because the access of financing from external and domestic non-bank sources has eased significantly. Banks felt that credit growth prospects remain favourable going forward. Apart from credit offtake, discussion centred around specific issues such as the new liberalised policy on branch authorisation, changes in provisioning norms, infrastructure financing, currency management, priority sector lending certificates (PSLCs), and the recommendations of the Working Group on BPLR.
Banks welcomed the liberalised policy on branch authorisation, which together with the liberalised business correspondents model, according to them, should promote financial inclusion and increase credit flow. As regards infrastructure financing by banks, the view was that while banks have a role in infrastructure financing, eventually it should be done through the corporate bond market with participation by long-term institution investors. Banks recognised the role of take-out financing and indicated that they are working with India Infrastructure Finance Company Ltd. (IIFCL) on this issue.
While banks welcomed the move to increase the provisioning requirement on commercial real estate exposures, they suggested certain modifications in the calculation of the provisioning cover and requested for more time. The Reserve Bank emphasised the importance of using modern technology, including note sorting machines. There was a general feeling that the merits and demerits of PSLCs need to be carefully examined. Banks were urged to generate the debate through seminars and workshops on the recommendations of the Working Group on BPLR.
There has been a discernable improvement in the global economy since the last review in July 2009. The recovery is underpinned by output expansion in emerging market economies, particularly in Asia. World output improved in the second quarter, manufacturing activity has picked up, trade is recovering, financial market conditions are improving, and risk appetite is returning. A sharp recovery in equity markets has enabled banks to raise capital to repair their balance sheets. There are concerns, however, that the recovery is fragile.
Even as output is reviving, unemployment is expected to increase to over 10 per cent. Investment is also expected to remain weak due to ruptured balance sheets, excess capacity and financing constraints. Bank collapses are continuing. World trade still remains below its level a year ago. On balance, while global economic prospects have improved, uncertainties remain about the pace and sustainability of economic recovery.
In India, too, there are definitive indications of the economy attaining the ‘escape velocity’ and reverting to the growth track. This is despite the continuing contraction in exports and the worst drought since 1972. The performance of the industrial sector has improved markedly in recent months. Domestic and external financing conditions are on the upturn. Capital inflows have revived. Activity in the primary capital market has picked up and funding from non-bank domestic sources has eased. Liquidity conditions have remained easy and interest rates have softened in the money and credit markets.
At the same time, some concerns persist. There are clear signs of rising inflation stemming largely from the supply side, particularly from food prices. Private consumption demand is yet to pick up. Agricultural production is expected to decline. Services sector growth remains below trend. Bank credit growth continues to be sluggish.
Management of the large government market borrowing programme in a non-disruptive manner has been a major challenge for the Reserve Bank. Consistent with the accommodative monetary stance, the Reserve Bank expanded its domestic assets through open market operations (OMO) and unwinding of market stabilisation scheme (MSS) securities to provide primary liquidity to support the borrowing programme. During 2009-10 so far, the Central Government has already completed over 80 per cent (Rs.3,19,911 crore) of its net market borrowing and State Governments have mobilised Rs.58,683 crore (net) through the market borrowing programme. Because of the front-loading of the market borrowing programme, net issuances under the Central Government borrowing programme in the remaining period of 2009-10 will be only around Rs.62,500 crore. In the context of the debate on raising the held to maturity (HTM) investment limit for banks, on considerations of the merits and demerits of the issue, the Reserve Bank has determined that it is not advisable to raise the HTM ratio.
Liquidity Situation and Interest Rates
The liquidity situation has remained comfortable since mid-November 2008 as evidenced by large absorption of nearly Rs.1,20,000 crore on a daily average basis under the liquidity adjustment facility (LAF) window of the Reserve Bank. With most commercial banks reducing their deposit rates, the cost of funds has declined enabling banks to reduce their lending rates.
On current assessment, the growth projection for GDP for 2009-10 has been retained at 6.0 per cent with an upward bias, unaltered from that made in the July review. This assumes a modest decline in agricultural production, as the South-West monsoon rainfall this year has been the weakest since 1972 affecting both yield and acreage of agricultural crops, but a faster recovery in industrial production.
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(Source-Press Statement by Dr. D. Subbarao, Governor on 2nd Quarter Review of Monetary Policy)
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