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1. Post-Reform
Period: A State Level Analysis
1.1
Introduction
Page 1
Page 2
Page 3
Page 4
Section III
Credit 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)
VARIABLE
TY.B.F.M
1981-1992
1993-2001
1981-2001
Page 5
Output
2.7
Agriculture
Industries
Services
1.6
3.6
4.0
Credit
Output
Credit
Output
Credit
12.9
4.1
12.9
3.1
13.2
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
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, higher
growth 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). Thus, a much deeper
Table 2: Share in Output and Credit
(Per cent)
Sector
Output
Credit
Output
Credit
Agriculture
37
15.7
29
10
Industry
23
43.5
25.5
48
Services
40
40.8
45.5
42
Page 6
TY.B.F.M
Page 7
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
States with
higher growth
output but lower
growth in credit
(Group F)
States with
lower growth in
output and credit
Delhi, Karnataka,
Andhra Pradesh,
Arunachal Pradesh,
Kerala Maharastra,
and Rajasthan
Gujarat,
Himachal Pradesh,
(Group H)
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-visthe
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 IV
Data 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 19811992 (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 199394 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 Methodology
To 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 crosssectional 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 V
Empirical 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 percapita 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.3 For 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).
ANDHRAPRADESH
Industry
Services
Overall5
ARUNACHAL PRADESH
ASSAM
GUJARAT
HARYANA
BIHAR
DELHI
HIMACHAL PRADESH
KARNATAKA
KERALA
MADHYAPRADESH
MAHARASHTRA
MEGHALAYA
ORISSA
MANIPUR
PONDICHERRY
PUNJAB
RAJASTHAN
TAMIL NADU
TRIPURA
UTTARPRADESH
WEST BENGAL
Note : 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
Section VI
Conclusion
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 dimensions, and the well known low power of conventional unit root tests
when applied
to a single time series, there may be considerable potential for tests
that can be
employed in an environment where the time series may be of limited
length, but
very similar data may be available across a crosssection of
countries, regions,
firms, or industries.
2 Both fixed and random effects estimation of elasticity of output
with respect to
credit shows deterioration in allocative efficiency in the post reform
period for
the 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 exception
5 Overall refers to the State Domestic Product
State
Agriculture
Industry
Services
NSDP
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
PRADESH
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
4.4
ASSAM
0.1
-0.3
-0.1
1.4
2.0
0.5
2.4
1.4
2.3
1.2
0.8
1.0
BIHAR
0.2
-0.4
-1.3
4.3
3.8
2.1
3.2
3.6
2.7
2.2
2.1
0.9
DELHI
-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
3.1
-2.6
1.2
-0.8
2.4
-2.9
0.2
1.1
3.7
2.2
-0.3
1.8
0.7
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
2.1
0.7
-0.9
1.7
3.9
4.4
4.3
5.0
5.9
6.2
3.6
4.2
4.6
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
-0.8
-0.9
-1.4
5.1
-1.9
4.1
4.3
5.9
4.4
2.0
1.6
1.4
PONDICHERRY
-1.8
-2.7
-2.6
1.0
21.6
3.2
2.2
10.0
5.2
0.9 12.3
2.8
PUNJAB
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
UTTAR
PRADESH
0.5
0.0
0.3
5.2
2.5
3.3
3.9
2.9
3.0
2.5
1.7
1.9
WEST
3.2
2.1
2.9
1.3
4.4
2.6
2.7
8.3
4.6
2.4
5.5
3.5
PRADESH
PRADESH
JAMMU &
KASHMIR
PRADESH
MAHARA-
SHTRA
BENGAL
1
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
PRADESH
14.0
11.1
ARUNACHAL
37.3
7.7
19.6 36.4
-7.2
18.5 32.3
5.7 15.2
ASSAM
BIHAR
DELHI
15.3
14.8
-1.9
0.3
7.2 19.4
10.0 11.0
1.7
1.6
13.2 18.0
14.8 15.1
6.8 10.6
4.9 11.5
GUJARAT
-5.9
19.4
14.3
6.7
HARYANA
11.4
8.5
7.6
12.8
15.8
12.4
13.2
13.3
12.1
HIMACHAL
13.4
7.1
7.6
18.0
12.2
12.4
16.8
12.2
13.3
PRADESH
9.1
14.1
10.3
16.2
4.3
15.1
11.0
7.9
12.3 13.2
PRADESH
JAMMU &
KASHMIR
13.0
8.6
7.3
16.6
4.8
8.9
16.1
17.9
14.8
KARNATAKA
16.1
12.2
12.1
14.8
15.1
14.0
17.2
19.5
16.0
13.6
17.1
12.3
10.2
12.0
12.8
10.6
15.4
23.3
27.2
14.0
7.9
-3.7
8.1
13.0 38.8
10.1 36.0
9.2 19.8
7.8
7.5
KERALA
MADHYA
PRADESH
MAHARA
-SHTRA
MANIPUR
MEGHALAYA
ORISSA
PONDI
-CHERRY
PUNJAB
7.9
11.0
RAJASTHAN
14.2
12.3
TAMILNADU
16.1
TRIPURA
20.4
UTTAR
PRADESH
WEST
16.6
15.5
13.1
17.6
6.9
15.4
7.1
12.2
16.2
15.1
15.8
7.0
15.9
14.2
13.4
10.1
14.7
12.7
11.3
13.8 11.3
8.4
12.2
16.0
16.1
15.5
17.9
17.6
17.8
1.7
10.1
26.9
-2.3
10.9
21.8
4.6
12.5
22.5
13.6
9.0
10.8 13.8
8.5
14.4
3.9
BENGAL
2
14.1
8.1
11.8
13.2 14.8
2.8 11.6
9.8 11.9
LPAGRI
LPINDS
LPSERV
LPNSDP
LPACS
LPICS
LPSCS
LPTCAS
-4.52
2.27
3.36
2.91
0.68
2.40
1.20
1.73
-2.58
2.37
3.53
3.58
1.33
1.98
2.81
2.58
1993-2001
IPS
ADF
-stat
-6.13
2.45
4.54
3.99
1.46
0.74
5.31
2.20
-6.31
-0.42
2.85
2.29
2.36
0.17
3.88
2.54
-6.67
0.47
2.49
1.58
1.67
1.49
2.36
2.47
-4.56
0.73
3.46
2.18
2.82
2.57
3.49
3.53
-3.73
0.73
3.25
2.51
2.63
1.87
3.22
3.33
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.
Panel v-statistics
1993-2001
LPINDS
and
LPICS
LPSERV LPNSDP
and
and
LPSCS LPTCAS
4.52
2.49
2.97
1.02
2.80
1.79
Panel rho-statistics
-1.96
-1.71
-1.51
-0.39
-0.84
-0.80
Panel pp-statistics
-3.57
-2.96
-2.96
-3.83
-2.89
-3.65
Panel adf-statistics
-4.45
-3.47
-1.99
-2.03
-3.32
-2.48
Group rho-statistics
-0.34
0.21
0.0006
1.01
1.35
0.47
Group pp-statistics
-4.31
-3.02
-3.20
-6.66
-3.56
-6.44
Group adf-statistics
-5.75
-5.09
-3.75
-23.83
-15.36
-22.65
Notes : The critical values for the panel cointegration tests are base on Pedroni (2001a).
LPAGRI =
Log of per capita agricultural output
LPINDS = Log of per capita industrial output
LPSERV = Log of per capita services sector output
LPNSDP = Log of per capita net State domestic product
LPACS
= Log of per capita agricultural credit
LPICS
= Log of per capita industrial credit
LPSCS
= Log of per capita services sector credit
LPTCAS = Log of per capita total credit outstanding for all sectors of the State
1981-1992 1993-2001
LPNSDP
ANDHRAPRADESH
ARUNACHAL PRADESH
ASSAM
BIHAR
DELHI
GUJARAT
HARYANA
HIMACHAL PRADESH
JAMMU & KASHMIR
KARNATAKA
KERALA
MAHARASHTRA
MANIPUR
MEGHALAYA
MADHYAPRADESH
ORISSA
PONDICHERRY
PUNJAB
RAJASTHAN
TAMILNADU
TRIPURA
UTTARPRADESH
WESTBENGAL
POOLED
LPNSDP
1981-1992 1993-2001
LPINDS
1993-2001
LPSERV
LPSERV
0.22
(-12.95)
0.17
(-42.90)
0.05
(-78.06)
0.14
(-26.38)
0.42
(-10.74)
0.15
(-29.75)
0.37
(-11.96)
0.22
(-12.84)
-0.02
(-38.75)
0.21
(-25.53)
0.15
(-15.67)
0.08
(-33.23)
0.31
(-14.19)
0.09
(-97.31)
0.08
(-22.14)
0.14
(-55.82)
0.06
(-57.65)
0.29
(-11.00)
0.32
(-12.24)
0.25
0.31
(-33.96)
(52.30)
(-63.08)
(-23.21)
(-28.70)
(-65.09)
0.11
(-22.23)
0.19
(-63.23)
0.21
(-30.22)
0.18
1.46
-1.91
0.17
(-38.75)
0.5
(-29.80)
0.34
0
(-39.83)
0.05
(-51.47)
0.21
(-16.57)
0.03
-2.31
(-3.05)
0.29
(-11.36)
0.49
(-29.83)
0.18
0.3
(-19.08)
(-156.24)
(-124.94)
(-194.26)
(-162.03)
0.06
(-26.11)
0.11
(-48.25)
0.19
(-8.86)
0.33
(-11.09)
0.21
(-13.17)
0.26
(-85.73)
0.29
(-41.42)
0.1
(-61.07)
0.39
(-13.58)
0.28
(-49.23)
0.15
(-36.83)
0.24
(-74.81)
0.48
(-2.92)
0.2
(-6.10)
0.11
(-58.34)
1.09
-0.48
0.22
(-86.15)
0.27
(-11.18)
0.33
(-166.41)
0.41
(-10.60)
0.15
(-31.56)
-0.03
(-86.56)
0.34
(-12.21)
0.32
(-32.89)
0.28
(-15.23)
0.52
(-9.53)
0.03
(-14.24)
-0.19
(-13.13)
0.02
(-43.88)
0.09
(-13.33)
-0.05
(-47.65)
0.03
(-9.61)
-0.01
(-129.84)
-0.06
LPINDS
1981-1992
(-75.61)
0
(-16.08)
-0.12
(-13.49)
0.16
(-7.50)
0.14
(-6.93)
0.16
0.44
0.32
(-27.86) (-13.61)
0.1
0.34
(-6.07)
(-19.96)
0.25
0.14
(-11.31)
(-37.71)
0.05
0.17
(-6.08) (-153.24)
-0.09
0.55
(-16.46)
(-2.82)
0.27
0.34
(-24.29) (-27.64)
0.25
0.43
(-235.33)
(-8.25)
0.47
0.34
(-7.34)
(-11.42)
-0.24
0.08
(-13.86) (-67.00)
0.4
0.34
(-12.76) (-24.92)
0.3
0.2
(-36.07) (-31.35)
0.29
0.23
(-27.18) (-47.62)
0.25
0.4
(-55.47)
(-5.83)
0.02
0.2
(-1.38)
(-47.02)
0.14
0.29
(-5.11)
(-10.05)
-0.59
0.25
(-9.70)
(-76.56)
2.19
0.14
-1.18 (-133.73)
0.34
0.27
(-17.70) (-18.51)
0.53
0.46
(-13.45)
(-8.75)
0.24
0.32
0.27
(-30.85)
0.17
(-70.59)
0.28
0.35
(-45.14)
0.38
(-8.08)
0.09
(-52.65)
0.37
(-8.82)
0.36
(-9.69)
0.47
(-14.50)
0.52
(-31.67)
0.46
(-18.74)
0.2
(-51.85)
0.47
(-15.15)
0.4
(-25.86)
0.38
(-18.57)
0.35
(-24.06)
0.44
(-7.77)
0.24
(-9.58)
0.43
(-60.82)
0.66
(-8.45)
0.37
(-16.08)
0.37
(-16.27)
0.5
(-15.10)
0.97
(-0.64)
0.28
(-64.79)
0.63
(-9.82)
0.42
(-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
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 groupmean 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 tbar 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 nocointegration 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 cointegration 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 co- integration 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 FMOLS
In the event the variables are co-integrated, to get appropriate estimates of the cointegration 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 model
yitxiiitxuitx,(u)(2) (2)itit 1ititit,itthe asymptotic distribution of the OLS
estimator depends on the long run covariance matrix of the residual process w.
February 1992
Indian Institute of Management, Ahmedabad
This 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.
The 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
It 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 Hedging
With 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
If 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.
We 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.
Opening 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
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.
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 CRAR
1. 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
Conversion Factor
2%
10%
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 offBalance 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
Conversion Factor
0.5%
1.0%
3.0%
(b) Step 2 -The adjusted value thus obtained shall be multiplied by the risk
weightage 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
Over 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 and
integrated 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 for
bank 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 involvement
ALM process
=> Risk parameters
=> Risk identification
=> Risk measurement
repo rate
CRR
6.00
6.00
4.50
4.75
6.00
5.00
6.00
6.00
6.00
6.25
6.50
6.75
7.00
7.25
5.00
5.00
5.00
5.00
5.00
5.00
5.00
5.25
7.25
5.50
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
3.5
5/7/1935
Rate
Effective Date
1
(a)5% of DL 5/7/1935
Rate
Effective Date
1
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
(b)2% of TL
27 24-04-1970
316-09-1962
5/2/1970
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
6
17-02-1965
7.2527-11-1981
34 1/12/1978
issuing money (the rupee) and adequately ensuring a high quality money
supply;
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 banks 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 issues
xi.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 Negative Carry on CRR and SLR
100
100
Current
Annex
100
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.
iii.
iv.
v.
Small and marginal farmers with landholdings of 5 acres and less, and
landless 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.
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 where
interest 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 month
ii) Over one month and upto 3 months
iii) Over 3 months and upto 6 months
iv) Over 6 months and upto 12 months
v) Over 1 year and upto 3 years
vi) Over 3 years and upto 5 years
vii) Over 5 years
viii) 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 negative
Gap (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 classifica
components of assets and liabilities into different time buckets for preparation of Gap
and Interest Rate Sensitivity) as indicated in Appendices I & II is the benchmark. Ban
equipped to reasonably estimate the behavioural pattern, embedded options, rolls-in
various components of assets and liabilities on the basis of past data / empirical stud
them in the appropriate time buckets, subject to approval from the ALCO / Board. A
approved by the ALCO / Board may be sent to the Department of Banking Supervisio
Background
INTRODUCTION
The 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 setup. 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 which
adversely affect the working of banks.
Upgradation of technology to ensure prompt and efficient customer
service.
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/train
tickets 24 X 7).
Internet Banking.
Debit Cards (dispensed the need for carrying cash for making purchases).
Mobile Banking (stage wise implementation) and the youngsters accessing
banking 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
netrf Banking
s to the remote
s of the country
en
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 Board
Memorandum 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 Disputes
Redressal 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 Bank
of 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 former
CMD, Vijaya Bank, Bangalore.
Shri Kaza Sudhakar, Chief General Manager, Customer Service
Department, 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 and
pensioners segment.
b) Evaluate the existing system of grievance redressal mechanism prevalent in
banks, its structure and efficacy and recommend measures for expeditious
resolution of complaints. The Committee may also lay down a suitable time
frame for disposal of complaints including last escalation point within that
time frame.
c) Examine the functioning of Banking Ombudsman Scheme - its structure,
legal framework and recommend steps to make it more effective and
responsive.
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 Banks Commitment to Customers.
Chapter 2
Introduction
Very useful insights on the causes and events that shaped the direction and
pace 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 can
be carried out with different ways of periodisation. Our method of periodisation is
primarily based on the policy environment. Based on the policy framework, broadly
two distinct regimes can be delineated in the monetary policy history of India,
since
Independence. The first regime refers to the credit-planning era followed since the
beginning 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
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 policy
predominantly caused by interventionist character of credit policy and external
developments. 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 INDIA
17 government occupied the pivotal role in monetary management and the RBI was
pushed 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 of
the 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 37.6
per 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 mid1980s. 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 then
prevailing 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 and
unsatisfactory 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
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, new
instruments 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
Conclusion
Factory 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.
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 economy
Inflation 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
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