ARTICLE
DYNAMICS OF MONETARY POLICY FRAMEWORK IN INDIA
Manoel Pacheco and Priyanka Shiraly
¥
Monetary policy framework in India has evolved
Indian economy has moved from a regulated
over time with a shift in focus from a controlled
economy to a market-based economy as
expansion in the initial years to an anti-
indicated by the gradual changes in monetary
inflationary policy in the recent years. The
management in terms of objectives, instruments
developments in the government securities
and operational procedures.
changes in the operating procedure of monetary
policy. In the process, the liquidity management
facility (LAF) has emerged as the principal
operating procedure of monetary policy, with
repo rates as the key indicators for signaling the
monetary policy stance, supported by other
instruments such as open market operations
(OMO), cash reserve ratio (CRR) and statutory
liquidity ratio (SLR), among others. Against this
backdrop, the following article highlights the
monetary policy framework and instruments
used by the Reserve Bank of India (RBI), and the
evolution and the recent developments of the
monetary policy in India.
1. MONETARY POLICY FRAMEWORK
AND INSTRUMENTS:
Monetary management, which comprises of
assessing the liquidity needs of the banking
system and accordingly supplying or absorbing
the appropriate amount of liquidity through
various instruments, plays a central role in
implementation of the monetary policy. The
¥
The monetary policy in India presently pursues
the objectives of maintaining price stability,
providing adequate credit for economic growth
and ensuring financial stability. The importance
of price stability as a key objective of monetary
policy initially gained momentum with the onset
of financial liberalization when strong capital
flows nudged inflation into double digits. The
importance of price stability was once again
reinforced in 2004-05 when the country had to
face sharp increases in international commodity
prices. More recently, from 2009-10 to 2011-12,
RBI had followed a contractionary monetary
policy stance to rein in a surging inflation mainly
induced by supply side factors. While the three
objectives are complementary to one another in
the long run, the RBI has persistently had to
address the tradeoff arising in the short run. The
dilemma of providing credit at viable rates to
support economic growth without fuelling
inflation is a constant tussle faced by the Central
Bank. Further, in a rapidly globalizing world,
financial stability has also gained importance in
monetary policy decision making, more so, after
the global financial crises.
Mr. Manoel Pacheco and Ms. Priyanka Shiraly are Senior Executive Officers,
Monthly Newsletter January 2014
financial sector reforms have led to several
CCIL
market and money market brought about by
Economic Research and Surveillance Department, CCIL
7
ARTICLE
Monetary Policy Targets
Central banks seek to achieve the final objectives
of monetary policy through intermediate targets.
Like in other countries, in India too, these targets
have evolved over time from broad money to a
multiple indicator approach. The RBI did not
have a formal intermediate target till the 1980s,
and bank credit served the purpose of both the
operating and intermediate targets. However,
due to the high level of government borrowings
there was a shift to a new policy framework in
1985 in the form of monetary targeting with
feedback. Broad money (M3) became the
intermediate monetary aggregate, reserve money
remained the main operating target, and the
short-term interest rate proxied by overnight call
money rate emerged as the supplementary
operating target. The process of financial
liberalization, which gathered momentum in the
1990s, necessitated a relook into the monetary
policy and the efficiency of broad money as an
intermediate target of monetary policy. The
Reserve Bank, therefore, formally adopted a
multiple indicator approach in April 1998.
CCIL
Monthly Newsletter January 2014
1.1. Instruments of Monetary Control
Historically, RBI employed a range of direct
instruments such as cash and liquidity reserve
ratios, directed credit (targets prescribed for
allocation of credit to preferred
sectors/industries) and administered interest
rates (deposit and lending rates). However, in
consonance with international experiences and
the financial sector reforms initiated in the early
1990s, the monetary policy framework in India
also witnessed a transformation, inducing a shift
8
from direct to indirect instruments of monetary
control. The indirect instruments include bank
rate, marginal standing facility (MSF), market
stabilization scheme (MSS) and open market
operations, including outright and repurchase
agreement (repo).
1.1.1. Cash Reserve Ratio
CRR is the cash balances which a bank is required
to hold with the RBI. The RBI which was earlier
empowered to impose and alter the CRR
anywhere between 3% to 15% of the net demand
and time liabilities (NDTL) has been given the
flexibility to fix the CRR without any ceiling rate
as per the RBI (Amendment) Act, 2006. Pursuing
its medium term objective of reducing the CRR,
the RBI has reduced the CRR progressively in
phases from the peak of 15% in 1992 to around
5% in the recent years. Currently, the CRR stands
at 4%.
1.1.2. Statutory Liquidity Ratio
SLR, another instrument of monetary policy
control was first imposed on banks in 1949 and
was fixed at 20%. It remained at this level for
almost 15 years till September 1964, when it was
raised to 25%. The next change in SLR was in
February 1970. Since then the SLR has stepped
up successively and frequently until it was raised
to 38.5% in September 1990. Subsequently,
phased reduction of the SLR was designed and
efforts were made to make banks and financial
institutions hold government securities
voluntarily. As a part of this policy, SLR was
reduced from 38.25% at the beginning of 1993 to
25% in 1997. Currently, the SLR stands at 23%.
ARTICLE
1.1.3. Bank Rate
1.1.4. Liquidity Adjustment Facility
Bank rate, the rate at which the RBI buys or re-
LAF, introduced in June 2000, consists of daily
discounts bills of exchange or other commercial
infusion or absorption of liquidity on a
paper presented by a scheduled bank, was
repurchase basis, through repo (liquidity
historically aligned with short-term interest
injection) and reverse repo (liquidity absorption)
rates. The Bank rate was fixed at 3.5% in 1935 and
auction operations, using government securities
after a few occasional changes it was increased to
as collateral. An Interim Liquidity Adjustment
12% in 1991. The bank rate which was
Facility (ILAF) was introduced in April 1999,
dysfunctional was reactivated in April 1997, and
which was gradually converted into a full-fledged
was sharply used between 1998 to 2003, with the
LAF from June 5, 2000 in phases. The LAF was
rate varying from 11% in April 1997 to 6% in
operated through overnight fixed rate repo and
April 2003. However, with the introduction of
reverse repo from November 2004, which
LAF, the bank rate began losing its significance,
provided an informal corridor for the call money
as monetary policy signaling was done through
rate. However, there were two major drawbacks,
modulations in the reverse repo rate and the repo
one is the lack of a single policy rate and second
rate under the LAF. But in February 2012, as a
was lack of a formal corridor. To overcome these
part of money market operations, the RBI
shortcomings, a new operating procedure for
aligned the bank rate with marginal standing
LAF was put in place in May 2011 (table 4).
facility rate, which in turn is linked to the policy
repo rate under the LAF. Currently, the bank rate
stands at 8.75%.
Table 1 : Changes in Monetary Policy Rates and Reserve requirements
No. of times
CRR
Range (%)
No. of times
SLR
Range (%)
No. of times
Range (%)
1935-1970
8
3.0 - 6.0
2
2.0 - 3.0
5
20.0 - 28.0
1970-1980
3
6.0 - 9.0
8
4.0 - 7.0
5
29.0 - 34.0
1980-1990
1
10.0 - 10.0
16
6.5 - 15.0
8
34.5 - 38.0
1990-2000
12
7.0 - 12.0
29
8.0 - 15.0
11
25.0 - 38.5
2000-2007
5
6.0 - 7.5
18
4.5 - 8.25
-
-
2007-2010
-
-
12
5.0 - 9.0
2
24.0 - 25.0
2010-2012
1
9.5 - 9.5
3
4.75 - 6.0
1
24.0 - 24.0
2012-2013
3
8.5 - 9.0
3
4.0 -4.5
1
23.0 - 23.0
2013-2014*
5
8.25 - 10.25
-
-
-
-
* up to Dec'13
Source: RBI
Monthly Newsletter January 2014
Bank Rate
CCIL
Year
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ARTICLE
Table 2: Evolution of LAF
April 1998
The Narasimham Committee II on Banking Sector Reforms recommended the introduction of a
Liquidity Adjustment Facility (LAF).
April 21, 1999
Introduction of an Interim Liquidity Adjustment Facility (ILAF) through repos and lending against
collateral of Government of India securities.
June 5, 2000
ILAF was replaced by full - fledged Liquidity Adjustment Facility (LAF) operating through variable rate
repo/reverse repo auctions with same day settlement.
May 8, 2001
Changes in the operating procedures of LAF. Minimum bid size was reduced from `10 crore to `5
crore. Auction format for LAF was changed from the uniform price auction method to the multiple price
auction. The timing for LAF auctions was advanced by 30 minutes.
March 29, 2004
Repo operation on an overnight basis was retained but 1-day reverse repos was phased out, and in its
place the 7-day fixed rate reverse repo on a daily basis and the 14-day variable rate reverse repo on a
fortnightly basis were introduced.
August 16, 2004
1-day fixed rate reverse repo was re-introduced.
October 29, 2004
The nomenclature of repo and reverse repo was interchanged as per international usage.
November 1, 2004
7-day fixed rate and 14-day variable rate reverse repos were phased out and the LAF was operated through
overnight fixed rate repo and reverse repo.
November 28, 2005
Second LAF (SLAF) was introduced on a daily basis, providing market participants a second window to
fine-tune their management of liquidity.
May 3, 2011
Revised Operating Procedure for LAF was introduced.
Table 3: Mechanics of Operation of LAF
CCIL
Monthly Newsletter January 2014
Mechanics of Operation - LAF
10
Tenor
Overnight repo auctions and reverse repo auctions are conducted on a daily basis (Monday to Friday,
except on holidays).
Rate of Interest
Repo and reverse repo operations are conducted at a fixed rate determined by RBI.
Participants
Scheduled Commercial Banks (excluding Regional Rural Banks) and Primary Dealers (PDs) having
Current Account and SGL Account with RBI.
Bid Size
Minimum amount of `5 crore and in multiples of `5 crore thereafter.
Timings of LAF
operations
LAF Repo is conducted between 9.30 A.M. and 10.30 A.M., LAF Reverse Repo operations are conducted
in the afternoon between 4.30 P.M. and 5.00 P.M.
Eligible Securities
SLR-eligible transferable Government of India dated Securities, Treasury Bills and SDL’s.
Settlement
Settlement of transactions in the auction will take place on the same day.
ARTICLE
Table 4: New Operating Procedure of LAF
Key features - LAF
Explicit operating target
Weighted average call money rate
Independent variable policy rate
Repo rate
Institution of new MSF
Linking of MSF to repo rate
Scheduled commercial banks can borrow overnight at 100 basis points above the repo
rate up to 1% (currently raised to 2%) of their respective net demand and time
liabilities (NDTL).
Bank Rate is aligned to the MSF rate.
Revised Corridor
Defined with a fixed width of 200 basis points
Repo rate is placed in the middle of the corridor
Reverse repo rate at 100 basis points below repo rate
MSF rate as well as the Bank Rate at 100 basis points above repo rate
Table 5 : Changes in LAF Rates
No. of times
Reverse Repo
Range (%)
No. of times
Range (%)
2001-2002
4
8.0 - 9.0
3
6.0 - 6.75
2002-2003
3
7.0 - 7.5
3
5.0 - 5.75
2003-2004
1
6.0 - 6.0
1
4.5 - 4.5
2004-2005
-
-
1
4.75 - 4.75
2005-2006
2
6.25 - 6.5
3
5.0 - 5.5
2006-2007
5
6.75 - 7.75
2
5.75 - 6.0
2007-2008
-
-
-
-
2008-2009
8
5.0 - 9.0
3
3.5 - 5.0
2009-2010
2
4.75 - 5.0
2
3.25 - 3.5
2010-2011
7
5.25 - 6.75
7
3.75 - 5.75
2011-2012
5
7.25 - 8.5
5
6.25 - 7.5
2012-2013
3
7.5 - 8.0
3
6.5 - 7.0
2013-2014*
3
7.25 - 7.75
3
6.25 - 6.75
* up to Dec'13
Source: RBI
1.1.5. Marginal Standing Facility
Before the new operating procedure of LAF was
introduced, the repo rate and the reverse repo rate
were informally supposed to be the boundaries of
the LAF corridor so as to enable the call rate to
settle in between. However, there were several
instances in the past years when the call rates
have breached the corridor on either side due to
excessive surplus or shortage of liquidity in the
market, thus refuting the very purpose of the
corridor. Thus, the MSF was introduced in May
2011 to serve as an upper bound of the corridor
and was fixed as 100 bps above the repo rate. It is a
kind of safety valve which market participants
can approach when their funding from the LAF
Monthly Newsletter January 2014
Repo
CCIL
Year
repo window is exhausted. Currently, the MSF
rate stands at 8.75%.
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ARTICLE
1.1.6. Open Market Operations
maintain interest rates at reasonable levels. Since
With the progressive phasing out of the
administered interest rate structure and the
evolution of a regime of market determined
2008-2009, on account of liquidity deficit there
has been an ongoing increase in open market
purchases by RBI.
Table 6: Open Market Operations
Year
Purchase
Sale
(` crores)
Net Purchase (+) / Net Sales (-)
1995-96
913.00
1443.16
-530.30
1996-97
623.18
11205.91
-10582.74
1997-98
466.50
8080.74
-7613.94
0.00
26348.32
-26348.32
0*
3320 *
-3320*
1244.00
36613.51
-35369.51
5700.5 *
1191.91 *
4508 *
4471.05
23795.10
-19324.05
5*
2679 *
-2674*
2001-02
5084.00
35418.45
-30334.59
2002-03
0.00
53401.52
-53401.52
2003-04
0.00
41598.01
-41598.01
2004-05
0.00
2899.24
-2899.24
2005-06
740.00
4652.71
-3912.71
2006-07
720.00
5845.26
-5125.38
2007-08
13510.00
7587.17
5922.83
2008-09
104480.34
9932.03
94548.32
2009-10
85399.39
9931.45
75467.93
2010-11
78799.05
11574.75
67224.30
2011-12
142271.84
8186.81
134086.03
2012-13
164240.00
10737.00
153503.00
21660.00
4985.00
16675.00
1998-99
1999-00
2000-01
2013-14 **
CCIL
Monthly Newsletter January 2014
* OMO's of T-bills
** includes data up to July 2013
Source: RBI
interest rate on Government securities, OMO's
has gained ground and emerged as an important
tool of liquidity management. OMO's have
come into sharper focus since 1995-96 and in
1998-99 treasury bills of varying maturities were
included in OMO. On account of large capital
inflows from 2001-02 onwards, RBI conducted a
series of open market sales during 2001 to end of
March-2007 to absorb excess liquidity and
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1.1.7. Market Stabilization Scheme (MSS)
Post 1990 reforms, India witnessed a significant
increase in capital flows which posed serious
challenges to the conduct of monetary policy.
The foreign investment flows surged from to US$
4161 million in 2002-2003 to US$ 43326 million
in 2007-08. The reserve accretion of a high
magnitude due to massive capital flows led to
substantial excess liquidity in the economy.
ARTICLE
Initially, the liquidity impact of large capital
maturities, including dated government
inflows were sterilized through OMO sales and
securities. Generally, since the introduction of
LAF. Subsequently, there was a need to introduce
MSS, the preference has been for short-term
an additional instrument to absorb the liquidity
instruments, particularly 91-day T-bills. In 2007-
of an enduring nature and thus based on the
2008, on account of favorable liquidity
recommendations of the Working Group on
conditions in the market there were large
Instruments of Sterilization, MSS was
additional issuances of government securities
introduced in April 2004. Under the MSS
under the MSS, with total issuances of dated
scheme, the Reserve Bank issues treasury
securities and T-bills amounting to `222762
bills/dated Government securities by way of
crore.
auctions on behalf of the Government and the
money raised is impounded in a separate cash
account maintained and operated by RBI. The
Table 7: Cost of Sterilization to the Government
(as % to GDP)
Year
Interest Payments on MSS
2004-05
0.1
2005-06
0.1
appropriated only for the purpose of redemption
2006-07
0.1
and/or buyback of T-bills and/or dated securities
2007-08
0.2
issued under the MSS.
2008-09
0.2
amounts credited into the MSS account are
Source: RBI
(` Crore)
Chart 1: MSS Issuances
Sterilization operations
through MSS, OMOs/LAF
100000.00
and increase in CRR
80000.00
involve fiscal and monetary
60000.00
costs, which are borne by
40000.00
the government, the RBI,
20000.00
and banking system,
respectively. The T-bills and
2004-05
2005-06
2006-07
2007-08
2008-09
G-sec
25000.00
5995.41
15998.80
112316.10
11000.00
91-day bill
67955.00
52057.00
48222.00
64841.12
16500.00
182-day bill
0.00
13078.00
16125.00
20605.00
7000.00
impact on revenue and
364-day bill
20981.00
16000.00
20440.00
25000.00
9000.00
fiscal balances of the
absorbing surplus liquidity by instruments of
short-term maturities, such as 91-day, 182-day
and 364-day T-bills, and medium-term
the purpose of MSS have an
government to the extent of
Source: CCIL, `RBI
MSS has been used effectively by RBI in
dated securities issued for
interest payment on the
outstanding under the MSS. Table 7 shows the
interest payments on MSS borne by the
government.
Monthly Newsletter January 2014
0.00
CCIL
` Crore
120000.00
13
ARTICLE
During 2008-2009, the foreign investment flows
1.1.8. Cash Management Bills (CMB)
to India fell significantly from their peak in
The RBI has used CMBs introduced in May 2010
2007-2008. Thus, in order to provide adequate
liquidity, RBI had to ease the monetary policy.
as a tool to manage liquidity in the system by
auctioning CMBs to drain out excess liquidity
Accordingly, RBI ceased fresh bond issuances
from the banking system and check volatility in
under MSS after September 2008 and also bought
the forex market. During 2013-2014, in order to
back existing MSS securities amounting to
`47544 crore with effect from November 2008 in
order to inject liquidity into the system.
Reflecting these operations, MSS balances
Table 8: Issuance of Cash Management Bills
Issue Year
Amount
2010-2011
28 to 35
12000
2011-2012
35 to 77
93000
declined significantly and the RBI unwound all
2012-2013
the remaining MSS balances amounting to
2013-2014*
`317crore on July 23, 2010.
* up to Sep'13
-
-
6 to 56
107195
Source: RBI
tackle the volatile rupee, the RBI
Chart 2: MSS Outstanding Amount (as of March-end)
` Crore
Tenor Range (Days)
(` crores)
180000
resorted to liquidity tightening
160000
measures and increased the auction
140000
amounts to `22000 crore of CMB's
120000
every week starting mid-August with
100000
80000
shorter maturities.
60000
2.
40000
20000
INDIA'S OPERATIONAL
0
2004-05
CCIL
Monthly Newsletter January 2014
MSS Amount
14
THE RESERVE BANK OF
2005-06
2006-07
2007-08
2008-09
64211
29062
62974
168392 88077
* MSS Bal Outstanding as on July 23, 2010
FRAMEWORK:
2009-10 2010-11 *
2737
317
2.1.
Monetary
and
Liquidity
Management in the Pre-Reform
Period
Source: RBI
Table 9: Highlights of Monetary Policy in the Pre-reform Period
Monetary Conditions
(a) Highly regulated interest rates in the
financial markets.
(b) Increase in government borrowings
and deterioration in the government’s
fiscal balance in the 1980’s.
(c) Increase in reserve money and money
supply, contributed primarily by the
RBI’s credit to the government.
Techniques of Monetary Control
RBI used direct instruments of monetary
control, in particular the CRR and SLR.
(a) SLR: progressively increased from the
statutory minimum of 26% in February
1970 to 36% in September 1984 as
dispensation of credit to the government
took place via SLR.
(b) CRR: increased from its statutory
minimum of 3% since September 1962 to
5% in June 1973 and then hiked to 15%
in July 1989 to neutralize the inflationary
impact of deficit financing.
Significant Monetary Policy
Developments
(a) Shift to ‘monetary targeting’ as the
framework of monetary policy based on
the recommendations of the Chakravarty
Committee (1985).
(b) In order to support the process of
monetary targeting, money market
instruments such as 182 day T-bills, CD’s,
CP’s and inter-bank participation
certificates were introduced based on the
recommendations of Vaghul Committee
(1987).
ARTICLE
During this period, money market lacked
changes in the framework of the monetary
depth and the interest rates were highly
policy.
regulated in the credit market. As a result,
banks were forced to set aside a substantial
portion of their NDTL for investments in
government securities and the SLR reached a
2.2. Monetary and Liquidity Management in the
Post-Reform Period up to 2000
Monetary policy assumed greater significance in the
1990's and was mainly guided by the recommendations
peak of 38.5% in September 1990. These
of the Narasimham committee with the main objective
developments along with the balance of
of deepening the financial markets.
payments crisis again called for necessary
Table 10: Highlights of Monetary Policy in the Post-reform Period upto 2000
Focus of Monetary
Policy
(a) Liberalization of
interest rates
(b) Phased reduction in
the reserve requirement
ratios of CRR and SLR.
(c) Inter-linkages across
various segments of
financial markets.
(d) Activation of OMO
by the RBI to influence
liquidity.
(e) Restoration of the
Bank Rate as a signaling
instrument for
monetary policy.
Techniques of Monetary Control
(a) Introduction of auction system in April 1992 for new central
government borrowings at market interest rates, which in turn
helped in development of government securities markets.
(b) OMO’s gained ground and was used by the RBI to moderate
excess liquidity on account of surge in foreign capital inflows.
(c) To support OMO operations RBI developed repos
(repurchase agreements) between RBI and commercial banks. The
first such auction of repos with periods ranging from overnight
to 14 days, collateralized by central government securities were
issued in December 1992.
(d) The RBI reduced the CRR to around 10% in 1996-97.
(e) Reactivation of the bank rate in April 1997 linking it to the
RBI refinance rate.
(f) Introduction of ILAF in April 1999.
Significant Monetary Policy
Developments
(a) Greater reliance on indirect
instruments and reactivation of
the bank rate.
(b) The use of CRR was
progressively brought down.
(c) The RBI switched from a
‘monetary targeting framework’
to a ‘multiple indicator
approach’ from 1998-99.
Table 11: Changes in the Monetary Policy Framework in India
Monetary Targeting with
feedback
Key Features
Nominal Anchor: Broad money (M3)
Operating Target: Reserve Money
Main Operating Instrument: Bank Reserves
1998-99 to
2004-05
Multiple Indicators Approach
Use of Quantity and rate variables
Information Variable: Broad money (M3)
Other multiple indicators: interest rates in financial markets, currency, credit,
capital flows, inflation, GDP and BOP.
2004-05 to
current
Augmented Multiple
Indicators Approach
Use of forward indicators (variables from industrial outlook, capacity
utilization, professional forecasters’ and inflation expectations survey) in
addition to quantity and rate variables
Monthly Newsletter January 2014
1985-86 to
1997-98
Monetary Policy Framework
CCIL
Period
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ARTICLE
2.3. Monetary and Liquidity Management
during 2001 to 2008
02 was clearly focused on managing surplus
liquidity, simultaneously operating
through LAF, OMO and issuances under
MSS. During this period, although RBI
reduced its reliance on CRR for liquidity
management operations, it was used by RBI
as an important instrument for regulating
liquidity in the economy, and SLR was used
to provide sufficient liquidity buffer.
Liquidity management was complex during
this period on account of surge in capital
flows and variations in cash balances of the
government. Against this background, the
full-fledged LAF was introduced to manage
liquidity conditions on a daily basis.
Further, liquidity management since 2001-
Chart 3: LAF volumes for the period of 01-04-2001 to 31-03-2008
80000
Amount in ` Crore
60000
40000
20000
0
-20000
-40000
01-01-2008
01-07-2007
01-10-2007
01-04-2007
01-01-2007
01-10-2006
01-07-2006
01-01-2006
01-04-2006
01-10-2005
01-07-2005
01-01-2005
01-04-2005
01-10-2004
01-07-2004
01-04-2004
01-01-2004
01-10-2003
01-04-2003
01-07-2003
01-01-2003
01-10-2002
01-07-2002
01-01-2002
01-04-2002
01-10-2001
01-07-2001
01-04-2001
-60000
Date
Net LAF
+1% of NDTL
-1% of NDTL
Source: RBI
Table 12: Monetary and liquidity management operations during 2001-2002 to 2007-2008
Liquidity Conditions
Monetary policy developments and measures by RBI
Monthly Newsletter January 2014
Easy liquidity conditions
CCIL
2001-02
Comfortable liquidity conditions
16
(i) With a view to achieving its medium term objective of reducing the CRR to its
statutory minimum level of 3%, RBI gradually reduced the CRR from 11% in August
1998 to 7.5% in May 2001 and to 5.5% effective from November 2001.
(ii) Repo rate was reduced four times during the period from 7% to 5.75%.
(iii) Owing to sharp fall in industrial activity and exports, the Bank Rate was reduced to
6.50% with effect from October 22, 2001, its lowest level since May 1973.
(iv) Mostly outright open market sales were conducted to neutralize the monetary impact
of private placement of government securities and to sterilize foreign capital inflows.
However, due to adverse reactions in the financial markets in the wake of the terrorist
attack on September 11, 2001 open market purchases were made during September 18 to
October 3, 2001.
2002-03
i) LAF was actively used during 2002 - 03 to manage the injections of liquidity due to large
capital inflows. (Chart 3)
(ii)OMO sales were higher during the period to sterilize large inflows of foreign capital.
(iii) Bank Rate was reduced in stages to 6.25% in October 2002.
ARTICLE
2003-04
Comfortable liquidity conditions
(i) During April – December 2003, RBI continued to absorb liquidity emanating from
capital flows by an even mix of OMO sales and LAF. CRR reduced from 4.75% to 4.50%
effective August 25, 2003. Bank Rate was reduced to 6% effective April 30, 2003.
(ii) During January – March 2004, sterilization was mainly through LAF repo.
2004-05
Liquidity conditions moderated
during May - July 2004, but
bounced back in the 2nd half of the
year as capital inflows to India
resumed.
(i) During April to May 2004, there was ample liquidity on account of capital inflows,
which was absorbed through LAF and MSS.
(ii) During May to October 2004, capital outflows, rising import demand, hike in crude
oil prices and build up of the center’s surplus with RBI brought down the surplus
liquidity. Thus, to ease liquidity conditions, RBI mainly injected liquidity through repos.
(iii) During November to March 2005, there was a diversified trend in liquidity
management through LAF and MSS.
(iv) With the introduction of MSS in April 2004, the pressure on the LAF window
gradually reduced and the outstanding reverse repo amount fell from `89,435 crore
(mid-April 2004) to only `15,820 crore by December 10, 2004.
2005-06
Liquidity conditions remained
mostly stable during the period,
while it tightened in the last quarter
of 2005-2006.
(i) During April – July 2005, the liquidity surplus was absorbed through continued
issuances under MSS accompanied by reduction in absorption through reverse repos
under LAF.
(ii) Liquidity in the system increased during July 23 – August 12, 2005, mainly due to the
spurt in foreign exchange inflows (following the revaluation of the Chinese currency) and
a further reduction in the Centre’s surplus investment balances with RBI. This was
absorbed through LAF reverse repos which rose from `10,485 crore as on July 22, 2005
to a peak of `50,610 crore as on August 3, 2005.
(iii) Towards the end of 3rd quarter and in the 4th quarter, liquidity conditions tightened
and balances under LAF transited from absorption to injection mode and auctions of TBills under the MSS were discontinued effective November 16, 2005 to inject liquidity.
2006-07
2007-08
Liquidity condition remained
volatile throughout the year.
(i) Policy rates remained unchanged throughout the year.
(ii) Ceiling of `3000 crores was imposed by RBI on the reverse repo window of RBI
(`2000 crores in case of the 1st LAF and `1000 crores in case of the 2 nd LAF) until
August 6th 2007 on account of surplus liquidity which emanated on account of easing
central government deposits with RBI.
(iii) Following a hike in the CRR rate, the liquidity conditions tightened.
Monthly Newsletter January 2014
(i) LAF reverse repo and repo rates were increased twice by 25 basis points each to 6.0%
and 7.0%, respectively LAF shifted from an absorption mode to injection mode from
December 2006 onwards and again shifted back to absorption mode from February 2007.
(ii) CRR was hiked by a cumulative of 100 basis points in four equal phases of 25 basis
points each during December 2006 - March 2007.
st
(iii) In addition to LAF, RBI also used MSS to mop up excess liquidity in the economy.
CCIL
Complex liquidity conditions due
to variations in government cash
balances & capital flows.
17
CCIL
18
01-04-2008
01-06-2008
01-08-2008
01-10-2008
01-12-2008
01-02-2009
01-04-2009
01-06-2009
01-08-2009
01-10-2009
01-12-2009
01-02-2010
01-04-2010
01-06-2010
01-08-2010
01-10-2010
01-12-2010
01-02-2011
01-04-2011
01-06-2011
01-08-2011
01-10-2011
01-12-2011
01-02-2012
01-04-2012
01-06-2012
01-08-2012
01-10-2012
01-12-2012
01-02-2013
01-04-2013
01-06-2013
01-08-2013
01-10-2013
01-12-2013
100000
Amount in ` Crore
Monthly Newsletter January 2014
01-04-2008
01-06-2008
01-08-2008
01-10-2008
01-12-2008
01-02-2009
01-04-2009
01-06-2009
01-08-2009
01-10-2009
01-12-2009
01-02-2010
01-04-2010
01-06-2010
01-08-2010
01-10-2010
01-12-2010
01-02-2011
01-04-2011
01-06-2011
01-08-2011
01-10-2011
01-12-2011
01-02-2012
01-04-2012
01-06-2012
01-08-2012
01-10-2012
01-12-2012
01-02-2013
01-04-2013
01-06-2013
01-08-2013
01-10-2013
01-12-2013
%
ARTICLE
2.4.
Monetary and Liquidity Management
tested from 2008-09 to 2012-13, with dipping
during 2008 to 2013
growth due to the onset of the global financial
The efficacy of RBI's monetary policy was truly
Reverse Repo Rate
Net LAF
Source: RBI
crises, a spiraling inflation and a sharp
depreciation in the rupee in 2013.
22.00
20.00
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
Chart 4: Movement of Call Rates within the LAF corridor
Date
Repo Rate
MSF vol
Call Rate
+1% of NDTL
MSF Rate
Source: RBI
200000
Chart 5: Net LAF volumes for the period 01-04-2008 to 31-12-2013
150000
50000
0
-50000
-100000
-150000
-200000
-250000
Date
-1% of NDTL
ARTICLE
Table 13: Highlights of Monetary Policy during 2008-2013
Macro-economic and Liquidity Conditions
Monetary Policy Action
2008-09
i
i
i
Surge in inflation during the first half of the
year.
Economic growth tumbled due to the fallout
of the global financial crises.
As a consequence of the crises, mutual funds
began to face large redemption pressures and
began to withhold their liquidity from money
markets.
i
RBI raised the repo rate on 3 occasions to 9% in the first 6 months
of the year.
ii
The CRR rate was increased on 6 occasions to 9%.
i
The repo rate was reduced by a cumulative of 400 bps to 5%, while
the reverse repo was cut on 3 occasions to 3.5%.
ii
The CRR was also cut 3 times by 350 basis points from 9% to 5.50%
i
RBI began to conduct a second LAF on a daily basis.
ii
A special fixed rate term repo of 14 days tenor under LAF was
introduced on a daily basis.
ii Other market participants such as NBFCs
that relied on Mutu al funds for meeting their
financing needs began to take a hit.
iii These market participants turned to
commercial banks to shoulder their funding
requirements.
iv The wedge between bank credit and aggregate
deposits started widening.
i
i
India’s GDP grew from 5.7% in Q1 to 11.2%
in Q4.
Mounting inflation pressures mainly induced
from supply side factors.
To complete the central and state government
borrowings smoothly.
i
RBI maintained an accommodative monetary policy by reducing the
repo and reverse repo rate by 4.75% and 3.25% and thereafter left the
rates unchanged for nearly 12 months.
ii
By keeping the overnight interest rates low, there was a higher
pressure among banks to reduce their lending rates.
iii
The continuance of low policy rates transmitted across the maturity
spectrum, albeit rather slowly to the long term lending rates of
banks.
i
The special term repo facility was discontinued by the end of
October 2009.
ii
RBI raised the CRR of scheduled banks in two stages from 5% to
5.75% of their NDTL by February 2010.
iii
By mid -March 2010, the RBI raised the repo rate to 5% and the
reverse repo rate to 3.5%.
i
RBI added primary liquidity through OMOs and the unwinding of
MSS balances.
2010-11
i
i
WPI inflation rate ranged from 8.20% to
10.88% through the year.
Liquidity pressures due to an increase in the
government balances with the RBI produced
from the 3G/BWA spectrum auctions in May
and June 2010.
i
RBI increased the repo rate by a cumulative of 175 bps to 6.75% and
the reverse repo rate by 225 bps to 5.75%.
ii
The CRR was also adjusted upwards to 6%.
i
RBI extended the additional liquidity support to SCBs under the
LAF to the extent of up to 0.5% of their NDTL.
ii
RBI began conducting Second LAF on a daily basis up to July 16 th
2010.
CCIL
i
Monthly Newsletter January 2014
2009-10
19
ARTICLE
Table 13: Highlights of Monetary Policy during 2008-2013
i
i
The Net LAF surpassed RBI’s comfort zone
of +/-1% of the NDTL in October 2010 due
to a significant build -up of government cash
balances as a result of higher than anticipated
tax receipts.
i
iii
The RBI conducted a special Second LAF and special two -day repo
auction.
The RBI allowed waiver of penal interest on shortfall in maintenance
of SLR to the extent of 1% of NDTL.
RBI introduced a daily Second LAF.
The Net LAF touched a record ( -) `1,70,485
crores in December 2010.
i
The RBI purchased government securities through OMOs.
ii
2011-12
i
Headline WPI inflation rate remained at
elevated levels.
ii India’s GDP rate started decelerating.
i
Repo rate was increased by a cumulative of 175 bps to 8.5%.
The US sovereign credit rating downgrade
and the deepening of the Euro area crises led
to an appreciation of the USD against major
emerging market currencies as the US dollar
was considered to be a safe haven.
ii RBI intervened through the sale of USD
along with stern capital account measures
which consequently began to strain the rupee
liquidity in the system.
iii The Net LAF breached the comfort zone of
RBI and exceeded (- ) `1,00,000 crores in
November 2011.
i
A series of OMO purchase auctions were initiated by RBI.
i
2012-13
i
Domestic growth remained at one of its
weakest post crises levels.
i
ii
RBI reduced the repo rate on 3 occasions, by a cumulative of 100
bps, to 7.5%.
The borrowing limit of SCBs under MSF was also increased f rom 1%
to 2% of their NDTL.
2013-14 (up to Dec’ 2013)
i
To curb the mounting inflationary pressures.
i
RBI raised the repo rate to 7.75%.
i
Sharp depreciation in the rupee due to a
growing market perception of a possible
tapering in the quantitative easing
programme of the Unites States.
i
The RBI raised the MSF rate to 10.25%, capped the overall allocation
of funds under the LAF to 1% of the NDTL of the banking system
and announced open market sales of government securities of
`12,000 crore on July 15th 2013.
The RBI put a limit on the overall access to LAF by each individual
bank at 0.5% of their outstanding NDTL and mandated a minimum
daily CRR balance of 99% of the requirement on July 23rd 2013.
On August 8 th 2013 , the RBI announced the auction of cash
management bills for a notified amount of `22,000 crore once
every week on Mondays.
RBI announced a special swap window for oil marketing companies
to shift their dollar requirements out of the inter - bank market on
August 28th 2013.
RBI offered a window to the banks to swap the fresh FCNR dollar
funds, mobilized for a minimum tenor of three years and over at a
fixed rate of 3.5% per annum for the tenor of the deposit. Further,
Banks were allowed to swap the overseas borrowing mobilized by
banks at a concessional rate of 100bps below the ongoing swap rate
prevailing in the market.
CCIL
Monthly Newsletter January 2014
ii
20
iii
iv
v
i
The rupee strengthened by the September -end
along with a reduction in volatility.
i
ii
MSF rate was reduced in phases back to 8.75%.
The minimum daily maintenance of the CRR was brought down to
95% of the NDTL.
ARTICLE
Concluding Remarks:
References:
Over the years, the RBI's monetary policy
1.
Monetary Policy Rules in India'
framework has evolved by leaps and bounds with
2.
Reserve Bank of India Conduct its
However, the role of RBI in formulating its
Monetary Policy?'
monetary policy has turned more complex with a
persistent tussle to satisfy price stability, boost
Deepak Mohanty (2011); 'How does the
3.
Rakesh Mohan (2006) 'Coping With
economic growth and maintain financial
Liquidity Management in India: A
stability as seen in the recent months. The LAF
Practitioner's View'
framework of RBI has progressed as a flexible
monetary policy tool that has not only helped in
4.
Working Group on Operating Procedure of
stabilizing the money market rates, but also
Monetary Policy'.
helped strike a comfortable liquidity position
among market participants. The introduction of
5.
in Indian money markets.
Reserve Bank of India; 'Annual
Reports'(Various Issues)
the MSF rate has further provided leeway to the
central bank to maneuver liquidity management
Reserve Bank of India (2011); 'Report of the
6.
Reserve Bank of India; 'Notifications and
Press Releases' (Various Issues)
7.
Reserve Bank of India (2003-04); 'Report on
Currency and Finance'.
8.
Reserve Bank of India: Report on Currency
and Finance 2009-12: Fiscal-Monetary Coordination.
Monthly Newsletter January 2014
steer market liquidity in the desired trajectory.
CCIL
diverse tools being introduced in the process to
Deepak Mohanty (2013) 'Efficacy of
21
CCIL
22
12.0
Q1 2007-08
Q2 2007-08
Q3 2007-08
Q4 2007-08
Q1 2008-09
Q2 2008-09
Q3 2008-09
Q4 2008-09
Q1 2009-10
Q2 2009-10
Q3 2009-10
Q4 2009-10
Q1 2010-11
Q2 2010-11
Q3 2010-11
Q4 2010-11
Q1 2011-12
Q2 2011-12
Q3 2011-12
Q4 2011-12
Q1 2012-13
Q2 2012-13
Q3 2012-13
Q4 2012-13
Q1 2013-14
Q2 2013-14
GDP growth Rate (%)
Monthly Newsletter January 2014
Quarter
India's GDP Growth Rate
Trend of India's GDP Growth Rate
10.0
8.0
6.0
4.0
2.0
0.0
Central Government Deposits with RBI
02-Apr-2013
02-Aug-2013
02-Dec-2013
02-Apr-2012
02-Aug-2012
02-Dec-2012
02-Aug-2011
02-Dec-2011
02-Aug-2010
02-Dec-2010
02-Apr-2011
02-Aug-2009
02-Dec-2009
02-Apr-2010
02-Aug-2008
02-Dec-2008
02-Apr-2009
WPI
02-Dec-2007
02-Apr-2008
02-Apr-2007
02-Aug-2007
Oct-13
Apr-13
Oct-12
Apr-12
Oct-11
Apr-11
Oct-10
Apr-10
Oct-09
Apr-09
Oct-08
Apr-08
Oct-07
Apr-07
Inflation Rate (%)
ARTICLE
Annexure 1- Snapshot of India's Macro Economic Indicators:
20.00
Y-o-Y growth in India's WPI and CPI Inflation
15.00
10.00
5.00
0.00
-5.00
Month
CPI
1,200.00
Central Government Deposits with RBI
1,000.00
800.00
600.00
400.00
200.00
0.00