analysis on rbi growth

ANALYSIS ON RBI STUNNING GROWTH AFTER 1991

1. Post-ReformPeriod: A State Level Analysis

Biswa Swarup MisraThis paper examines whether allocative efficiency of the Indian Banking system has improved after the introduction of financial sector reforms in the early 1990s. Allocative efficiency has been studied for twenty three States of India. To get a comparative perspective, allocative efficiency has been estimated for two periods 1981-1992 and 1993- 2001; broadly corresponding to the pre financial sector reforms and the post reforms periods, respectively. The analysis carried under panel cointegration framework reveals that overall allocative efficiency of the banking system has almost doubled in the post reform period. This goes to suggest the success of reforms in improving allocative efficiency of the banking system in India. Allocative efficiency at the State and sectoral level hasalso been estimated to get a deeper insight. While allocative efficiency of Banks' funds deployed in the services sector has improved that in the agriculture and industry has deteriorated in the post reform period for the majority of the States. The study finds improvement in the overall allocative efficiency in the post reform period for the majority of the States. Further, the improved allocative efficiency is more marked for the services sector than for industry across the States.

TY.B.F.M Page 1


1.1 IntroductionEnduring growth, in the context of a developing economy like India

invariably requires that the economy be put to a trajectory of higher savings and ensuring, further, that the realised savings are chanelised into productive investment. In this scheme of growth, the banking system has a dual role to play. The banking system acts both as a mobiliser of savings as well as an allocator of credit for production and investment. Effectiveness of the banking sector ’s contribution to the economic growth and development is broadly determined by its efficiency in the allocation of the mobilised savings amongst competing projects. Financial sector reforms were initiated in India in 1992-93 to promote a diversified, efficient and competitive financial system with the prime objective of improving the allocative efficiency of available resources. Banking sector being the dominant segment in India's financial system, a number of measures specific to the banking system were initiated to improve its allocative efficiency. Freedom to price their products along commercial considerations, relaxation in various balance sheet restrictions in the form of statutory pre-emptions, exposing the banking sector to an increased competition by allowing entry of new private sector banks and the introduction of prudential norms relating to income recognition, asset classification and capital adequacy were some of the ingredients of the banking sector reforms. Improved allocative efficiency was sought to be achieved through operational flexibility, improved financial viability and institutional strengthening. The early initiatives in the banking reforms were geared towards removing the functional and operational constraints impinging upon bank operations, and subsequently, providing them with greater operational autonomy to take decision based on commercial considerations. With gradual relaxation of administered controls, banks and financial institutions were expected to evolve as truly commercial entities. More importantly, the operation of banks under free interplay of market forces in a

TY.B.F.M Page 2


deregulated atmosphere was expected to lead to increased allocative efficiency of scarce resources among competing sources of demand. Banking sector reforms have been in vogue for more than a decade in India. In this context, it would be appropriate to study whether the various reform measures have helped in improving the allocative efficiency of the banking system.This study seeks to enquire whether the financial sector reforms in general, and banking sector reforms in particular had any beneficial impact on the allocative efficiency of the banking system. To get a comparative perspective, the allocative efficiency of the banking system in the post banking sector reforms period has been compared and contrasted with that of the pre-reform period. Allocative efficiency is measured for the twenty-three States of India, individually and as well for all the States taken together. In addition to the scenario at the aggregate level, the allocative efficiency in the sectoral context has also been studied to get a deeper insight. Therest of the study is schematised as follows. Section I discusses the manner in which allocative efficiency has been construed in this study. Section II reviews the literature on allocative efficiency. Some of the stylized facts regarding the credit deployment pattern are discussed in Section III. The data and the empirical framework have been discussed in Section IV. The econometric findings are discussed in Section V. Finally, Section VI presents some concluding observations.

Section IInterpreting Allocative Efficiency

Efficiency of a financial system is generally described through four broad nomenclatures i.e., information arbitrage efficiency, fundamental valuation efficiency, full insurance efficiency and functional efficiency. The ensuing discussion in this paper would centre around the concepts of functional or allocative efficiency. Allocative efficiency can be judged either directly by monitoring some proxy of allocative efficiency or indirectly by estimating the contribution of a financial variable to economic growth. As far as direct measures are concerned, the interest rate structure, cost of intermediation and net interest margin (RBI, 2002a) as measures of bank efficiency are the oftenly-

TY.B.F.M Page 3


used criterions to evaluate the allocative efficiency of the banking system. Allocative efficiency, however, can also be inferred indirectly by studying whether a bank's resources are allocated to most productive uses or not. Most productive use, in turn, can be defined in terms of the economic rate of return (ERR) of a project financed by the banking system. Allocative efficiency would mean that projects with very high ERR are being financed by the banks. It would imply that the funds of the banking system are so deployed as to maximise the rate of return (ERR) of the projects financed by them. The ERR o f individual bank financed projects, however, is difficult to quantify in practice. Akin to the interpretation of allocative efficiency of a bank's resources in terms of the ERR for individual projects, one can conceptualise the allocative efficiency of the entire banking system. In an aggregated sense, allocative efficiency would imply that maximum output is obtained from the deployment of banking system's resources. The concept of 'maximum output', however, is rather vague. As such, studying changes in allocative efficiency reflected in changes in output from a given pool of financial resources under two different time periods or circumstances is more comprehendible than the concept of allocative efficiency per se. Allocative efficiency of an individual bank involves some sort of constrained optimisation. When studied in the cross section dimension, efficiency measurement generally involves use of nonparametric frontier methodology (English, Grosskopfet al., 1993). In the panel context, however, the frontier approach does not capture the panel nature of the data and treats each observation as a separate unit. So it is like a pooled regression, unlike random/ fixed effects models. There are recent developments to overcomethis problem, but it is still in a nascent stage. Consequently in a panel context, following RBI (2002a) allocative efficiency has been approximated by the elasticity of output with respect to credit in this study

Section IIReview of Literature

There has been a revival of finance and economic development linkage by the endogenous growth theory over the past decade. In the endogenous growth theory framework, bank finance has a scope to influence economic growth by either increasing the productivity of capital, lowering the intermediation cost, or augmenting the savings rate. The role of financial institutions is to collect and analyse information so as to channel investible funds into investment activities that yield the highest returns [Greenwood and Jovanovic (1990)]. Though in a pure neo-classical framework, the financial system is irrelevant to economic growth, in practice, an efficient financial system can simultaneously lower the

TY.B.F.M Page 4


cost of external borrowing, raise the return to savers, and ensure that savings are allocated in priority to projects that promise the highest returns ; all of which have the potential for improving growth rates (RBI, 2001a). Commercial banks are the main conduit for resource allocation in a bank dominated financial system like India. Commercial banks generally provide the working capital needs of business. There is no strict boundary of division, however, in the us age of the funds;once disbursed by financial institutions. Once allocated, a part ofthe bank funds may very well be put towards building up fixedcapital. This is because, a business enterprise would be encouraged to undertake fixed capital formation, once it is assured of working capital needs. Though in India there have been institutions created specifically to meet the long term investment needs of business enterprise, the pervasive character of the scheduled commercialbanks had a greater role to play in reaching to a wider mass of people through its vast branch-banking network. Pattrick (1966) provides a reference framework to study financial development by enunciating the 'demand-following approach' and the 'supply-leading approach' to financial development. Demand following is defined as a situation where financial development is an offshoot of the developments in the real sector. In the case of supply leading, financial development precedes and stimulates the process of economic growth; the supply of financial services and instruments create the demand for them. Patrick suggested that in the early stages of economic development, a supply-leading relation is more likely since a direct stimulus is needed to mobilise savings to finance investment for growth. At a later stage, when the financial sector is more developed, the demand-following relation will be more prevalent. Empirical studies such as Gupta (1984), Jung (1986) and St. Hill (1992) are broadly suggestive of the pattern of financial development envisaged by Patrick (1966). However, such a theoretical dichotomy between 'demand following' and 'supply leading' is difficult to defend in the context of continuous interaction between the real and the financial sectors in practice. Regarding the impact of bank finance on growth, a number of empirical studies drive home the positive impact of bank credit on output. Employing GMM panel estimators on a panel data set of 74 countries and a cross sectional instrumental variable estimator for 71 countries, Levine et al (2000) find that the exogenous component of financial intermediary development is positively associated with economic growth. Further, empirical studies by King and Levine (1993), Gregorio and Guidotti (1995) strongly borne out the positive effect of financial development on the long run growth of real per capita GDP. In the tradition of disentangling the impact of bank credit on growth, Reserve Bank of India (2002a) explored the relative impact of finance in inducing output growth using panel regression techniques. Estimates of elasticity of output with respect to credit improved from 0.30 during the period 1981-1991 to 0.35 during 1992- 2001 indicating as improvement in the allocative efficiency of the banking system at the all India

TY.B.F.M Page 5


level (RBI 2002a). Sector-wise credit elasticities of output also indicate as improvement in the allocative efficiency for most of the sectors in the post reform period compared to the 1980s. However, no attempt has been made to study allocative efficiency at the State level and across the sectors. The present study seeks to fill this gap.

Section IIICredit and Output in the Spatial Dimension: Some Stylised Facts

The relative growth rates in credit and output in the pre and post- reforms periods can act as pointers to allocative efficiency. Aggregate credit has grown at a similar pace both in the pre reform and the post Table 1: Growth of Output and Credit(Per cent)

VARIABLE1981-1992 1993-2001 1981-2001

NSDP*

Output Credit Output Credit Output Credit

2.7 12.9 4.1 12.9 3.1 13.2

Agriculture

Industries

Services

1.6

3.6

4.0

11.1

15.1

11.2

0.7

5.6

6.0

9.6

11.5

15.3

1.5

4.2

4.6

9.1

14.2

13.3

* Net State Domestic ProductSource : Central Statistical Organisation and Reserve Bank of India

reform period, aggregate output, however, grew at a distinctly higher rate in the

post reform phase. This indicates that at the aggregate level, there could be

some improvement in the allocative efficiency. However, one finds a mixed

picture at the sectoral level. While both output and credit growth has

decelerated for the agricultural sector, that for services sector has accelerated in

the post reform phase as compared to the pre reform phase. For industry,

however, highergrowth in output is witnessed in spite of deceleration in credit growth in the reform period. Focusing only on growth rates of output and credit to comment on the allocative efficiency may be quite misleading, if the share of different sectors in aggregate credit and output has not remained the same. In fact, the share in credit and output has increased for both industry and services sector and has declined for the agriculture sector in the post reform period (Table 2). TY.B.F.M Page 6


Thus, a much deeper Table 2: Share in Output and Credit(Per cent)

SectorAverage Share in the pre-banking sector reformperiod

Average Share in the post banking sector reformperiod

Agriculture

Industry

Services

Output

37

23

40

Credit

15.7

43.5

40.8

Output

29

25.5

45.5

Credit

10

48

42

Source : Central Statistical Organisation and Reserve Bank of India.

analysis is required to comment on the allocative efficiency in different sectors in the post reform phase. At the State level, all the States under study can be broadly classified into four categories based on their shares in aggregatecredit and output. States with increased share in output and credit in the post reform phase as compared to the pre reform period are the 'Group A' States. States with increased share in output but reduced share in credit are the 'Group B' States. States ith increased share in credit and reduced share in output are 'Group C' status, and States with decline in their share in output and credit belong to the 'Group D' category. As can be seen from Table 3, the majority of the States (Thirteen) belong to Group D, which have suffered a decline in their share in aggregate output and credit. In total, share of credit in the aggregate credit has gone down for 16 States and has improved for 7 States in the post reform phase. Considerable inequality is thus , seen among the States in terms of their share in overall credit. In such a scenario, it becomes interesting to enquire, whether, States receiving an increasing share of the credit resource have been able to make the most of it. In other words, whether, rising credit shares are also accompanied with improved allocative efficiency. Further, if allocative efficiency of credit has improved even

Table 3 : Changing Share of Different States in Output andCredit: A Comparison of Pre-Reform and Post-Reform Period

States with States with States with States with decline increased share in increased share in increased share in in their share in output and credit output but reduced credit and reduced output and credit

TY.B.F.M Page 7


(Group A)share in credit(Group B)

share in output(Group C) (Group D)

Andhra Pradesh, Arunachal Pradesh, Kerala Assam, Bihar,

Delhi, Tamil Nadu, Rajasthan and Himachal Pradesh,

Maharastra,

Karnataka

and Gujarat

West Bengal Jammu & Kashmir,

Pondicherry,

Manipur,

MadhyaPradesh,

Punjab, Orissa,

Uttar Pradesh,

Tripura, Meghalaya

and Haryana


TY.B.F.M Page 8

for States that have undergone a decline in their share of credit, it would have well served the purpose of reforms in the banking sector. Hence, it would be useful to decipher,if any pattern is emerging at the State level, when allocative efficiency of the banking system is seen in conjunction with their credit shares. Apart from differences in their shares in output and credit, States have also exhibited a varied pattern in their growth of output and credit in the post reform period. Based on their growth in aggregate credit and output, there can be four categories of States. States with increased share in output and credit in the post reform phase as compared to the pre reform period are the 'Group E' States. States with higher growth in output but lower growth in credit belong to 'Group F'. 'Group G' States are those with higher growth in credit and lower growth in output and States with reduced growth both in output and credit belong to the 'Group H' category. The differential growth pattern in credit and output can act as a guide to comment on allocative efficiency across States. Group F States that have shown an increased growth in output along with low credit growth in the post reform period are likely to exhibit higher allocative efficiency. On the other hand, Group G States with lower output and higher credit growth are clear candidates where allocative efficiency would be deteriorating. However, it is tricky to judge about the allocative efficiency for States belonging to the Group E and group H, that have experienced either increased or

Table 4: Growth in Output and Credit of Different States:A Comparison of Pre – Reform and Post - Reform Period

States with higher States with States with higher States with growth in output higher growth growth in credit and lower growth in and credit

(Group E)

output but lowergrowth in credit(Group F)

lower growth inoutput (Group G)

output and credit

(Group H)

Delhi, Karnataka, Andhra Pradesh,

Kerala Maharastra, Gujarat,

Punjab and Haryana Arunachal Pradesh,

Assam, Bihar, Orissa

and Rajasthan Himachal Pradesh,

Jammu & Kashmir,

MadhyaPradesh,

Manipur,Meghalaya

Pondicherry,

Tamil Nadu, Tripura

and West Bengal

and Uttar Pradesh


reduced growth both in credit and output. For Group E States, that have witnessed higher growth both in credit and output, allocative efficiency would be guided by the relative growth of output vis-a-visthat of credit. Similarly, for

Group H States that have experienced a lower growth of both credit and output in the post reform phase, allocative efficiency would depend on the relative decline in onevis-a-vis the other. The indications for allocative efficiency obtained from the above informal analysis, however, need to be corroborated with more rigorous analysis to arrive at robust inferences. The empirical framework to estimate the allocative efficiency is discussed in the next section.

Section IVData and Empirical Methodology

The study examines the allocative efficiency of the banking system for 23 States of India. Allocative efficiency has been estimated separately for the two periods 1981-1992 (first period) and 1993-2001(second period). The periods have been so chosen as torepresent the pre banking sector reforms and the post banking sector reforms scenario s, respectively. The credit output dynamics has been studied for three broad sectors of each State viz, agriculture, industry and services. While measuring output; the following classification has been used. Agriculture includes agriculture, forestry and fishing and logging. Industry includes mining, quarrying and manufacturing (registered and non-registered) and services include electricity, gas and water supply, transport, storage and communication, trade, hotels and restaurants, banking and insurance, real estate, ownership of dwellings and business services, public administration and other services. Income originating from the States rather than income accruing to State concept has been used to measure output. The data on output has been taken from the information supplied by the various States to the Central Statistical Organisation. SDP data at the 1993-94 base has been used in the study. The data on credit refers to the outstanding credit to different sectors from all scheduled commercial banks in a region. The data for credit has been taken from the 'Basic Statistical Returns' published by the Reserve Bank of India. The output variable is represented by log of per capita net State Domestic Product (LPNSDP) and the credit variable by the log of per capita credit for the State (LPTCAS). Though certain new regions have been carved out from the existing ones in the year 2000, for analytical purposes, necessary adjustments have been made to make the output and credit figures for the year 2001 comparable to that for the previous years. The choice of the regions and the time period have been completely motivated by the availability and consistency of the data. However, with inclusion of regions having share of less than one percent and as well having more than ten percent in the combined NSDP for all the 25 regions, heterogeneity that prevails across the regions in India has been captured considerably.

Empirical MethodologyTo estimate the credit elasticities of output, we have twelve data points for the pre reform and nine data points in the post reform period. Use of time series estimation techniques, however, isprecluded given the small number of observations for estimation.However, taking advantage of the panel nature of the data, one canuse panel data techniques. With panel data techniques, information from the time-series dimension is combined with that obtained from the cross-sectional dimension, in the hope that inference about the existence of unit roots and cointegration can be made more straightforward and precise. To ascertain the appropriate estimation technique , the variables have been first examined for stationarity in a panel context. If the variables are found to contain a unit root, the variables are then examined for possible cointegration. In the event cointegration between the variables, Fully Modified OLS (FMOLS) estimation technique is used to obtain coefficient estimates. Specifically, the panel unit root tests developed by Levin, Lin and Chu and Im, Pesaran and Shin have been employed. Pedroni's method is used to test for panel cointegration. Fully modified OLS estimation technique given by Pedroni is used to derive the elasticities. The details of the empirical methodology are given in the Annex 6.

Section VEmpirical Results

The results of the panel unit root tests for each of our variables are shown in Annex 3. In no case, can we reject the null hypothesis that every country has a unit root for the series in log levels. Once ascertained that both the variables are I (1), we turn to the question of possible cointegration between log of per capita SDP and log of per capita credit. In the absence of cointegration, we can first Differentiate the data and then work with these transformed variables.However, in the presence of cointegration, the first differences do not capture the long run relationships in the data and the cointegration relationship must be taken into account. Annex 4 depicts the evidence on the cointegration property between per-capita SDP

and per-capita credit for the Indian States. The panel cointegration tests suggested by Pedroni (1999) have been applied. In general, the Pedroni (1999) tests turn out to be in favour of a cointegrating relation between the variables that are non stationary. The agriculture sector has not been studied for cointegration as the output variable for agriculture is stationary and the credit variable is non stationary. 2 Efficient FMOLS estimation technique is used to obtain the estimate of elasticity of output with respect to credit for each sub-period. The results are given in Annex 5. The changing allocative efficiency over time and across States can be seen from Chart 1. The results broadly indicate an improvement in the allocative efficiency for the majority of the States.3For instance, for fifteen States, there was an improvement in allocative efficiency with respect to the State Domestic Product. It may be noted that eight out of these fifteen States had undergone a decline in their share in aggregate credit in the post reform period. As indicated by the analysis of growth in terms of credit and output, the allocative efficiency of banks' funds has improved for all States that had higher output and lower credit growth in the post reform phase.For all States taken together, allocative efficiency has improved from 0.18 to 0.34 as indicated by the pooled estimates. An overview of the results in terms of States and sectors that have witnessed an improvement in allocative efficiency of bank funds is given in Table 5. At the sectoral level, an improvement in allocative efficiency of bank funds in the services sector is witnessed for 18 States and in the industrial sector for 12 States (Table 5).

RESERVE BANK OF INDIA

OCCASIONAL PAPERS

Table 5: Allocative Efficiency Across Sectors and Statesin the Post reform periodSectorsState

ANDHRAPRADESH

ARUNACHAL PRADESH

ASSAM

BIHAR

DELHI

GUJARAT

HARYANA

HIMACHAL PRADESH

JAMMU & KASHMIR

KARNATAKA

KERALA

MADHYAPRADESH

MAHARASHTRA

MANIPUR

MEGHALAYA

ORISSA

PONDICHERRY

PUNJAB

RAJASTHAN

TAMIL NADU

TRIPURA

UTTARPRADESH

WEST BENGAL

Industry

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Services

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Overall5

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Ö

Note :Ö indicates improvement in allocative efficiency in the post reform phase as compared

to the pre reform period. Blank cells indicate deterioration in allocative efficiency in

the post reform period.

Section VIConclusion

One of the main aims of financial sector reforms in the post 1990s was to improve the allocative efficiency of the financial system. The efficiency improvement of the banking system has a bearing on the overall efficiency of the Indian financial system as the banking sector has a dominant role to play in the entire financial edifice. This study attempted to enquire into the allocative efficiency of the Indian banking system on a wider canvass encompassing twenty three States and across the agriculture, industry and services sectors. Th e finding of the study broadly corroborates that there hasbeen an improvement in allocative efficiency for all States taketogether as far as elasticity of total output to total credit is concerned. At the sectoral level, however, the picture is mixed. For the services sector there has been a distinct improvement in allocative efficiency of credit in the post reform period. The agriculture and industry sector, however, have witnessed a decline in the allocative efficiency of credit in the same period. At theState level, majority of the States witnessed an improvement in the overall allocative efficiency in the post reform period. The improved allocative efficiency is more marked for the services sector than for industry across the States.

Notes

1 Given that credit – output relations involve relatively short time series dimen-sions, and the well known low power of conventional unit root tests when appliedto a single time series, there may be considerable potential for tests that can beemployed in an environment where the time series may be of limited length, butvery similar data may be available across a cross–section of countries, regions,firms, or industries.2 Both fixed and random effects estimation of elasticity of output with respect tocredit shows deterioration in allocative efficiency in the post reform period forthe agriculture sector.3 Allocative efficiency as defined by elasticity of SDP with respect to total credit.

The individual and pooled FMOLS estimates are given in Annex-5.4 Manipur is an exception5 Overall refers to the State Domestic Product

State Agriculture Industry Services NSDP

ANDHRAPRADESH

1981 1993 1981 1981 1993 1981 1981 1993 1981 1981 1993 1981

-1992 -2001 -2001 -1992 -2001 -2001 -1992 -2001 -2001 -1992 -2001 -2001

0.1 1.5 0.7 6.1 6.2 6.3 6.0 5.8 5.4 3.6 4.5 3.8

ARUNACHAL 5.1 -3.5 2.4 5.1 0.9 5.3 6.0 6.8 6.6 5.4 1.0 4.4PRADESH

ASSAM

BIHAR

DELHI

0.1 -0.3 -0.1 1.4 2.0 0.5 2.4 1.4 2.3 1.2 0.8 1.0

0.2 -0.4 -1.3 4.3 3.8 2.1 3.2 3.6 2.7 2.2 2.1 0.9

-0.3 -10.8 -6.8 4.1 -0.3 2.7 3.4 5.9 4.5 3.5 4.1 3.8

GUJARAT -2.8 -3.1 -0.2 4.8 4.3 5.9 5.0 6.8 5.5 2.4 3.7 4.0

HARYANA 2.1 -0.3 1.3 6.4 4.1 4.3 5.4 7.2 5.1 4.0 3.5 3.3

HIMACHAL 0.3 -1.8 -0.2 5.4 7.2 6.5 5.0 5.1 4.1 3.0 3.6 3.1PRADESH

JAMMU & -2.6 1.2 -0.8 2.4 -2.9 0.2 1.1 3.7 2.2 -0.3 1.8 0.7KASHMIR

KARNATAKA 0.7 3.0 1.9 4.9 5.8 4.8 5.5 9.0 6.4 3.4 6.1 4.3

KERALA 1.2 0.4 1.8 1.9 4.1 4.3 2.8 6.8 4.8 2.0 4.3 3.7

MADHYA -0.4 -1.8 0.3 2.7 7.4 6.8 4.1 4.0 3.5 1.6 2.1 2.1PRADESH

MAHARA- 0.7 -0.9 1.7 3.9 4.4 4.3 5.0 5.9 6.2 3.6 4.2 4.6SHTRA

MANIPUR -0.4 1.9 0.2 4.0 8.1 3.0 4.1 5.3 4.2 2.2 4.9 2.7

MEGHALAYA -1.6 2.7 -1.1 2.6 6.7 4.0 4.9 2.8 3.6 2.3 3.4 2.2

ORISSA

PONDI-CHERRY

PUNJAB

-0.8 -0.9 -1.4 5.1 -1.9 4.1 4.3 5.9 4.4 2.0 1.6 1.4

-1.8 -2.7 -2.6 1.0 21.6 3.2 2.2 10.0 5.2 0.9 12.3 2.8

3.1 0.2 1.9 5.1 4.9 5.0 2.5 4.9 2.8 3.3 2.8 2.9

RAJASTHAN 1.9 0.0 1.7 4.3 7.0 5.6 6.2 5.8 5.4 3.7 4.1 3.8

TAMILNADU 2.6 0.8 2.7 3.2 4.4 4.1 5.1 8.2 6.2 3.9 5.3 4.7

TRIPURA -0.1 0.4 -0.6 -1.2 12.3 4.2 6.2 5.0 5.9 2.6 4.4 3.1

UTTARPRADESH

WEST

BENGAL

0.5 0.0 0.3 5.2 2.5 3.3 3.9 2.9 3.0 2.5 1.7 1.9

3.2 2.1 2.9 1.3 4.4 2.6 2.7 8.3 4.6 2.4 5.5 3.5

1 Compound annual growth rates.

Annex 2: Growth of Sector-wise Credit2

(Per cent)

State Agriculture Industry Services TotalCredit

1981 1993 1981 1981 1993 1981 1981 1993 1981 1981 1993 1981

-1992 -2001 -2001 -1992 -2001 -2001 -1992 -2001 -2001 -1992 -2001 -2001

ANDHRA 14.0 11.1 11.0 17.1 12.3 14.9 19.7 17.2 17.4 17.0 14.1 14.8PRADESH

ARUNACHAL 37.3 7.7 19.6 36.4 -7.2 11.1 23.8 20.3 18.5 32.3 5.7 15.2PRADESH

ASSAM

BIHAR

DELHI

15.3 -1.9 7.2 19.4 1.7 8.9 17.8 13.7 13.2 18.0 6.8 10.6

14.8 0.3 10.0 11.0 1.6 8.7 20.2 8.4 14.8 15.1 4.9 11.5

-5.9 19.4 9.1 14.1 10.3 16.2 4.3 15.1 11.0 7.9 12.3 13.2

GUJARAT 14.3 6.7 11.1 15.1 15.4 14.0 15.3 16.0 15.6 15.0 14.5 14.0

HARYANA 11.4 8.5 7.6 12.8 15.8 12.4 13.2 13.3 12.1 12.4 13.5 11.0

HIMACHAL 13.4 7.1 7.6 18.0 12.2 12.4 16.8 12.2 13.3 16.5 11.6 12.1

PRADESH

JAMMU &

KASHMIR 13.0 8.6 7.3 16.6 4.8 8.9 16.1 17.9 14.8 15.9 14.2 12.6

KARNATAKA 16.1 12.2 12.1 14.8 15.1 14.0 17.2 19.5 16.0 15.9 16.3 14.3

KERALA 13.6 12.3 11.1 11.8 11.1 11.0 14.9 17.6 15.3 13.5 14.9 13.2

MADHYA 17.1 10.2 12.1 18.7 14.6 14.6 19.2 10.7 15.0 18.5 12.1 14.1PRADESH

MAHARA 12.0 12.8 10.6 14.1 16.6 15.5 13.1 17.6 15.4 13.4 16.9 15.1

-SHTRA

MANIPUR 23.3 7.9 13.0 38.8 1.3 19.9 21.2 12.8 14.1 25.3 8.6 15.3

MEGHALAYA 27.2 -3.7 10.1 36.0 5.7 16.0 17.1 9.5 14.3 23.3 6.3 13.7

ORISSA

PONDI-CHERRY

PUNJAB

14.0 8.1 9.2 19.8 7.9 12.2 20.1 14.1 14.9 18.5 11.0 12.7

7.8 7.5 6.9 15.4 7.1 12.2 16.2 15.1 15.8 14.0 10.6 12.5

7.9 11.0 7.0 15.9 14.2 13.4 10.1 14.7 12.7 11.3 13.8 11.3

RAJASTHAN 14.2 12.3 11.1 12.9 12.7 13.0 14.6 16.1 14.1 13.8 13.9 12.9

TAMILNADU 16.1 8.4 12.2 16.0 16.1 15.5 17.9 17.6 17.8 16.6 15.8 15.9

TRIPURA 20.4 1.7 10.1 26.9 -2.3 10.9 21.8 4.6 12.5 22.5 2.8 11.6

UTTARPRADESH

WEST

BENGAL

13.6 9.0 10.8 13.8 8.5 11.3 16.7 11.3 13.2 14.8 9.8 11.9

14.4 3.9 8.1 11.8 8.7 10.9 16.7 13.1 14.4 13.4 10.0 11.8

2 Compound annual growth rates.

Annex 3 : Panel Unit Root Tests 1981-1992 1993-2001

Variable Levin- Levin- Levin- IPS Levin- Levin- Levin- IPS

Lin rho Lin t-rho Lin ADF Lin rho Lin t-rho Lin ADF-stat -stat ADF-stat -stat -stat -stat ADF-stat -stat

LPAGRI -7.80 -4.52 -2.58 -6.13 -6.67 -4.56 -3.73 -6.31

LPINDS

LPSERV

LPNSDP

LPACS

LPICS

LPSCS

LPTCAS

1.15

2.45

1.75

0.82

2.09

1.08

1.64

2.27

3.36

2.91

0.68

2.40

1.20

1.73

2.37 2.45

3.53 4.54

3.58 3.99

1.33 1.46

1.98 0.74

2.81 5.31

2.58 2.20

0.47

2.49

1.58

1.67

1.49

2.36

2.47

0.73

3.46

2.18

2.82

2.57

3.49

3.53

0.73 -0.42

3.25 2.85

2.51 2.29

2.63 2.36

1.87 0.17

3.22 3.88

3.33 2.54

Notes : a. The critical values are from Levin and Lin (1992).

b. IPS indicates the Im et al. (1997) test. The critical values are taken from Table 4.c. Unit root tests include a constant and heterogeneous time trend in the data.

Annex 4 : Panel Cointegration Tests

1981-1992 1993-2001

Statistics LPINDS LPSERV LPNSDP LPINDS LPSERV LPNSDPand and and and and and

Panel v-statistics

LPICS LPSCS LPTCAS

4.52 2.49 2.97

LPICS LPSCS LPTCAS

1.02 2.80 1.79

Panel rho-statistics

Panel pp-statistics

Panel adf-statistics

-1.96 -1.71

-3.57 -2.96

-4.45 -3.47

-1.51

-2.96

-1.99

-0.39

-3.83

-2.03

-0.84

-2.89

-3.32

-0.80

-3.65

-2.48

Group rho-statistics -0.34 0.21 0.0006 1.01 1.35 0.47

Group pp-statistics

Group adf-statistics

-4.31 -3.02

-5.75 -5.09

-3.20

-3.75

-6.66

-23.83

-3.56

-15.36

-6.44

-22.65

Notes : The critical values for the panel cointegration tests are base on Pedroni (2001a).

LPAGRI = Log of per capita agricultural outputLPINDS = Log of per capita industrial output

LPSERV = Log of per capita services sector outputLPNSDP = Log of per capita net State domestic productLPACS = Log of per capita agricultural credit

LPICS = Log of per capita industrial creditLPSCS = Log of per capita services sector credit

LPTCAS = Log of per capita total credit outstanding for all sectors of the State

Annex 5 : Individual and Pooled FMOLS Results

States 1981-1992 1993-2001 1981-1992 1993-2001 1981-1992 1993-2001

LPNSDP LPNSDP LPINDS LPINDS LPSERV LPSERV

ANDHRAPRADESH 0.22 0.31 0.41 0.44 0.32 0.35

ARUNACHAL PRADESH(-12.95) (-33.96)

0.17 0.06(-10.60) (-27.86) (-13.61) (-45.14)

0.15 0.1 0.34 0.38

ASSAM

(-42.90) (-26.11) (-31.56) (-6.07) (-19.96)0.05 0.11 -0.03 0.25 0.14

(-8.08)0.09

BIHAR(-78.06) (-48.25) (-86.56) (-11.31) (-37.71) (-52.65)

0.14 0.19 0.34 0.05 0.17 0.37(-26.38) (-8.86) (-12.21) (-6.08) (-153.24) (-8.82)

DELHI 0.42 0.33 0.32 -0.09 0.55 0.36

GUJARAT

(-10.74) (-11.09) (-32.89) (-16.46) (-2.82)0.15 0.21 0.28 0.27 0.34

(-9.69)0.47

HARYANA(-29.75) (-13.17) (-15.23) (-24.29) (-27.64) (-14.50)

0.37 0.26 0.52 0.25 0.43 0.52(-11.96) (-85.73) (-9.53) (-235.33) (-8.25) (-31.67)

HIMACHAL PRADESH 0.22 0.29 0.03 0.47 0.34 0.46

JAMMU & KASHMIR(-12.84) (-41.42)

-0.02 0.1(-38.75) (-61.07)

(-14.24) (-7.34) (-11.42) (-18.74)-0.19 -0.24 0.08 0.2

(-13.13) (-13.86) (-67.00) (-51.85)KARNATAKA 0.21 0.39 0.02 0.4 0.34 0.47

KERALA(-25.53) (-13.58)

0.15 0.28(-15.67) (-49.23)

(-43.88) (-12.76) (-24.92) (-15.15)0.09 0.3 0.2 0.4

(-13.33) (-36.07) (-31.35) (-25.86)MAHARASHTRA 0.08 0.15 -0.05 0.29 0.23 0.38

MANIPUR(-33.23) (-36.83)

0.31 0.24(-14.19) (-74.81)

(-47.65) (-27.18) (-47.62) (-18.57)0.03 0.25 0.4 0.35

(-9.61) (-55.47) (-5.83) (-24.06)MEGHALAYA 0.09 0.48 -0.01 0.02 0.2 0.44

MADHYAPRADESH(-97.31)

0.08(-22.14)

(-2.92) (-129.84) (-1.38) (-47.02)0.2 -0.06 0.14 0.29

(-6.10) (-75.61) (-5.11) (-10.05)

(-7.77)0.24

(-9.58)ORISSA 0.14 0.11 0 -0.59 0.25 0.43

PONDICHERRY(-55.82) (-58.34)

0.06 1.09(-57.65) -0.48

(-16.08) (-9.70) (-76.56) (-60.82)-0.12 2.19 0.14 0.66

(-13.49) -1.18 (-133.73) (-8.45)PUNJAB 0.29 0.22 0.16 0.34 0.27 0.37

RAJASTHAN

(-11.00) (-86.15)0.32 0.27

(-7.50) (-17.70) (-18.51) (-16.08)0.14 0.53 0.46 0.37

TAMILNADU(-12.24) (-11.18) (-6.93) (-13.45) (-8.75) (-16.27)

0.25 0.33 0.16 0.24 0.32 0.5(52.30) (-63.08) (-23.21) (-28.70) (-65.09) (-15.10)

TRIPURA 0.11 1.46 0 -2.31 0.3 0.97

UTTARPRADESH(-22.23)

0.19-1.91 (-39.83) (-3.05) (-19.08)0.17 0.05 0.29 0.27

(-0.64)0.28

WESTBENGAL(-63.23) (-38.75) (-51.47) (-11.36) (-30.85) (-64.79)

0.21 0.5 0.21 0.49 0.17 0.63(-30.22) (-29.80) (-16.57) (-29.83) (-70.59) (-9.82)

POOLED 0.18 0.34 0.03 0.18 0.28 0.42(-162.03) (-166.41) (-156.24) (-124.94) (-194.26) (-111.37)

Note : Figures are estimated elasticities of output with respect to credit of the respective sectors.

Figuresinparenthesisindicatet-value

Annex 6

Panel Unit Root, Panel Cointegration and Fully Modified OLS Estimation Panel unit root Tests

There are several techniques, which can be used to test for a unit root in panel data. Specifically, we are interested to test for non- stationarity against the alternative that the variable is trend stationary. Levin, Lin and Chu (LLC) TestOne of the first unit root tests to be developed for panel data is that of Levin and Lin, as originally circulated in working paper form in 1992 and 1993. Their work was finally published, with Chu as a coauthor, in 2002. Their test is based on analysis of the equation:∆yt tyi tiii i t,, 1i 1,2,.. ,N t 1,2,... ., ,This model allows for two-way fixed effects (a and q) and unit- specific time trends. The unit-specific fixed effects are an important source of heterogeneity, since the coefficient of the lagged dependent variable is restricted to be homogeneous across all units of the panel. The test involves the null hypothesis H0: ri= 0 for all I against the alternativeHA: ri =r< 0 for all I with auxiliary assumptions under the null also being required about the coefficients relating to the deterministic components. Like most of the unit root tests in the literature, LLC assume that the individual processes are cross- sectionally independent. Given this assumption, they derive conditions and correction factors under which the pooled OLS estimate will have a standard normal distribution under the null hypothesis. Their work focuses on the asymptotic distributions of this pooled panel estimate of r under different assumptions on the existence of fixed effects and homogeneous time trends. The LLC test may be viewed as a pooled Dickey-Fuller (or ADF) test, potentially with differing lag lengths across the units of the panel.The Im-Pesaran-Shin TestThe Im-Pesaran-Shin (IPS, 1997) test extends the LLC framework to allow for heterogeneity in the value of riunder the alternative hypothesis. Given the same equation:∆yi tiittyi 1,2,.. ,N t 1,2,... ., ,The null and alternative hypotheses are defined as:H0: ∀i0 I and H A:iN0,i 1,2,...,1;i0,i N11, N12,...N Thus under the null hypothesis, all series in the panel are nonstationary processes; under the alternative, a fraction of the series in the panel are assumed to be stationary. This is in contrast to the LLC test, which presumes that all series are stationary under the alternative hypothesis. The errors are assumed to be serially autocorrelated, with different serial correlation properties and differing variances across units. IPS propose the use of a group- mean Lagrange multiplier statistic to test the null hypothesis. The ADF regressions are computed for each unit, and a standardized statistic computed as the average of the LM tests for each equation. Adjustment factors (available in their paper) are used to derive a test statistic that is distributed standard Normal under the null hypothesis. IPS also propose the use of a group-

mean t-bar statistic, where the t statistics from each ADF test are averaged across the panel; again, adjustment factors are needed to translate the distribution of t-bar into a standard Normal variate under the null hypothesis. IPS demonstrates that their test has better finite sample performance than that of LLC. The test is based on the average of the augmented Dickey-Fuller (ADF) test statistics calculated independently for each member of the panel, with appropriate lags to adjust for auto- correlation. The adjusted test statistics, [adjusted using the tables in Im, Pesaran, and Shin (1995)] are distributed as N(0,1) under the null of a unit root and large negative values lead to the rejection of a unit root in favor of stationarity.

Panel Cointegration Tests and Efficient Estimation

Cointegration analysis is carried out using a panel econometric approach. Since the time series dimension is enhanced by the cross section, the analysis relies on a broader information set. Hence, panel tests have greater power than individual tests, and more reliable findings can be obtained. We use Pedroni's (1995, 1997) panel cointegration technique, which allows for heterogeneous cointegrating vectors. The panel cointegration tests suggested by Pedroni (1999) extend the residual based Engle and Granger (1987) cointegration strategy. First, the cointegration equation is estimated separately for each panel member. Second, the residuals are examined with respect to the unit root feature. If the null of no-cointegration is rejected, the long run equilibrium exists, but the cointegration vector may be different for each cross section. Also, deterministic components are allowed to be individual specific. To test for cointegration, the residuals are pooled either along the within or the between dimension of the panel, giving rise to the panel and group mean statistics (Pedroni, 1999). In the former, the statistics are constructed by summing both numerator and denominator terms over the individuals separately; while in the latter, the numerator is divided by the denominator prior to the summation. Consequently, in the case of the panel statistics the autoregressive parameter is restricted to be the same for all cross sections. If the null is rejected, the variables in question are cointegrated for all panel members. In the group statistics, the autoregressive parameter is allowed to vary over the cross section,as the statistics amounts to the average of individual statistics. If the null is rejected, cointegration holds at least for one individual. Therefore, group tests offer an additional source of heterogeneity among the panel members. Both panel and group statistics are based on augmented Dickey Fuller (ADF) and Phillips- Perron (PP) method. Pedroni (1999) suggests 4 panel and 3 group s tatistics. Under appropriate standardization, each statistic is distributed as standard normal, when both the cross section and the time series dimension become large. The

asymptotic distributions can be stated in the form Z Z* −N(1)v where Z* is the panel or group statistic, respectively, N the cross section dimension m and n and arise from of the moments of the underlying Brownian motion functionals. They depend on the number of regressors and whether or not constants or trends are included in the co-integration regressions. Estimates for m and n are based on stochastic simulations and are reported in Pedroni (1999). Thus, to test the null of no co-integration, one simply computes the value of the statistic so that it is in the form of (1) above and compares these to the appropriate tails of the normal distribution. Under the alternative hypothesis, the panel variance statistic diverges to positive infinity, and consequently the right tail of the normal distribution is used to reject the null hypothesis. Consequently, for the panel variance statistic, large positive values imply that the null of no co-integration is rejected. For each of the other six test statistics, these diverge to negative infinity under the alternative hypothesis, and consequently the left tail of the normal distribution is used to reject the null hypothesis. Thus, for any of these latter tests, large negative values imply that the null of no cointegration is rejected. The intuition behind the test is that using the average of the overall test statistic allows more ease in interpretation: rejection of the null hypothesis means that enough of the individual cross sections have statistics 'far away' from the means predicted by theory were they to be generated under the null.

Panel FMOLSIn the event the variables are co-integrated, to get appropriate estimates of the co-integration relationship, efficient estimation techniques are employed. The appropriate estimation method is so designed that the problems arising from the endogeneity of the regressors and serial correlation in the error term are avoided. Due to the corrections, the estimators are asymptotically unbiased. Especially, fully modified OLS (FMOLS) is applied. In the modelyitxiiitxuitx,(u)(2) (2)itit −1ititit,itthe asymptotic distribution of the OLS estimator depends on the long run covariance matrix of the residual process w. This matrix is given by Ωlim1T∑E ϖT∑ϖ ′ ϖ,ϖu,(3)(3)iT→∞Tt1itt1itiiϖu iϖ,ifor the i-th panel member, where1T2∑ ∑ ϖϖ′u iilimTEitit,2,T →∞t1u i,i(4)1 T −1T∑∑ ,u iiiT→∞Tkt1E wwitit k′ui,,i(4)denote the matrices of contemporaneous correlation coefficients and theauto-covariance, respectively, where the latter are weighted according to the Newey and West (1994) proposal. For convenience, the matrix ,ui, ∑ ii∞∑E ww'(5)(5)i,,ij 0ii 0 is defined. The endogeneity correction is achieved by the transformation *−ϖˆuiˆyityit,ϖ−,1i∆xit(6) and the fully modified estimator is ˆ* −1*ˆ*i'iiX yii−Tu)('(7) (7)ˆwhere,*uˆ u −ϖϖˆ ˆ−i1ˆ,provides the autocorelation correction, The estimates

needed for thetransformations are based on OLS residuals obtained in a preliminary step. The panel FMOLS estimator is just the average of the individuals parameters.

Narasimham Committee Report - Some Further Ramifications and Suggestions Jayanth R. Varma, V. Raghunathan, A.Korwar and M.C. Bhatt Working Paper No. 1009 February 1992 Indian Institute of Management, Ahmedabad

2. Narasimham Committee Report Some Further Ramifications and Suggestions

AbstractThis paper while agreeing with the general thrust of the Narasimham Committee Report, calls attention to some logical corollaries of the Report and analyses some possible fallout from implementing the Report. We agree with the view that control of banking system should be under an autonomous body supervised by the RBI. However at the level of individual banks, closer scrutiny of lending procedures may be called for than is envisaged in the Report. In a freely functioning capital market the potential of government bonds is enormous, but this necessitates restructuring of the government bond market. The government bonds may then also be used as suitable hedging mechanisms by introducing

options and futures trading. We recommend freeing up the operation of pension and provident fund to enable at least partial investment of such funds in risky securities. In the corporate sector, we believe that the current 2:1 debt equity norm is too high and not sustainable in the long term. We envisage that high debt levels and higher interest rates, combined with higher business risk may result in greater incidence of corporate sickness. This may call for various schemes for retrenched workers and amendment to land laws for easy exit of companies. On account of interdependencies across different policies, any sequencing of their implementation may be highly problematic. We therefore suggest a near simultaneity in the implementation of various reforms in order to build up a momentum which would be irreversible if people are to have confidence that the reforms will endure, and if we are to retain our credibility with international financial institutions.

Narasimham Committee Report

Some Further Ramifications and SuggestionsThe Narasimham Committee Report is without doubt a major path- breaking piece of work and deserves the support of all who yearn for a more rational and effective banking system in this country. We strongly agree with the general thrust of the report and enthusiastically endorse its major recommendations. In particular, we welcome its proposals to delink the entire issue of concessional credit from the issue of banking operations, to reduce the SLR limits, to strengthen the capital base of banks, and to bring about a general freeing of interest rates. We also strongly endorse the call for greater transparency in banking reports as well as the proposal to strengthen the regulatory role of SEBI while abolishing the office of the CCI. The concept of ARF for bad debts and the idea of having special tribunals to expedite recovery of dues are also very practical and eminently implementable. The intent of this note is not to comment paragraph by paragraph on the Committee Report or to attempt to pick holes in what is a welcome as well as a comprehensive set of recommendations to reform the banking system. Instead, what we shall attempt to do here is to call attention to some natural corollaries of the Report, and to speculate about some possible fall-out from implementing the Report which the Government and the financial system in general may want to look out for. The note is structured in five parts: in the first, we shall examine the implications of the Report for the government bond markets. This will be followed by a look at the implications for the corporate sector. After this section, a brief look at the implications for the rural sector will be followed by some speculations regarding the financial auditing and consulting sector. Finally, a look at the interlinkages between the financial sector and the real economy, and we conclude with a word about the pace of reform.

I. Restructuring the Government Bond Market

Today, the government bond market is exclusively the province of banks and banking institutions. From the point of view of the banks, the chief function of government bonds is to satisfy the SLR requirements. One likely consequence of the proposed reduction in SLR limits from 38.5% to 25% is that government bonds will increasingly be subject to some of the market pressures other bonds experience in financial markets. The government bond market is likely to be increasingly integrated into the mainstream capital market with investors comparing the yields on government bonds with yields available on comparable financial instruments elsewhere. A considerable widening and deepening of the government bond market will be necessary to handle these changes. Currently, while government bonds are listed on the stock exchanges, they are not actively traded. Trading is essentially restricted to the interbank market. The potential role of government bonds in a freely functioning capital market is enormous - one has only to observe that the U.S. treasury bill and bond market is the largest in the world, to recognize this fact. Because of the virtual absence of default risk on government debts, government bonds have the potential to offer investors a riskless investment with which to manage overall portfolio risk. Private corporate funds, both large and small, would be attracted to such an investment as a place to park cash without undue risk. Mutual funds could use the government bond markets to manage the risk of their overall portfolios on a day to day basis - switching in and out of government bonds depending on their perception of the likely course of the stock markets. Government bonds are also an excellent vehicle to manage inflation risk - in a freely functioning bond market, yields on government bonds would have high correlations with expected inflation rates. Forecasting of inflation rates would also become possible as the government bond market develops and matures. Various organizations including corporations, trade associations and trade unions could use such forecasts in pricing and bargaining. Individuals would be able to use government bonds as part of their investment strategy, especially for trusts and legacies for their children. To cater to such demands, a number of bond trading firms would probably arise, specializing in dealing in government bonds. Operating on thin, almost invisible margins, such firms would help keep the government bond markets efficient in the informational efficiency sense, rather like Salomon Brothers, for instance, in the U.S. Public sector enterprises and government agencies may well find that an active, efficient bond market which attracts private capital could be a major source of much-needed funds.SLRIt is clear that the SLR limits are intended mainly to ensure that banks maintain adequate liquidity to discharge their obligations. It is difficult to see how long-term bonds - government or otherwise - could qualify as liquid assets. At the same time, there are a number of other financial assets which could qualify -

short-term corporate debt instruments like commercial paper of the highest quality, for instance. There is a need to rethink the meaning of liquidity, keeping foremost the basic intent of the SLR. This would be in line with the spirit of the Narasimham Committee Report - to return to sound banking practices. It would, in any case, be necessitated by the expected integration of the government bond market with the rest of the financial markets. Trust Securities

Bringing government bonds into the mainstream of financial markets would also mean that they should compete openly with other high-grade securities for inclusion in the portfolios of provident funds and pension funds. These, and similar bodies, are currently required to invest only in approved Trust securities which are essentially government bonds. We believe that non-government securities of comparable risk should be permitted as investment vehicles. In a further move to free up the operation of pension and provident funds, employees - the ultimate investors - should be permitted the option of choosing to have their funds deployed at least partly in equity securities. We believe such liberalisation of the investment activities of pension and provident funds will fuel an unprecedented boom in such funds. Strong funds of this kind can help mobilize savings just as mutual funds have in the past few years. Strong pension funds can serve two purposes - they can act as major sources of funding, both loans and equity, for companies in both the private and public sector. This would help alleviate some of the financing crunch so many companies are facing today. Secondly, well-managed pension funds can provide the banking system some healthy competition, which would force them to strive for greater efficiency and productivity. Interest Rate HedgingWith interest rates deregulated, there will be a need to develop suitable hedging mechanisms in the form of futures and options. In the long run, these mechanisms may well be needed for all securities. However, since government bonds would be influenced by a relatively small number of factors such as inflation and the term structure of interest rates, they would provide an ideal vehicle to experiment and learn how to operate options and futures markets in the Indian context. We believe government bonds should be the first choice of securities exchange boards contemplating introducing options and futures trading. II. The Corporate SectorIf we compare corporate debt levels in India with those elsewhere, we would find that Indian companies operate with an astoundingly high degree of borrowing. Debt levels of 2:1 and 3:1 are commonplace in India - whereas they would be unthinkable in most other financial markets of the world. There are many

aspects to this issue - a high debt level permits control of the company with a very small equity investment. The results of such 'control without commitment' are not always healthy for the company, to say the least. When major shareholders strip a company of its productive earning power and leave a shell behind, at least part of the blame must be ascribed to a system which allows such extraordinary levels of debt financing. In economic downturns and recessions - inevitable in any economy - high levels of debt will often cause a company to fall when it should only stumble. Why have such high debt levels been permitted? There are probably mean reasons, rooted in the history of the growth pains of a developing economy. One such reason would be that government controlled financial institutions have often seen it as their duty to provide funds to an 'approved' company - namely, any company which has been able to secure a license. Even companies implementing the riskiest of projects have been able to find debt financing, often at concessional rates, once they have been able to get a license for the project. With the reform of the financial system proposed by the Narasimham Committee, financial institutions will begin to move away from such concerns with developmental or societal objectives. One result will be that corporations will be forced to reduce their reliance on debt financing. There are at least three other reasons why the historical high debt levels of corporations cannot be sustained in the future. One is that, as the interest rates are deregulated, they are likely to rise, at least in the short term. This is especially the case because so much of corporate debt has been obtained in the past at concessional rates from financial institutions. The increase in interest rates will increase the debt service burden sharply at current levels of borrowings. As the equity markets grow, equity financing will appear more and more attractive in comparison. Further, with the greater reliance upon borrowing from the capital markets rather than from Development Finance Institutions, there will be less flexibility in terms of rescheduling of payments, since it is hardly practicable to convene a meeting of debenture-holders at every turn. Finally, since high debt levels increase the overall risk of the corporation, companies will have to seek ways to control their financial risk as they struggle to cope with the increased business risks they will face in openly competitive product markets. With the risk of mistakes and stumbles greatly increased, companies will find their equity values depressed if they burden themselves with debt and thereby invite financial disasters. This is one of the likely but thus far unheralded consequences of the liberalization of industrial policy by the present government, which has left few protected markets for companies to keep harvesting as they have in the past. Corporate Sickness

Until such time as the corporate debt levels are brought down to more manageable levels, the corporate sector will probably see a greater incidence of sickness on account of its inability to absorb the higher debt service charges.

This is especially true of the older, more established companies which will, at the same time, find their hitherto profitable and protected markets invaded by new and more aggressive competitors. The erosion of profitability and the increase in debt service burden will be a vise many such companies will find themselves inexorably squeezed in. Needless to say, this brings up issues such as exit policy, which we address in the section on Interlinkages. At this stage, however, we suggest that the debt equity norm should be reduced in a time-bound manner, say over a period of two years, from 2:1 to 1:1, in order to give the corporate sector some time to adjust their long-term financing mix. Eventually, of course, the debt equity norm will have to be determined purely on business considerations, and will vary in a complex manner from industry to industry if not from company to company. However, a phased move in this direction must be implemented as soon as the Narasimham Committee report itself is implemented in its final form.

III. Rural Sector BanksWith the implementation of the Narasimham Committee Report, commercial banks will no longer be cross-subsidizing loans to the rural sector with earnings from the urban sector. While this will certainly put an end to the strategic schizophrenia banks have been afflicted with in the past, it does mean that commercial banks, including their rural subsidiaries, will find it increasingly difficult to compete with specialized rural banks. We anticipate that the need and the demand for credit in the rural sector will only grow as the economy grows. To meet this demand, a number of such specialized banks are likely to arise, probably floated by entrepreneurs with strong rural roots. Because such entrepreneurs are likely to perform much better than the rural subsidiaries of the existing commercial banks at the critical tasks of credit appraisal and understanding the real needs of rural people, we expect these new financial institutions to serve rural markets better. However, they will always suffer from two major problems: they will always be localized and therefore not adequately diversified, which will make them prone to failure with every local disaster; secondly, they will be short of capital in the short run. We expect that government will have to find ways to provide capital to such new banks, preferably in the form of venture capital in the form of equity. It is hard to see what can be done to solve the problem of inadequate geographical diversification without jeopardizing the strong local expertise which will be the main competitive advantage for these new banks.

IV. Financial Auditing and ConsultingWe believe that the scheme proposed by the Committee for supervision of banks will be found to be inadequate, in as much as it relies strongly on self-regulation by banks with a small supervisory board. The main aim of bank supervision should be to protect the interests of depositors and to prevent any run on the

banking system which may be follow any significant bank failures. We propose that the best way to ensure this would be a strong system of bank examiners, coupled with a system of insurance of bank deposits. Bank examiners would be charged with the task of auditing the portfolios of individual banks, at a detailed level, and to assess the overall portfolio of the individual bank. Examiners should be able to provide an early warning system to the bank itself as well as to the RBI if the bank has excessive exposure to particular risks, for instance. Such examiners would need to be independent of the both the bank and the RBI. Ideally, they would be professionals, trained in financial and investment management. We suggest that such the RBI hire such professional services on a contract basis. A number of other financial services would need to be developed. For instance, we have proposed in the section on government bonds that pension and provident funds be allowed to invest in 'high grade' debt securities other than government bonds. Naturally, then, there will need to be a number of independent agencies specializing in the appraisal of debt securities.

V. Interlinkages with the Real EconomyStrong interrelationships obviously exist between the banking system and the rest of the economy. Exit PolicyOpening up the entries but keeping the exit clogged is clearly not a viable procedure. The need for a workable exit policy to go along with the liberal entry policies introduced by the current government, is a rather obvious one. The point to be made here is that this need for a workable exit policy will be greatly increased by some of the fallouts from the proposed reform of the banking sector. Quite apart from the fact that some banks themselves will become unviable and will have to start downsizing or adopting a more regional focus, we expect that the incidence of corporate failures will also increase as the debt burden increases. We have dealt with this issue at length in a previous section. Labour Laws

The retrenchment of workers arising from the sickness of firms could be taken care of by the following options: a) Rather than force sick units to continue retaining the labour force, which is not feasible in the long run in any case and results in a downward spiraling of morale and productivity in the short run, employers could be forced to find alternative employment for workers elsewhere. In practice, an employer who wishes to lay off workers may have to pay a new employer to take them on. Some form of insurance could be obtained by the old employer to help defray such costs in the event of sickness. We expect an active market in this area if this option is resorted to. b) An employment retrenchment insurance scheme wherein the employer pays

an insurance premium to an insurance company to cover retrenchment payments to employees (not covering retrenchment on disciplinary grounds etc.) The insurance company could pay the retrenched worker directly to provide him or her some cushion or to pay finance any retraining which would be needed for him or her to find a new job. Various combinations of the above schemes could also be worked out. In any case, as sickness and layoffs become more common, workers also need to have a variety of insurance and pension schemes which would not be dependent on any one employer. We anticipate a growing demand for independent insurance and pension fund companies as the proposed reforms are implemented.

Land Laws

Certain restrictions on the sale of certain kinds of land properties have acted as major impediments in the way of sick companies which could otherwise have sold the land to raise funds to finance rehabilitation efforts. With the increased incidence of corporate sickness we predict as a consequence of both the liberalized industrial policy and the reforms proposed in the Narasimhan Committee report, some major amendments to land laws appear to be urgently called for.

VI. Pace of ReformMajor economic reforms are being contemplated today. One issue which naturally arises is that of sequencing these reforms. At first blush, it may appear that it would be logical to implement reforms in some logical order of priority, based perhaps on some sense of relative urgency. However, a closer examination reveals that there is some sort of circular sequencing requirement here, where each reform appears to be a precondition for another. For example, it would make little sense to reform the banking system first, since the real urgency driving this set of reforms comes from the need to rationalize the entire economic system. On the other hand, how feasible would it be to implement the reform of the industrial system first, if there is not a strong banking system to finance the new entrants into newly deregulated industries? Again, how feasible would it be to implement an easy entry policy without an easy exit policy and how would an exit policy work without a system of insurance for retrenched workers, which would require a reformed financial system as a precondition? Indeed, reforms in industrial policy are hardly likely to win the enthusiastic support of industry if industry leaders did not have reason to believe that reforms in the financial system are imminent if not concurrent. We believe the simplest way out of such a dilemma is to aim for a near simultaneity in these reforms. This will necessarily mean a rapid pace of reform in which time is measured in days, not years. Days as units connote a sense of urgency not communicated by months and years. At the same time, there is a need to build up a momentum which would be irreversible if the

people are to have confidence that the reforms will endure. A slow pace of reform will breed a 'wait and see' attitude, which would neither bring the benefits of reform nor permit continued economic growth under the old rules of the game. The greatest danger is uncertainty - he who hesitates is indeed lost. As we look around us, we see even more momentous reforms being introduced in the world today, especially in Europe and the erstwhile Soviet Union. India cannot afford to be slower than these countries, especially if we are to retain our credibility with international financial institutions.

Capital Adequacy Ratio

INTRODUCTION

The instructions regarding the components of capital and capital charge required to be provided for by the banks for credit and market risks. It deals with providing explicit capital charge for credit and market risk and addresses the issues involved in computing capital charges for interest rate related instruments in the trading book, equities in the trading book and foreign exchange risk (including gold and other precious metals) in both trading and banking books. Trading book for the purpose of these guidelines includes securities included under the Held for Trading category, securities included under the Available For Sale category, open gold position limits, open foreign exchange position limits, trading positions in derivatives, and derivatives entered into for hedging trading book exposures.

Measurement of capital charge for foreign exchange and gold open positions

Foreign exchange open positions and gold open positions are at present risk weighted at 100%. Thus, capital charge for foreign exchange and gold open position is 9% at present. These open positions, limits or actual whichever is higher, would continue to attract capital charge at 9%. This is in line with the Basel Committee requirement.

Capital Adequacy for Subsidiaries 1.The Basel Committee on Banking Supervision has proposed that the New Capital Adequacy Framework should be extended to include, on a consolidated basis, holding companies that are parents of banking groups. On rudential considerations, it is necessary to adopt best practices in line with international standards, while duly reflecting local conditions. 2.Accordingly, banks may voluntarily build-in the risk weighted components of

their subsidiaries into their own balance sheet on notional basis, at par with the risk weights applicable to the bank's own assets. Banks should earmark additional capital in their books over a period of time so as to obviate the possibility of impairment to their net worth when switchover to unified balance sheet for the group as a whole is adopted after sometime. Thus banks were asked to provide additional capital in their books in phases, beginning from the year ended March 2001.3.A consolidated bank defined as a group of entities which include a licensed bank should maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR)as applicable to the parent bank on an ongoing basis. While computing capital funds, parent bank may consider the following points :i.Banks are required to maintain a inimum capital to risk weighted assets ratio of 9%. Non-bank subsidiaries are required to maintain the capital adequacy ratio prescribed by their respective regulators. In case of any shortfall in the capital adequacy ratio of any of the subsidiaries, the parent should maintain capital in addition to its own regulatory requirements to cover the shortfall. ii.Risks inherent in deconsolidated entities (i.e., entities which are not consolidated in the Consolidated Prudential Reports) in the group need to be assessed and any shortfall in the regulatory capital in the econsolidated entities should be deducted (in equal proportion from Tier I and Tier II capital) from the consolidated bank's capital in the proportion of its equity stake in the entity.Procedure for computation of CRAR1. While calculating the aggregate of funded and non-funded exposure of a borrower for the purpose of assignment of risk weight, banks may ‘net-off’ against the total outstanding exposure of the borrower -(a) advances collateralised by cash margins or deposits,(b) credit balances in current or other accounts which are not earmarked for specific purposes and free from any lien,(c) in respect of any assets where provisions for depreciation or for bad debts have been made (d) claims received from DICGC/ ECGC and kept in a separate account pending adjustment, and (e) subsidies received against dvances in respect of Government sponsored schemes and kept in a separate account. 2.After applying the conversion factor as indicated in Annex 10, the adjusted off Balance Sheet value shall again be multiplied by the risk weight attributable to the relevant counter-party as specified.

3. Computation of CRAR for Foreign Exchange Contracts and Gold: Foreign exchange contracts include- Cross currency interest rate swaps, Forward foreign exchange contracts, Currency futures, Currency options purchased, and other contracts of a similar nature Foreign exchange contracts with an original maturity of 14 calendar days or less, irrespective of the counterparty, may be assigned "zero" risk weight as perinternational practice. As in the case of other off-Balance Sheet items, a two stage calculation prescribed below shall be applied:

(a) Step 1- The notional principal amount of each instrument is multiplied by the conversion factor given below:

Residual Maturity Conversion Factor

One year or less 2%

Over one year to five years 10%

Over five years 15%

(b) Step 2 - The adjusted value thus obtained shall be multiplied by the risk weight age allotted to the relevant counter-party as given in Step 2 in section D of Annex 10. 4. Computation of CRAR for Interest Rate related Contracts::Interest rate contracts include the Single currency interest rate swaps, Basis swaps, Forward rate agreements, Interest rate futures, Interest rate options purchased and other contracts of a similar nature. As in the case of other off-Balance Sheet items, a two stage calculation prescribed below shall be applied:(a)Step 1 - The notional principal amount of each instrument is multiplied by the percentages given below :Residual Maturity

One year or less

Over one year to five years

Over five years

Conversion Factor

0.5%

1.0%

3.0%

(b) Step 2 -The adjusted value thus obtained shall be multiplied by the riskweightage allotted to the relevant counter-party as given in Step 2 in Section I.D. of Annex

The Committee on Banking Regulations and Supervisory Practices (Basel Committee) had released the guidelines on capital measures and capital standards in July 1988 which were been accepted by Central Banks in various countries including RBI. In India it has been implemented by RBI w.e.f. 1.4.92

Objectives of CAR : The fundamental objective behind the norms is to strengthen the soundness and stability of the banking system.

Capital Adequacy Ratio or CAR or CRAR : It is ratio of capital fund to risk weighted assets expressed in percentage terms i.e.

Minimum requirements of capital fund in India: * Existing Banks 09 % * New Private Sector Banks 10 % * Banks undertaking Insurance business 10 % * Local Area Banks 15% Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot be more than 50% of the total capital.

Capital fund Capital Fund has two tiers - Tier I capital include *paid-up capital *statutory reserves *other disclosed free reserves *capital reserves representing surplus arising out of sale proceeds of assets. Minus *equity investments in subsidiaries, *intangible assets, and *losses in the current period and those brought forward from previous periods

to work out the Tier I capital. Tier II capital consists of: *Un-disclosed reserves and cumulative perpetual preference shares: *Revaluation Reserves (at a discount of 55 percent while determining their value for inclusion in Tier II capital) *General Provisions and Loss Reserves upto a maximum of 1.25% of weighted risk assets: *Investment fluctuation reserve not subject to 1.25% restriction *Hybrid debt capital Instruments (say bonds): *Subordinated debt (long term unsecured loans:

Risk weighted assets - Fund Based : Risk weighted assets mean fund based assets such as cash, loans, investments and other assets. Degrees of credit risk expressed as percentage weights have been assigned by RBI to each such assets.

Non-funded (Off-Balance sheet) Items : The credit risk exposure attached to off-balance sheet items has to be first calculated by multiplying the face amount of each of the off-balance sheet items by the credit conversion factor. This will then have to be again multiplied by the relevant weightage.

Reporting requirements : Banks are also required to disclose in their balance sheet the quantum of Tier I and Tier II capital fund, under disclosure norms. An annual return has to be submitted by each bank indicating capital funds, conversion of off-balance sheet/non-funded exposures, calculation of risk -weighted assets, and calculations of capital to risk assets ratio,

Asset - Liability Management System in banks - GuidelinesOver the last few years the Indian financial markets have witnessed wide ranging changes at fast pace. Intense competition for business involving both the assets and liabilities, together with increasing volatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on the management of banks to maintain a good balance among spreads, profitability and long-term viability. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic andintegrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their business - credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk, liquidity risk and operational risks. 2. This note lays down broad guidelines in respect of interest rate and liquidity risks management systems in banks which form part of the Asset-Liability Management (ALM) function. The initial focus of the ALM function would be to enforce the risk management discipline viz. managing business after assessing the risks involved. The objective of good risk management programmes should be that these programmes will evolve into a strategic tool forbank management. 3. The ALM process rests on three pillars:ALM information systems=> Management Information System=> Information availability, accuracy, adequacy and expediency

ALM organisation=> Structure and responsibilities=> Level of top management involvementALM process=> Risk parameters=> Risk identification=> Risk measurement=> Risk management=> Risk policies and tolerance levels.

TRENDS IN DOMESTIC RATES AND YILED CURVE

The major focus of prudential regulation in developing countries has traditionally been on credit risk. While banks and their supervisors have grappled with non-performing loans for several decades, interest rate risk is a relatively new problem. Administrative restrictions on interest rates in India have been steadily eased since 1993. This has led to increased interest rate volatility. Table I shows the trends in domestic interest rates in India during the study period. It is clear that the rates are increasing.

Table I - Trends in Domestic Interest Rates in India (in %)

Effective since reverse repo rate repo rate CRRMar 31, 2004 4.50 6.00 4.50Sep 18, 2004 4.50 6.00 4.75Oct 2, 2004 4.50 6.00 5.00

Oct 27, 2004 4.75 6.00 5.00Apr 29, 2005 5.00 6.00 5.00Oct 26, 2005 5.25 6.00 5.00Jan 24, 2006 5.50 6.25 5.00Jun 9, 2006 5.75 6.50 5.00Jul 25, 2006 6.00 6.75 5.00Oct 31, 2006 6.00 7.00 5.00Dec 23, 2006 6.00 7.25 5.25Jan 6, 2007 6.00 7.25 5.50

Source: RBI Bulletin

The yield curve has shifted upward since March ‘04, with the 10-year yields moving from 5% to 7% (Fig.I). However,the longer end of the curve has flattened. The significant drop in turnover in 2004-05 and 2005-06 could be due to a ‘buy and hold’ tendency of the participants other than commercial

banks (like insurance companies) and also due to the asymmetric response of investors to the interest rate cycle. Inthe absence of a facility of short selling in government securities, participants generally refrained from taking positions which resulted in volumes drying up in a falling market. The Reserve Bank's efforts to elongate the maturity profile resulted in a smooth and reliable yield curve to act as a benchmark for the other markets for pricing and valuationpurposes. The weighted average maturity of securitiesincreased from 5.5 years in 1995-96 to 14.6 years during2006-07. The weighted average yield of securities alsodeclined to 5.7 per cent in 2003-04 and since then, it has increased to 7.3 per cent in 2005-06 and further to 7.9 percent in 2006-07.The Indian yield curve today compares with not only emerging market economies but also the developed world.

Cash Reserve Ratio*

Statutory

Liquidity

Ratio**

RateEffective Date RateEffective

DateRateEffective Date

1 2 1 2 1 2

3.5 5/7/1935 (a)5% of DL 5/7/1935 20 16-03-1949

(b)2% of TL

3 28-11-1935 (a)5% of DL 6/3/1960

(b)2% of TL @ 25 16-09-1964

(a)5% of DL 6/5/1960

(b)2% of TL @

3.5 15-11-1951 (a)5% of DL11/11/1960 26 5/2/1970

(b)2% of TL 27 24-04-1970

316-09-1962 28 28-08-1970

529-06-1973

4 16-05-1957 6 8/9/1973

722-09-1973 29 4/8/1972

5 1/7/1974 30 17-11-1972

4.514-12-1974

4.5 3/1/1963 428-12-1974

5 4/9/1976 32 8/12/1973

613-11-1976

6 @14-01-1977

5 26-09-1964 6 @ 1/7/1978 33 1/7/1974

6 @ 5/6/1979

6.531-07-1981

721-08-1981 34 1/12/1978

6 17-02-1965 7.2527-11-1981

7.525-12-1981

7.7529-01-1982 34.5 25-09-1981

7.25 9/4/1982 35 30-10-1981

5 2/3/1968 7 @ 11/6/1982

7.5 @27-05-1983 35.5 28-07-1984

8 @29-07-1983 36 1/9/1984

8.5 @27-08-1983

6 9/1/1971 8.5 @12/11/1983

9 @ 4/2/1984 36.5 8/6/1985

9 @27-10-1984 37 6/7/1985

9 @ 1/12/1984

7 31-05-1973 9 @26-10-1985

9 @22-11-1986

9.5 @28-02-1987 37.5 25-04-1987

9.5 @23-05-1987

9 23-07-1974 10 @24-10-1987

10 @23-04-1988 38 2/1/1988

10.5 @ 2/7/1988

11 @30-07-1988

10 12/7/1981 15 @ 1/7/1989

15 @ 4/5/1991 38.5 22-09-1990

15 @ 11/1/1992

15 @(21-04-1992)

11 4/7/1991 15 @ 8/10/1992 38.5 + #(29-02-1992)

14.517-04-1993

12 9/10/1991 1415-05-1993

14.5 11/6/1994 38.25 + 9/1/1993

14.75 9/7/1994 38 + 6/2/1993

15 6/8/1994 37.75 + 6/3/1993

11 16-04-1997 14.511/11/1995 37.5 + 21-08-1993

14 9/12/1995 37.25 + 18-09-1993

10 26-06-1997 13.527-04-199634.75 ^ $ 16-10-1993

13 11/5/1996

9 22-10-1997 12 6/7/1996

11.526-10-1996 34.25 ^ 20-08-1994

11 9/11/1996 33.75 ^ 17-09-1994

10.5 4/1/1997 31.5 ! & 29-10-1994

11 17-01-1998 1018-01-1997

9.7525-10-1997

10.5 19-03-1998 9.522-11-1997 25 25-10-1997

10 6/12/1997

10 3/4/1998 10.517-01-1998

10.2528-03-1998

9 29-04-1998 10 11/4/1998

1129-08-1998

10.513-03-1999

10 8/5/1999

8 2/3/1999 9.5 @@ 6/11/1999

920-11-1999

7 2/4/2000 8.5 8/4/2000

822-04-2000

8 22-07-2000 8.2529-07-2000

8.5 12/8/2000

7.5 17-02-2001 8.2524-02-2001

8 10/3/2001

7 2/3/2001 7.519-05-2001

6.5 23-10-2001 5.75 3/11/2001

6.25 30.10.2002 5.529-12-2001

501.06.2002

4.7516.11.2002DL : Demand LiabilitiesTL : Time Liabilities

Date in brackets refer to announcement dates.

*: The data for CRR are as percentage of domestic Net Demand and time liabilities ( NDTL ) which pertain only to domestic deposits.

@ : Accompanied with additional reserve requirements of CRR on incremental NDTL.

**: Till March 29, 1985 the banks were required to maintain statutory liquidity ratio as a prescribed proportion of gross DTL as on every Friday in the following week on daily basis. Thereafter, it is maintained daily on a fortnightly basis as a prescribed portion of net DTL as on last Friday of second preceding fortnight. The data pertains only to domestic deposits.

+ : SLR on net DTL as on April 3, 1992.

# : In addition there was 30% SLR on the increase in net DTL over April 3, 1992 level.

^ : SLR on net DTL as on September 17, 1993.

$ : In addition there was 25% SLR on the increase in net DTL over September 17, 1993 level.

! : SLR on net DTL as on September 30,1994.

& : In addition there was 25% SLR on the increase in net DTL over September 30, 1994 level.

@@ : In order to improve the cash management by the banks, effective from the fortnight CRR will be maintained by every Scheduled Commercial Bank based on its NDTL as on the last Friday of the second preceding fortnight. Further to facilitate banks to tide over the contingency during the millennium change, it has been decide to treat cash in hand maintained by banks for compliance of CRR for a limited period of two months commencing from December 1,1999 to January 31, 2000. The cash in hand which will be counted for CRR purpose, during the above period cannot be treated as eligible asset for SLR purpose simultaneously.

RBI repo rate - Indian central bank’s interest rateCharts - historic RBI interest rates

Graph Indian interest rate RBI - interest rates last year

Graph Indian interest rate RBI - long-term graph

The current Indian interest rate RBI (base rate) is 8.500 %

RBI - Reserve Bank of IndiaThe Reserve Bank of India (RBI) is the Indian central bank. The RBI’s most important goal is to maintain monetary stability - moderate and stable inflation - in India.. The RBI uses monetary policy to maintain price stability and an adequate flow of credit. Rates which the Indian central bank uses for this are the bank rate, repo rate, reverse repo rate and the cash reserve ratio. Reducing inflation has been one of the most important goals for some time.

Other important tasks of the Reserve Bank of India are: to maintain the population’s confidence in the system, to safeguard the

interests of those who have entrusted their money and to supply cost-effective banking systems to the population;

to manage foreign currency controls: facilitating exports, imports and international payment traffic and developing and maintaining the trade in foreign currencies in India;

issuing money (the rupee) and adequately ensuring a high quality money supply;

providing loans to commercial banks in order to maintain or grow the Gross National Product (GNP);

acting as the government’s banker;

acting as the banks’ banker.

RBI Repo rate or key short term lending rateWhen reference is made to the Indian interest rate this often refers to the repo rate, also called the key short term lending rate. If banks are short of funds they can borrow rupees from the Reserve Bank of India (RBI) at the repo rate, the interest rate with a 1 day maturity. If the central bank of India wants to put more money into circulation, then the RBI will lower the repo rate. The reverse repo rate is the interest rate that banks receive if they deposit money with the central bank. This reverse repo rate is always lower than the repo rate. Increases or decreases in the repo and reverse repo rate have an effect on the interest rate on banking products such as loans, mortgages and savings. This page shows the current and historic values of Indian central bank's Repo rate

Base Ratei.The Base Rate system will replace the BPLR system with effect from July 1, 2010. Base Rate shall include all those elements of the lending rates that arecommon across all categories of borrowers. Banks may choose any benchmark to arrive at the Base Rate for a specific tenor that may be disclosed transparently. An il ustration for computing the ase Rate is set out in theAnnex. Banks are free to use any other methodology, as considered appropriate, provided it is consistent and is made available for supervisory review/scrutiny, as and when required. ii. Banks may determine their actual lending rates on loans and advances with reference to the Base Rate and by including such other customer specific charges as considered appropriate. iii.In order to give banks some time to stabilize the system of Base Rate calculation, banks are permitted to change the benchmark and methodology any time during the initial six month period i.e. end-December 2010. iv.The actual lending rates charged may be transparent and consistent and be made available for supervisory review/scrutiny, as and when required. Applicability of Base Rate v.All categories of loans should henceforth be priced only with reference to the Base Rate. However, the fol owing categories of loans could be priced without reference to the Base Rate: (a) DRI advances (b) loans to banks’ own employees (c) loans to banks’ depositors against their own deposits.

vi.The Base Rate could also serve as the reference benchmark rate for floating rate loan products, apart from external market benchmark rates. The floating interest rate based on external benchmarks should, however, be equal to or above the Base Rate at the time of sanction or renewal. vii.Changes in the Base Rate shall be applicable in respect of all existing loans linked to the Base Rate, in a transparent and non-discriminatory manner.viii.Since the Base Rate wil be the minimum rate for all loans, banks are not permitted to resort to any lending below the Base Rate. Accordingly, the current stipulation of BPLR as the ceiling rate for loans up to Rs. 2 lakh stands withdrawn. It is expected that the above deregulation of lending rate will increase the credit flow to small borrowers at reasonable rate and direct bank finance will provide effective competition to other forms of high cost credit. ix.Reserve Bank of India will separately announce the stipulation for export credit.Review of Base Rate x.Banks are required to review the Base Rate at least once in a quarter with theapproval of the Board or the Asset Liability Management Committees (ALCOs) as per the bank’s practice. Since transparency in the pricing of lending products has been a key objective, banks are required to exhibit the information on their Base Rate at all branches and also on their websites. Changes in the Base Rate should also be conveyed to the general public from time to time through appropriate channels. Banks are required to provide information on the actual minimum and maximum lending rates to the Reserve Bank on a quarterly basis, as hitherto.Transitional issuesxi.The Base Rate system would be applicable for all new loans and for those old loans that come up for renewal. Existing loans based on the BPLR system may run till their maturity. In case existing borrowers want to switch to the new system, before expiry of the existing contracts, an option may be given to them,on mutually agreed terms. Banks, however, should not charge any fee for such switch-over.xii.In line with the above Guidelines, banks may announce their Base Rates after seeking approval from their respective ALCOs/ Boards. Effective date xiii.The above guidelines on the Base Rate system will become effective on July 1, 2010.

Illustrative Methodology for the Computation of the Base Rate

Base Rate

a – Cost of Deposits/funds(benchmark)

b ‐

Negativ

e Carry

on CRR

and SLR 1100

c ‐ Unallocatable Overhead Cost 100

d ‐ Average Return on Net Worth 100

Where: Cost of Deposits/funds Total Deposits Time Deposits Current Deposits Saving Deposits Deployable Deposits

Annex

1Total deposits less share of deposits locked as CRR and SLR balances, . .

CRR : Cash Reserve Ratio SLR : Statutory Liquidity Ratio 364 T‐Bill Rate Unallocatable Overhead CostNP : Net Profit NW : Net Worth Capital Free Reserves

Negative Carry on CRR and SLR

Negative Carry on CRR and SLR 100 Negative carry on CRR and SLR balances

arises because the return on CRR balances is nil, while the return on SLR

balances (proxied using the 364-day Treasury Bill rate) is lower than the cost of

deposits. Negative carry on CRR and SLR is arrived at in three steps. In the first

step, return on SLR investment was calculated using 364-day Treasury Bills. In

the second step, effective cost was calculated by taking the ratio (expressed as

a percentage) of cost of deposits(adjusted for return on SLR investment) and

deployable deposits (total deposits less the deposits locked as CRR and SLR

balances). In the third step, negative carry cost on SLR and CRR was arrived at

by taking the difference between the effective cost and the cost of deposits

Unallocatable Overhead Cost 100

Unallocatable Overhead Cost 5Unallocatable Overhead Cost is calculated by taking the ratio (expressed as a percentage) of unallocated overhead cost and deployable deposits.

Average Return on Net Worth

Average Return on Net Worth Average Return on Net Worth is computed as the

product of net profit to net worth ratio and networth to deployable deposits ratio

expressed as a percentage.

Guidelines on Benchmark Prime Lending Rate (BPLR) applicable to loans sanctioned upto June 30, 2010 ( Paragraph 2.2.1)

With effect from October 18, 1994, RBI has deregulated the interest rates

on advancesabove Rs.2 lakh and the rates of interest on such advances are determined by the banks themselves subject to BPLR and Spread guidelines. For credit limits up to Rs.2 lakh, banks should charge interest not exceeding their BPLR. Keeping in view the international practice and to provide operational flexibility to commercial banks in deciding their lending rates,banks can offer loans at below BPLR to exporters or other creditworthy borrowers, including public enterprises, on the basis of a transparent and objective policy approved by their respective Boards. Banks will continue to declare the maximum spread of interest rates over BPLR. Given the prevailing credit market in India and the need to continue with concessionality for small borrowers, the practice of treating BPLR as the ceiling for loans up to Rs. 2 lakh will continue.Banks are free to determine the rates of interest without reference to BPLR and regardless of the size in respect of loans for purchase of consumer durables, loans to individuals against shares and debentures / bonds, other non-priority sector personal loans, etc. as per details given below.BPLR will be made uniformly applicable at all branches of a bank.

Determination of Benchmark Prime Lending Rate (BPLR) In order to enhance transparency in banks’ pricing of their loan products as also to ensure that the BPLR truly reflects the actual costs, banks should be guided by the following considerations while determining their Benchmark PLR: Banks should take into account their (i) actual cost of funds, (ii) operating expenses and (iii) a minimum margin to cover regulatory requirement of provisioning / capital charge and profit margin, while arriving at the benchmark PLR. Banks should announce a Benchmark PLR with the approval of their Boards The Benchmark PLR will be the ceiling rate for credit limit up to Rs.2 lakh. All other lending rates can be determined with reference to the Benchmark PLR arrived at as above by taking into account term premia and / or risk premia. Detailed guidelines on operational aspects of Benchmark PLR have been issued by IBA on November 25, 2003.In the interest of customer protection and to have greater degree of transparency in regard to actual interest rates charged to borrowers, banks should continue to provide information on maximum and minimum interest rates charged together with the Benchmark PLR.

Freedom to fix Lending Rates Banks are free to determine the rates of interest without reference to BPLR and regardless of the size in respect of the following loans:

I. Loans for purchase of consumer durables; Loans to individuals against shares and debentures / bonds;

iii. Other non-priority sector personal loans including credit card dues;iv. Advances / overdrafts against domestic / NRE / FCNR (B) deposits

with the bank,provided that the deposit/s stands / stand either in the name(s) of the borrower himself / borrowers themselves, or in the names of the borrower jointly with another person;

v. Finance granted to intermediary agencies including housing finance intermediary agencies (list as given below) for on-lending to ultimate beneficiaries and agencies providing input support.;

vi. Discounting of Bills;vii. Loans / Advances / Cash Credit / Overdrafts against commodities

subject to Selective Credit Control; viii. To a co-operative bank or to any other banking institution;ix. To its own employees;

State sponsored organisations for on-lending to weaker sections. Weaker sections include –

i) Small and marginal farmers with landholdings of 5 acres and less, andlandless labourers, tenant farmers and share-croppers;

ii) Artisans, village and cottage industries where individual credit requirements do not exceed Rs. 50,000/-;

iii) Beneficiaries of Swarnjayanti Gram Swarozgar Yojana (SGSY);iv) Scheduled Castes and Scheduled Tribes;v) Beneficiaries of Differential Rate of Interest (DRI) scheme;vi) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY);vii) Beneficiaries under scheme of Liberation and Rehabilitation of Scavengers(SLRS);viii) Advances to Self-Help Groups (SHGs);ix) Loans to distressed poor to repay their debt to informal sector, against

appropriate collateral or group security;Loans granted under (i) to (viii) above to persons from minority communities as may be notified by Government of India from time to time.In states, where one of the minority communities notified is, in fact, in majority, item

x) will cover only the other notified minorities. These States/Union Territories are Jammu and Kashmir, Punjab, Sikkim, Mizoram, Nagaland and Lakshadweep.

An Illustrative list of Intermediary Agencies1. Loans covered by refinance schemes of term lending institutions.2. Distributors of agricultural inputs / implements.3. State Financial Corporations (SFCs) / State Industrial Development Corporations (SIDCs) to the extent they provide credit to weaker sections.

4. National Small Industries Corporation (NSIC).5. Khadi and Village Industries Commission (KVIC).6. Agencies involved in assisting the decentralised sector.7. State sponsored organisations for on-lending to the weaker sections.

8. Housing and Urban Development Corporation Ltd. (HUDCO).9. Housing Finance Companies approved by National Housing Bank (NHB) for refinance.10. State sponsored organisations for SCs / STs (for purchase and supply of inputs to and / or marketing of output of the beneficiaries of these organisations).

11. Micro Finance Institutions / Non-Government Organisations (NGOs) on-lending to SHGs.Interest Rate Risk (IRR)

The phased deregulation of interest rates and the operational flexibility given to banks inpricing most of the assets and liabilities have exposed the banking system to Interest Rate Risk. Interest rate risk is the risk where changes in market interest rates might adversely affect a bank's financial condition. Changes in interest rates affect both the current earnings (earnings perspective) as also the net worth of the bank (economic value perspective). The risk from the earnings' perspective can be measured as changes in the Net Interest Income (Nil) or Net Interest Margin (NIM). In the context of poor MIS, slow pace of computerisation in banks and the absence of total deregulation, the traditional Gap analysis is considered as a suitable method to measure the Interest Rate Risk. It is the intention of RBI to move over to modern techniques of Interest Rate Risk measurement like Duration Gap Analysis, Simulation and Value at Risk at a later date when banks acquire sufficient expertise and sophistication in MIS. The Gap or Mismatch risk can be measured by calculating Gaps over different time intervals as at a given date. Gap analysis measures mismatches between rate sensitive liabilities and rate sensitive assets (including off-balance sheet positions). An asset or liability is normally classified as rate sensitive if:

i) within the time interval under consideration, there is a cash flow;ii) the interest rate resets/reprices contractually during the interval;iii) RBI changes the interest rates (i.e. interest rates on Savings Bank Deposits, advances upto

Rs.2 lakhs, DRI advances, Export credit, Refinance, CRR balance, etc.) in cases whereinterest rates are administered ; and

iv) it is contractually pre-payable or withdrawable before the stated maturities.

The Gap Report should be generated by grouping rate sensitive liabilities, assets and off- balance sheet positions into time buckets according to residual maturity

or next repricing period, whichever is earlier. The difficult task in Gap analysis is determining rate sensitivity. All investments, advances, deposits, borrowings, purchased funds etc. that mature/reprice within a specified timeframe are interest rate sensitive. Similarly, any principal repayment of loan is also rate sensitive if the bank expects to receive it within the time horizon. This includes final principal payment and interim instalments. Certain assets and liabilities receive/pay rates that vary with a reference rate. These assets and liabilities are repriced at pre-determined intervals and are rate sensitive at the time of repricing. While the interest rates on term deposits are fixed during their currency, the advances portfolio of the banking system is basically floating. The interest rates on advances could be repriced any number of occasions, corresponding to the changes in PLR. The Gaps may be identified in the following time buckets:

i) upto 1 monthii) Over one month and upto 3 monthsiii) Over 3 months and upto 6 monthsiv) Over 6 months and upto 12 monthsv) Over 1 year and upto 3 yearsvi) Over 3 years and upto 5 yearsvii) Over 5 yearsviii) Non-sensitive

The various items of rate sensitive assets and liabilities in the Balance Sheet may be classified as explained in Appendix - II and the Reporting Format for interest rate sensitive assets and liabilities is given in Annexure II.The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates that it has more RSAs than RSLs whereas the negative Gap indicates that it has more RSLs. The Gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a positive Gap (RSA > RSL) or whether it is in a position to benefit from declining interest rates by a negativeGap (RSL > RSA). The Gap can, therefore, be used as a measure of interest rate sensitivity.Each bank should set prudential limits on individual Gaps with the approval of the Board/Management Committee. The prudential limits should have a bearing on the total assets, earning assets or equity. The banks may work out earnings at risk, based on their views on interest rate movements and fix a prudent level with the approval of the Board/Management Committee.RBI will also introduce capital adequacy for market risks in due course. The classification of various components of assets and liabilities into different time buckets for preparation of Gap reports (Liquidity and Interest Rate Sensitivity) as indicated in Appendices I & II is the benchmark. Banks which are better equipped to reasonably estimate the behavioural pattern, embedded options, rolls-in

and rolls-out, etc of various components of assets and liabilities on the basis of past data / empirical studies could classify them in the appropriate time buckets, subject to approval from the ALCO / Board. A copy of the note approved by the ALCO / Board may be sent to the Department of Banking Supervision.

Background INTRODUCTIONThe importance of extending speedy, efficient, fair and courteous customer service in banking industry is being regularly emphasised by the Government of India (GOI) and Reserve Bank of India (RBI). They have set up various high level Working Groups and Committees which led to considerable improvement in customer service in Banks

1.2In 1975, the Government of India had appointed the Talwar Committeeon customer service in banks. In 1990, RBI appointed the Goiporia Committee on customer service in banks. In 2004, the Tarapore Committee recommendations led to formation of Board level committees for monitoring customer service in banks. In 2006, Reserve Bank of India appointed a Working Group to formulate a scheme to ensure reasonableness of bank service charges under the chairmanship of Shri. N. Sadasivan. The recommendations of the various Committees / Working Groups reflected the need of the time in which the Committees / Working Groups were set-up. For instance, the Goiporia Committee broadly covered the following aspects: Causes of the persistence of below par customer service in banks.

Areas of deficiencies in customer service in banks.

Measures for improvement in work culture.

Steps for inculcation of greater customer orientation among bank employees.

Identification of structural and operational rigidities and inadequacies whichadversely affect the working of banks.

Upgradation of technology to ensure prompt and efficient customerservice.

In addition to the guidelines framed based on the recommendations of the Committees, RBI had been giving instructions to banks as and when required. Over the years, the customer service in banks has improved considerably with the introduction of technology based products: ATM (this has facilitated customer to access cash withdrawal/deposits/account querying/transfer of funds/payment of utilities/purchase of air/traintickets – 24 X 7).

Internet Banking.

Debit Cards (dispensed the need for carrying cash for making purchases).

Mobile Banking (stage wise implementation) and the youngsters accessingbanking services.

Further, the banking sector has undergone a sea-change from the time when the previous Customer Service Committees were appointed. There has been a huge proliferation of bank branches. Further, de-regulation has brought in its wake

numerous banking services, niche products etc. Widespread use of technology also enhanced the customer expectations, specifically on the aspects of speed and quality of service delivery. In addition, technology implementation has made branch banking redundant on many aspects, redefined several of the existing services and raised customer expectations regarding reasonableness of service charges. While the bankers hold a view that the introduction of core banking solution entailed huge cost and the passing of benefit will take some more time till substantial portion of customers start using technology based products. The economy is also experiencing demographic dividend, thereby the number of youngsters accessing banking service is on the increase with the resultant pressure on providing technology based services. 1.4 Citizens’ Charter

On the occasion of completing fifty years of independence, the Government of India introduced the concept of Citizens’ Charter in the form of a promise to the consumers from a public authority regarding its performance. The Government of India directed all Government Departments, public sector undertakings (including public sector banks) to display a Citizens’ Charter in each of their offices. The public sector banks were required

INTRODUCTION to specif ically indicate the products / services available and the normal time taken/tariffs to put through customer transactions. The introduction of the Citizens’ Charter was an exercise in setting benchmarks for prompt delivery of banking services (including the pricing thereof) and any customer not getting the service in the promised time could access the grievances redressal machinery of the bank.

The penetrf Banking services to the remote corners of the country has been

attempted both by the use of technology and change in regulations with the introduction of Business Facilitators and Business Correspondents of banks. However, the challenge of the un-banked and under-banked areas is being addressed by coordinated efforts from banks, Regulator, IBA and Government.Setting up of the Damodaran Committee on Customer Service (2010)In the above circumstances, RBI constituted a Committee (through a BoardMemorandum dated May 26, 2010) under the chairmanship of Shri M. Damodaran, former Chairman, SEBI (Securities and Exchange Board of India) to look into the customer service aspects. The following persons were the members of the Committee: Smt. M. Rajyalakshmi Rao, former member, National Consumer DisputesRedressal Commission, New Delhi.

Shri Ashok Ravat, Hon. Secretary, All India Bank Depositors’ Association,Mumbai.

Shri M.V. Nair, Chairman, Indian Banks’ Association and CMD, Union Bankof India, Mumbai.

Shri B.M. Mittal, Chief Executive Officer, BCSBI, Mumbai.

Shri M.S. Sundara Rajan, former CMD, Indian Bank, Chennai.

Shri S. Gopalakrishnan, former Banking Ombudsman, Chennai and formerCMD, Vijaya Bank, Bangalore.

Shri Kaza Sudhakar, Chief General Manager, Customer ServiceDepartment, RBI, CO, Mumbai and Member Secretary to the Committee.

The terms of reference of the Committee was broadly classified into:

a) Review the existing system of attending to customer service in banks -approach, attitude and fair treatment to customers from retail, small andpensioners segment.

b) Evaluate the existing system of grievance redressal mechanism prevalent inbanks, its structure and efficacy and recommend measures for expeditiousresolution of complaints. The Committee may also lay down a suitable timeframe for disposal of complaints including last escalation point within thattime frame.

c) Examine the functioning of Banking Ombudsman Scheme - its structure,

legal framework and recommend steps to make it more effective andresponsive.

d) Examine the possible methods of leveraging technology for bettercustomer service with proper safeguards including legal aspects in the lightof increasing use of Internet and IT for bank products and services andrecommend measures to enhance consumer protection.

e) Review the role of the Board of Directors of banks and the role of Regulators

in customer service matter

Banking Codes and Standards Board of India (BCSBI) -A profile

The expectations of customers of banks are generally confined to prompt delivery of services relating to their deposit accounts, assistance in handling the ancillary services, transparency in dealings and a helpful attitude to solve their difficulties. Towards this end, and as a part of the regulatory process, RBI has been taking various steps over the years to ensure that services rendered by the banks to customers and common persons meet their genuine requirements. However, while the customer expectations have kept rising, the services to common person have not improved to expected levels. Therefore, RBI in 2003 constituted a Committee on Procedures and Performance Audit in Public Services (CPPAPS) under Chairmanship of Shri S.S. Tarapore, former Deputy Governor of the Reserve Bank. The CPPAPS examined the areas of interaction of customers and common person with the banks and the quality of service rendered. The Committee in its various reports covered all facets of banking services like Government business, foreign exchange business, exchange of currency, etc. to customers of commercial banks. The Committee recommended that a Banking Codes and Standards Board of India (BCSBI) should be set up in India as an organization to evaluate and oversee observance of a code of conduct by banks so that there is healthy and virtuous pressure on the banks to provide good customer service on par with best practices. To fill in the institutional gap and to calibrate the banks against codes

and standards based on best practices, Dr. Y.V. Reddy, Governor, Reserve Bank in his Monetary Policy Statement on September 2005, announced the RBI intention to set up a Banking Codes and Standards Board of India as an independent organization. This Board is expected to function as a watchdog of the banking industry. The Governing Council of the Board consists of seven members drawn from different disciplines such as banking, accountancy, consumer forum, service industry, etc. The Board is intended to be a lean organization with minimum overheads.

Relationship between RBI and BCSBI

The Board has been set up as an independent and autonomous organisation. But it is strongly supported by RBI as RBI would bear the financial cost of this institution in the initial period of five years in the best interests of the entire banking system and more particularly the interests of the common person as customer.Although the membership of BCSBI is optional, RBI is expected to have more intensive oversight on banks that do not become members of BCSBI.

Functions of BCSBI

The initiative to establish the Board is driven by the banks themselves as this would lead to the empowerment of their customers for a higher level of satisfaction with regard to the services offered, through a significant and enduring improvement in customer services. Internationally, such codes are developed by associations of bankers as self-regulatory exercises. The IBA and the BCSBI have drawn up the voluntary codes in general terms and the codes will be followed by detailed Guidance Notes on each of the code. The adherence to the codes by banks will be monitored by BCSBI. The central task of the Board would, therefore, be to ensure that the subscriber banks file detailed compliance reports to the Board on observance of voluntary codes and that they are followed rigorously. If, after a thorough assessment the Board is still not satisfied with the compliance, the Board could contemplate sanctions which may include the

following: Follow “Name & Shame” policy. That is publication by the Board of the bank’s name and details of the breach; Inclusion of details of the breach in the Board’s Annual Report; Issue of instructions to banks on remedial action; Warning or reprimand; Public censure; andCancellation of registration with the Board. While provisions for penal action exist, the basic approach of BCSBI is to take collaborative remedial action rather than through penal measures.Of the 79 scheduled commercial banks, 70 banks have enrolledas members of the BCSBI and have voluntarily adopted the ‘Code of Bank’s Commitment to Customers’. Chapter 2

Analytics of Monetary (Policyin India since IndependenceChapter-IIANALYTICS OF MONETARY POLICY IN INDIASINCE INDEPENDENCEIntroductionVery useful insights on the causes and events that shaped the direction andpace of an event can be gained by studying its evolutionary process. It is also useful in guiding the current actions and future plans. This logic tempts to undertake a purposeful analytical review of policy trends in the sphere of monetary policy in India, since Independence. Over the last five decades, the conduct of monetary policy in India has undergone sharp transformation and the present mode of monetary policy has evolved over time with numerous modifications. In this chapter, we shall trace the evolution of institutional arrangements, changes in the policy framework, objectives, targets and instruments of monetary policy in India in the light of shifts in theoretical underpinnings and empirical realities. This will serve as a useful guide for the empirical analysis in the following chapters.The discussion on the historical developments of monetary policy in India canbe carried out with different ways of periodisation. Our method of periodisation isprimarily based on the policy environment. Based on the policy framework, broadlytwo distinct regimes can be delineated in the monetary policy history of India, sinceIndependence. The first regime refers to the credit-planning era followed since thebeginning upto the mid-1980s. The second is the regime started with adoption of

'money-multiplier' framework, implemented as per recommendations of Chakravarty Committee (RBI 1985). However, both the regimes command appropriateness under the circumstances and institutional structure existed during the respective periods. In the first regime, there was a shift towards a tightly regulated regime for bank credit and interest rates since the mid-1960s with emergence of a differential and regulated interest rate regime since 1964, adoption of the philosophy of social control in 14 December 1967, the event 'bank nationalisation' in 1969, increasing deficit financing by the government, etc. Similarly, The post-Chakravarty Committee regime also can be separated into two sub-periods distinguished by the event of economic reforms of 1991-92. There was a radical shift from direct to indirect instruments and emergence of a broad, deep and diversified financial market, with prevalence of greater autonomy, in the post-reform period. Thus, the whole period since Independence can be divided into four subperiodsin our discussion on the historical development of monetary policy in India.They are (i) Initial Formative Period, which extends since Independence upto 1963,(ii) Period of High Intervention (Regulation) and Banking Expansion with social control since 1964 to 1984, (iii) New Regime of Monetary Targeting with Partial Reforms, from 1985 to 1991, and (iv) Post-Reform Period with Financial Deepening,since 1992.

Initial Formative Period (1947-1963)Prior to the Independence, the broad objectives of monetary policy in Indiacould be classified as (a) issue of notes, acting in national interest by curtailingexcessive money supply and to overcome stringency where it mitigated productionactivities, (b) public debt management, and (c) maintaining exchange value of theRupee. In the initial days of Independence, there were some challenges for monetary operations due to the event of partition and consequent division of assets of RBI, and its responsibility of currency and banking management in the transitory phase in the two new Dominions. In Independent India, the advent of planning era with establishment of Planning Commission in 1950 brought a directional change in all parameters in the economic management. As bulk of the actions and responsibilities pertaining to the economic policy rested with the Planning Commission, other entities of policymaking including the monetary authority had a supplementary role. However, setting the tone of monetary policy, the First Five Year Plan envisaged, "judicious credit creation somewhat in anticipation of the increase in production and availability of genuine savings" (GOI, 1951). During the First Five Year Plan, monetary management witnessed a distinguished order with effective coordination between the then Finance

Minister Chintaman Deshmukh, a former Governor of RBI and the then Governor of RBI Benegal Rama Rau. The RBI decided to withdraw support to the gilt-edged market signifying the proof of an independent monetary policy (da Costa, 1985). The initiatives of the Finance Minister to control government expenditure with emphasis to enhance revenue and capital receipts facilitated such a move. A mere 10.3 percent growth of money supply in the whole First Plan reflects restrictive monetary policy during this period. In the next two five year plans, conduct of monetary policy faced unprecedented challenges due to the new initiatives in the planning regime and the degree of independence enjoyed by the RBI was heavily curtailed. At the beginning of the Second Five Year Plan, both foreign exchange reserves and India's external credit were very high for easy availability of required investments. In this backdrop, under the able leadership of Prof. P. C. Mahalanobis the plan exercise emphasised on heavy industries. Although, there were notable success in the front of output expansion mainly lead by industrialisation during the Second Five Year Plan, there were some setbacks for monetary policy operations. Firstly, finance minister T. T.Krishnamachari emphasised on transforming sterling balances into investment goods since 1956-57. The foreign exchange assets depleted to the extent of Rs. 664 crores during a decade since then. There was increasing pressure on the RBI to provide credit to the government. Thus, when the real income (NNP) increased by 21.5 per cent in Second Five Year Plan, money supply (Ml) increased by 29.4 per cent (da Costa, 1985). During this period, the prices increased by 35.0 per cent contrary to the magnificent control on it in the First Five Year Plan. 'Selective Credit Control' was followed during this period as a remedy to overcome the dilemma of controlling inflationary pressure and need for financing developmental expenditure (Iengar, 1958). Much needed expenditure on infrastructure projects, which was not immediately productive exerted upward pressure on the prices of consumer goods. On the other hand, the private sector was to be provided credit for complementary expansion of investment. Hence, monetary policy did not adopt general tightening or relaxation of credit but some sectors were provided preferential credit and for some others the credit was made expensive. In the Third Five Year Plan, the 1962 hostilities with China further added pressure on monetary policy operations. This was mainly due to the credit requirement of the government for the increasing defence and developmental expenditure. Thus, money supply (Ml) during this period increased by as high as 57.9 percent. With only 11.8 percent growth of NNP in the Third Plan, prices rose by close to 32 percent. Thus, the conduct of monetary policy became a process of passive accommodation of budget deficits, by early 1960s. The decade of 1960s witnessed a gradual shift of priority from price stability to greater concerns for economic growth and accompanying credit control. A new differential interest rates regime emerged

with a view to influence the demand for credit and imparting an element of discipline in the use of credit. Under the 'quota-cum-slab' introduced in October 1960, minimum lending rates were stipulated. This was the beginning of a move towards regulated regime of interest rates. Period of High Regulation and Bank Expansion (1964 - 1984)This period witnessed radical changes in the conduct of monetary policypredominantly caused by interventionist character of credit policy and externaldevelopments. The process of monetary planning was severely constrained by heavily regulated regime consisting of priority sector lending, administered interest rates, refinance to the banks at concessional rates to enable them to lend at cheaper rates to priority sectors, high level of deficit financing, external oil price shocks, etc. Inflation was thought to be primarily caused by supply factors and not emanating from monetary causes. Hence, output expansion was thought to be anti-inflationary and emphasis was attributed on the credit expansion to step up output. In the process, the ANALYTICS OF MONETARY POLICY IN INDIA17 government occupied the pivotal role in monetary management and the RBI waspushed down to the secondary position. Since the mid-1960s, regulation of the domestic interest rates became ubiquitous in India. In September 1964 a more stringent system for bank credit based on net liquidity position was introduced and both deposit and credit rates were regulated. The introduction of Credit Authorisation Scheme (CAS) in 1965 initiated rationing of bank credit (RBI, 1999). With implementation of CAS, prior permission of RBI was required for sanctioning of large credit or its augmentation. It served the twin objectives of mobilising financial resources for the Plans and imparting better credit discipline. The degree of constraints on the monetary authority started mounting up with the measures of 'social control' introduced by the Government of India in December 1967, which envisaged a purposive distribution of credit with a view to enhance the flow of credit to priority sectors like agriculture, small sector industries and exports coupled with mobilisation of savings. Accordingly, National Credit Council was set up to provide a forum for discussing and assessing the credit priorities. Credit to certain economic activities like exports was provided with concessional rates since 1968. The transfer of financing of public procurement and distribution and fertliser operations from government to banks in 1975-76 further constrained the banking operations. The rationalisation of CAS guided by recommendations of Tandon Committee (1975), Chore Committee (1979) and Marathe Committee (1983) subsequently refined the process of credit rationing. The event of nationalisation of major commercial banks in July 1969 constitutes an important landmark in the monetary history of India, which had significant bearings on the banking expansion and social control

of bank credit. The nationalisation of banks led to use of bank credit as an instrument to meet socioeconomic needs for development. The RBI began to implement credit planning with the basic objective of regulating the quantum and distribution of credit to ensure credit flow to various sectors of the economy in consonance with national priorities and targets. There was massive branch expansion in the aftermath of bank ANAL YTICS OF MONETARY POLICY IN INDIA nationalisation with the spread of banking facilities reaching to every nook and corner of the country. The number of bank branches rapidly increased from 8,262 in 1969 to 13,622 in 1972, which subsequently increased to 45,332 by 1984.These developments had significant implications for financial deepening ofthe economy. During this period the growth of financial assets was faster as compared to the growth of output. The volume of aggregate deposit of scheduled commercial banks increased from Rs 4,338 crore in March 1969 to Rs 60,596 crore in March 1984 and the volume of bank credit increased from Rs 3,396 crore to Rs 41,294 crore in between the same period (Table II. 1). Particularly, non-food credit increased from Rs 3,915 crore in March 1970 to Rs 37,272 crore in March 1984. The average annual growth rate of aggregate deposits markedly increased from 9.5 per cent for the perio1951-52 to 1968-69 to 19.3 per cent for the period 1969-70 to 1983-84. In between the same period, bank credit increased from annual average of 10.9 per cent to 18.2 per cent. This period also witnessed growing volume of priority sector lending, which had not received sufficient attention by the commercial banks prior to nationalisation. The share of priority sector advances in the total bank credit of scheduled commercial banks rose from 14 per cent in 1969 to 36 per cent in 1982. The share of medium and large industries in the bank credit had come down from 60.6 per cent in 1968 to 37.6per cent in 1982. During this period, monetary policy of the RBI mainly focused on bank credit, particularly non-food credit, as the policy indicator. Basically, the attention was limited to the scheduled commercial banks, as they had high proportion of bankdeposits and timely available data. Emphasis on demand management through control of money supply was not in much evidence upto mid-1980s. Reserve money was not considered for operational purposes as the major source of reserve money creation -RBI's credit to the government - was beyond its control. Due to lack of control on the reserve money and establishment of direct link between bank credit and output, credit aggregates were accorded greater importance as indicators of the stance of monetary policy and also as intermediate targets. ANALYTICS OF MONETARY POUCY IN INDIA Among the policy instruments, SLR was mainly used to serve the purpose of raising resources for the government plan expenditure from the banks. The level of SLR had progressively increased from the statutory minimum of 25 per cent in February 1970 to 36 per cent in September 1984 (Table II.2). Banks were

provided funds through standing facilities such as 'general refinance' and 'export refinance' to facilitate developmental financing as per credit plans. The instrument of CRR was mainly used to neutralise the inflationary impact of deficit financing. The CRR was raised from its statutory minimum of 3 per cent since September 1962 to 5 per cent in June 1973 (Table 11.2). Gradually it was hiked to 9 per cent by February 1984. During this period, the Bank Rate had a limited role in monetary policy operations. The year 1976 constitutes one of the most eventful period in the monetary thinking in India, when a heated debate surfaced on the issue of validity of the thenprevailing monetary policy procedure. The first dissenting note came from S.B. Gupta with his seminal article advocating in favour of 'money-multiplier' approach. Gupta (1976a) argued that, the then practice of RBI's money supply analysis simply sums up its various components, and hence merely an accounting or ex post analysis. It was accused of being tautological in nature. He suggested, money supply analysis based on some theory of money supply like money multiplier approach could provide better understanding of the determinants of money supply. He also highlighted the difference in monetary impact of financing government expenditure through credit from RBI versus investment of the banks in government securities. However, RBI economists rejected Gupta's analysis as mechanistic andunsatisfactory in theory and useless in practice (Mujumdar, 1976) and claimed that, RBI's analysis provides an economic explanation of money supply in India. Mujumdar (1976) questioned the basic ingredients of 'money-multiplier approach' such as stability of the relationship between money supply and reserve money,controllability of reserve money and endogeneity of money-multiplier, and stated that, "... in certain years if the expansion in M does not confirm to the postulated relationship, one has to explain away the situation by saying that the multiplier itself has changed". He also claimed that, RBI analysis takes into account both primary money supply through the RBI and secondary expansion through commercial banks and provides a total explanation of variations in money supply. As against this, multiplier approach explains only the secondary expansion through the moneymultiplier. Shetty, Avadhani and Menon (1976) supplemented Mujumdar in defending RBFs money supply analysis. They argued that, money supply is both an economicand a policy controlled variable. As an economic variable it may be determined by the behaviour of the public to hold currency and bank deposits, but as a policy controlled variable it depends on the monetary authority's perception about the appropriate level of primary and secondary money. Thus, they refuted any simple and mechanical relationship between reserve money and money supply. They completely rejected the appropriateness of projecting monetary aggregates based on money-multiplier in the short-term due to erratical behaviour of related

coefficients, but they do not rule out usefulness of long-term projections. On the issue of the relationship between reserve money and money supply, Shetty et al (1976) asserted that, "it is incorrect of Gupta tostate that the RBI is ignorant of the significance of reserve money in monetaryanalysis. The RBI, however, does not consider it as the single element for explanation of the sources of changes in money supply." At this point a reconciliatory note came from Khatkhate (1976). He emphasised the usefulness of 'money-multiplier framework' as suggested by Gupta (1976a), but was critical of him for accusing the RBI being not aware of it. According to Khatkhate (1976), "Gupta is quite right in suggesting this line, but the difficulty is that it has no connection with the RBI presentation of monetary data. And what is even worse is that Gupta does no better than the RBI in proposing his alternative.Towards end of 1970s, there were resentments regarding the way monetary management is operated in the policy circle. With large part of the monetary reserve outside the control of monetary authority, the channel of credit allocation to few pockets of the commercial sector could transmit very limited influence to the real ANALYTICS OF MONETARY POLICY IN INDIA economic variables. The neglect of issues related to monetary targeting viewed as an unnecessary byproduct of the preoccupation with credit targeting. The period 1979-82 witnessed a turbulent phase for Indian economy. During 1979-80 adverse weather conditions caused record downfall in foodgrains production. It was accompanied by a setback in industrial production. The budget nonetheless continued to be expansionary. The budgetary deficit as percentage of GDP was 2.13 per cent in 1979-80 and 1.82 per cent in 1980-81. The external sector added to further deterioration of the situation with hike in prices of petroleum products and fertilisers.All these contributed together towards prevalence of a widespread general inflation Reserve money growth was explosive and financial crowding out threatened long run prospects of stable growth. These macroeconomic developments made the conduct of monetary policy extremely difficult and progressively brought a sharp shift in monetary policy.

New Regime of Monetary Targeting (1985 - 1991)In the backdrop of intellectual debate as discussed above and prevailing economic conditions, it was imperative to comprehensively review the functioning ofthe monetary system and carry out necessary changes in the institutional set up and policy framework of the monetary policy. This was materialised by setting up a high level committee in 1982, under the chairmanship of Prof. Sukhamoy Chakravarty. The major recommendations of the Chakravarty Committee include, inter alia, shifting to 'monetary targeting' as the basic framework of monetary policy, emphasis on the objectives of price stability and economic growth, coordination between monetary and fiscal policy to reduce the fiscal

burden on the former and suggestion of a scheme of interest rates in accordance with some valid economic criteria. Clarifying the stand on monetary targeting with feedback, Rangarajan (2002) asserts that, c*the scheme of fixing monetary targets based on expected increase in output and the tolerable level of inflation is far removed from the Friedmanite or any other version of monetarism." The Committee endorsed the use of bank reserves as the main operating target of monetary policy and laid down guidelines relating to the optimal order of the growth of money supply in view of stability in demand for money. The recommendations of Chakravarty Committee guided far-reaching transformation in the conduct of monetary policy in India. There was a shift to a new policy framework in the conduct of monetary policy by introducing monetary targeting. In addition, recommendations of the Report of the Working Group on Money Market, 1987 (Chairman: Vaghul) and subsequent move to activate the money market by introducing new financial instruments such as 182-day Treasury Bills (TBs), Certificates of Deposit (CDs), Commercial Paper (CP) and Participation Certificates, and, establishment of Discount and Finance House of India (DFHI) in April 1988 created new institutional arrangements to support the process of monetarytargeting. It was felt that, the complex structure of administered interest rate and crosssubsidisation resulted in higher lending rates for the non-concessional commercial sector. The concessional rates charged to the priority sector necessitated maintaining the cost of funds i.e. deposit rates at a low level. Nevertheless, there was a move to activate money market with new instruments to serve as a transmission channel of monetary policy, within this administered regime. Gradually, the complex lending rate structure in the banking sector was simplified in 1990. By linking the interest rate charged to the size of loan, the revised structure prescribed only six slabs (Rangarajan, 2002). However, credit rationing continued with its due importance in the new framework to support the growth process. The share of priority sectors in total non-food credit rose from 36.9 per cent in 1980-81 to the peak of 43.6 per cent in 1986-87. But, inadequacy of this system slowly emerged due to problems in the monitoring of credit thereby causing delays in the sanctioning of bank credit. With the strengthening of the credit appraisal systems in banks, the CAS lost its relevance through the 1980s, eventually leading to its abolition in 1988.During this period, the primitive structure of the financial markets impeded their effective functioning. The money market lacked depth, with only the overnight interbank call money market in place. The interest rates in the government securities market and credit market were tightly regulated. The dispensation of credit to the government took place via SLR stipulations, where commercial banks were made to set aside a substantial portion of their liabilities for investments in government securities at below market rates, known in the literature as 'financial repression'. The

SLR had touched the peak of 38.5 by September 1990 (Table 11.2). As increasing SLR was not adequate, the RBI was forced to be a residual subscriber. The process of financing the government deficit involved 'automatic monetisation', in terms of providing short-term credit to the government that slipped into the practice of rolling over the facility. The situation was aggravated as the government's fiscal balance rapidly deteriorated. The process of creating 91-day ad hoc TBs and subsequently funding them into non-marketable special securities at a very low interest rate emerged as the principal source of monetary expansion. In addition, RBI had to subscribe dated securities those not taken up by the market. As a result, the net RBI credit to the Central Government which constituted about 77 per cent of the monetary base during the 1970s, accentuated to over 92 per cent during the 1980s (Table II. 1). In such an environment, monetary policy had to address itself to the task of neutralising the inflationary impact of the growing deficit by raising CRR from time to time. CRR was mainly being used to neutralise the financial impact of the government's budgetary operations rather than an independent monetary instrument. 2.5- Post-Reform Period with Financial Deepening (1992 Onwards) Indian economy experienced severe economic crisis in mid-1991, mainly triggered by a balance of payment difficulty. This crisis was converted to an opportunity by introducing far-reaching reforms in terms of twin programs of stabilisation and structural adjustment. The financial sector received its due share of attention in the reform process mainly guided by the influential recommendations of Narasimham Committee - I (1991) and - II (1998). To curtail the excessive fiscal dominance on the monetary policy in the spirit of the recommendations of the Chakravarty Committee (RBI, 1985) and Narasimham Committee (RBI, 1991), the memorandum of understanding (MoU) was signed between the Government of India and the RBI in 1994. Consequently, the issuance of ad hoc TBs was eliminated with effect from April 1, 1997. Instead, Ways and Means Advances (WMA) was introduced to cope with temporary mismatches. This was a momentous step and necessary condition towards greater autonomy in the conduct of monetary policy. As a result, the proportion of net RBI credit to government to reserve money has substantially come down to close to 50 per cent in recent years (Table II. 1). Interestingly, this period witnessed the new problem of coping with increasing inflow of foreign capital due to opening up of the economy for foreign investment. Foreign exchange reserves increased from mere US $ 5.83 billion in March 1991 to US $ 25.18 billion in March 1995. Presently, foreign exchange reserves with RBI stand at close to US $ 82 billion. Hence, increase in foreign exchange assets had a sizeable contribution to raise reserve money in this period. As a proportion of reserve money, the share of net foreign assets is increased from 9.1 per cent in 1990-91 to 38.1 per cent in 1995-96 and subsequently reached 78.1 per cent in

2001-02 (Table II. 1). To negate the effect of large and persistent capital inflows, RBI absorbed excess liquidity through outright OMO and repos under liquidity adjustment facility (RBI,2003a). In the post reforms era, emphasis was placed to develop and deepen various components of the financial market such as money market, government securities market, forex market, which has significant implication for the monetary policy to shift from direct to indirect instruments of monetary control. To widen the money market in terms of improving short term liquidity and its efficient management, newinstruments such as inter-bank Participation Certificates, CDs and CP were further activated and new instruments in the form of TBs of varying maturities (14-, 91- and 364-day) were introduced. The DFHI was instrumental to activate the secondarymarket in a range of money market instruments, and the interest rates in money market instruments left to be market determined. The government securities market witnessed radical transformation towards broadening its base and making the yields market determined. Major initiatives in this direction include introducing the system of auctions to impart greater transparency in the operations, setting up a system of Primary Dealers (PDs) and Satellite Dealers (SDs) to trade in Gilts, introducing a delivery versus payment (DvP) system for settlement, adopting new techniques of flotation, introducing new instruments with special features like zero coupon bonds, partly paid stock and capital-indexed bonds, etc. All these measures have helped in creating a new treasury culture in the country, and today, the demand for the government securities is not governed by solely SLR. requirements but by considerations of treasury management. Now, the SLR is at the statutory minimum of 25 per cent since October 1997, far below than its peak of 38.5 per cent in February 1992 (Table II.2). Also, the CRR has been gradually brought down to the current level of 4.5 per cent (effective from June 2003) from 10 per cent in January 1997 and 15 per cent in October 1992. Certain initiatives to reform the foreign exchange market include, inter alia, moving to full convertibility of Rupee in the current account since August 1994, greater freedom to Authorised Dealers (ADs) to manage their foreign exchanges, activation of the forward market and setting up a High Level Committee (Chairman: S.S. Tarapore) to provide a roadmap for capital account convertibility. All these measures acted towards making the foreign exchange rate market-determined and linking it to the domestic interest rates. In the process of reforms, the interest rate structure was rationalised in the banking sector and there is greater emphasis on prudential norms. Banks are given freedom to determine their domestic term deposit rates and prime lending rates (PLRs), except certain categories of export credit and small loans below 2 lakh Rupees. All money market rates were set free. The 'Bank Rate' was reactivated in

1997 by linking it to various refinance rates. Because of all these reforms, we find today, interest rates in various segments of the financial market are determined by the market and there is close association in their movement, as discussed in detail in Chapter 5. The developments in all the segments have led to gradual broadening and deepening of the financial market. This has created the enabling conditions for a smooth move towards use of indirect instruments of monetary policy such as open market operations (OMO) including repos and reverse repos. The operation of LAF has been used as an effective mechanism to withdraw or inject liquidity on day-to-day basis and providing a corridor for call money rate. In June 2002, RBI has come out with its Short Term Liquidity Forecasting Model to evaluate the short term interaction between the monetary policy measures and the financial markets, which will be immensely helpful for imparting discipline once started operation. Because of reforms in the financial market, new interest rate based transmission channels have opened up. Importantly, this period has witnessed emergence of monetary policy as an independent instrument of economic policy (Rangarajan, 2002).To sum up, this chapter undertakes an analytical survey of evolution of monetary policy in India. We observed that, the existing policy regime an institutional arrangements constrained monetary management in the pre-reform period. Monetary policy during this period was limited to credit rationing. The key segments of the financial market in India are developed only in the post-reform period and the interest rates were deregulated. Recently, there has been greater emphasis in short-term liquidity management in monetary policy operation with emergence of a broad-based and developed financial market. In the new environment, the operating procedure and monetary transmission mechanism are completely transformed. These observations will guide our econometric analysis of monetary policy in India in the following chapters.

ConclusionFactory output in June grew 8.8 per cent over the corresponding period last year, outstripping the consensus growth rate of 5.5 per cent forecast by 23 economists polled by Bloomberg. This sets the stage for another round of interest increase by Reserve Bank of India (RBI) in September.

The factory output data comes on the heels of a week of largely negative global developments that threaten to eventually affect the Indian economy. Despite the adverse implications of global factors on India, RBI is likely to continue with its policy of increasing rates in the near future as the domestic inflation rate will increase for a while longer. The second round impact of end-June's increase in the price of diesel is expected by economists to show up over the next couple of months, pushing inflation higher.

http://businesstoday.intoday.in/story/industrial-growth-revives-to-8.8-per-cent-in-june/1/17833.html

http://businesstoday.intoday.in/story/subir-gokarn-rbi-inflation/1/17642.html

The deterioration in the global scenario primarily on account of fears that the sovereign debt crisis in Europe may spread and the US economy may slip into recession may, however, begin to exert more influence on RBI's actions after September. By the last quarter of 2011, a more comprehensive picture of the way in which the US Federal Reserve plans to respond to the country's economic situation may be apparent. If the US Fed chooses to go through the third round of expanding its balance sheet to revive the economy (QE 3), RBI's task of managing the "impossible trinity" - an independent monetary policy, partly managed exchange rate and a liberalized capital account - would become more challenging on account of a part of the newly created liquidity finding its way into India. At that point, global developments may have a greater influence on monetary policy as compared to domestic factors.Home buyers in for trouble as RBI hikes key rates yet again For the moment, RBI's 26 July monetary policy statement is likely to be the dominant influence. It emphatically stated that RBI's foremost priority today is to rein in inflation, and the thrust of monetary policy would be in the direction of meeting this objective. On Friday, Subir Gokarn, RBI's deputy governor, who was in Delhi for a meeting, repeated the message of the July policy on the central bank's determination to combat inflation.June factory output data, as measured by the Index of Industrial Production (IIP), was driven primarily by a 10 per cent growth in manufacturing. IIP has been a volatile indicator of economic performance. Since the beginning of the last financial year, IIP has ranged between 13 per cent and 4 per cent. According to Gokarn, RBI typically juxtaposes IIP with other indicators before it reaches a conclusion on the state of economy.More than the growth in IIP, the strength of consumer demand in India appears to be driving monetary policy. As the 26 July policy and the subsequent interaction of RBI governor, D Subbarao, had with the media indicated, the central bank feels consumer spending will remain robust. Consequently, it has used interest rate as the primary tool to pull back demand and, thereby, lower the price level in the economyInflation can be brought down: RBI The next policy announcement is scheduled for September 16, when the central bank is likely to announce its 12th interest rate increase since March 2010. The

http://businesstoday.intoday.in/story/inflation-can-be-brought-down-to-4-4.5-per-cent-says-rbi/1/17669.html

http://businesstoday.intoday.in/story/rbi-hikes-key-rates-loans-costlier/1/17339.html

primary policy rate, that is, the repo rate stands at 8 per cent. Repo rate is the rate which RBI lends money to banks.The deterioration in the global scenario, which includes last week's unprecedented lowering of US's long-term rating by a notch to AA+ by Standard & Poor's, has led to mixed conclusions about the direction of monetary policy.For instance, two research reports released after Friday's factory output data reached different conclusions. Deepali Bhargava, economist at ING Vysya Bank, wrote she expected RBI to hike repo rate by 25 basis points (one basis point is one-hundredth of a percentage point) in its September policy announcement

http://businesstoday.intoday.in/story/sandp-downgrades-us-aaa-credit-rating-to-aa+/1/17697.html

analysis on rbi growth

Economy & Finance

fully modified

central statistical

debentures

unallocatable

notional principal

interest rate

gold open

workable exit