MONETARY POLICY OF INDIA (2007-2013)

During the economic crisis of 2008 when NAFC broke there was not initially much effect due to the
cuts in the US fed fund rates in 2007there was a dramatic increase in the net capital inflow of the
country and the GDP of the country almost touched double figures (10%) many measures were
taken by the RBI to ensure the liquidity of the foreign exchange during 2007-08 inflation was
pressurised due to the demand of people for domestic products and also due to global commodity
prices the main emphasis at that time was given to inflation rising.

Whereas there was a minimal effect on the financial institution of the country’s (banks) due to the
limiting of complex derivatives and macro prudential policies that were being set up by RBI but due
to the Lehman failure there was little stress that was formed in September 2008 the external
environment that is the inflow from other countries that was around 107bn in 2007-08 and created
a massive capital increase falls to 9bn in the respective year 2008-09 in September although FDI
shoed resistance and also the commercial borrowing was hit and trade was also effected. And as
India is the emerging market and not established so the domestic equity was hit badly due to the
selloff of the foreign companies and the money was pulled out of the Indian market causing a major
outflow of money and capital in the month of October in 2008 there was a constant pressure from
the foreign market but RBI used that money before so there was a significant drop in the value of
rupee and its liquidity.

With the consistent impact of NAFC on the world economy Indian economy also got hit by a
moderation in the second half the fiscal year 2008-09 in the fourth quarter the industrial output also
shoed decline that has not been experienced since 1990s. To ensure that the situation doesn’t go
south RBI also took some safety and in mid-September announced some alteration:

1. Monetary policy was eased and the repo rate falls from 9% to 4% and reverse repo rate
falls from 6% to 3.25% in April 2009. But the effective rate falls from 9% to 3.25%.

2. Further many other measures were being taken in between October 2008 and April 2009 to
ensure that least pressure should be on country’s economy’s liquidity.

RBI revoked the conventional measures like CRR reduction as well as many other unconventional
measures:

ENHANCEMENT OF BOARD MARKET’S LIQUIDITY

 Reduction in the CRR from 9% to 4.75%

 Unwinding MSS (Market Stabilisation Scheme)

UNCONVETIONAL MEASURES

 Introduction of repo window by the effect of LAF for the financial institutions
(banks) and for on-lending to mutual funds and home loans etc.

 SPV (Special Purpose Vehicle) to provide liquidity flow to the banks

 SRF (Special Refinance Facility) to be accessed by any bank if they require some
financial help in tough times without any collateral.

FOREX LIQUIDITY

 This intervention to use foreign exchange reserve money.

 Upward adjustments were made on the interest rate ceiling on types of non-
residential deposits and foreign currency.

 Relaxation on borrowing regime

 Exchange of rupee dollar facility for branches that are outside the country

These measures had a positive effect and the liquidity potentially increased over 5 trillion there by
easing the liquidity and also ensuring confidence in the domestic financial markets by the mid of
November 2008.

These unconventional measures has the effects on SLR (Statuary Liquidity Ratio) that was reduced
from 25% to 24% came back to original 25%. The refinance facility that was about 50% at the time of
crisis came back to 15% the way it was before the crisis. Also government established some more
facilities like special refinance to certain banks and special repo rate facility as mentioned above
these were the factors that help to re-establish the system at the state it was before crisis
 AMOUNT (RS. % OF GDP (2008-
MEASURE/FACILITY BILLION) 09)

1. CRR Reduction 1,600 2.9

Unwinding/Buyback/De-sequestering of MSS
2. Securities 1,590 2.9

3. Open Market Operations (purchases) * 1,041 1.9

4. Term Repo Facility 600 1.1

5. Increase in Export Credit Refinance 223 0.4

6. Special Refinance Facility for SCBs (Non-RRBs) 385 0.7

7. Refinance Facility for SIDBI/NHB/EXIM Bank** 160 0.3

Liquidity Facility for NBFCs through Special

8. Purpose Vehicle @ 250 0.4

9. Total (1 to 8) 5,850 10.5

LIQUIDITY INJECTION/AVAILABILITY DURING SEPTEMBER 2008-SEPTEMBER 2009

In response to the monetary policy the GDP of the country that got hit during the time of crisis
started recovering in 2009-10 that increased again to 8.6% and in 2010-11 increased to 8.9% but
inflation also occurred during this time firstly the food inflation in the later-half of 2009 and in April
2010 hit by underlying inflation because of the increase in price of the global market commodities
and the on availability of domestic need of food due to less crops and causing an increase in the
price of food. Inflation was about to occur before the crisis but immediately after crisis it reversed
but after 2010 it has been on a high.

The inflation pressure was going high during the time period of April 2010 to late 2013 but it was
gradual and at a slow rate. This inflation process was generalised as an increase in demand and rise
in the price of input through variable cost and fixed costs that reflected in the output prices these
factors resulted in the Increase in the underlying inflation.

Criticism was faced by the monetary policy of the country that whether it was consistent or not and
does it get affected by the global scenario breakdown giving a good consideration on the fact that
domestic consumption continued to play major role in the demand generation and the banking of
the country had a very little exposure to the toxic assets the criticism can’t be overlooked

MONETARY POLICY RATES IN INDIA (2008-2013)

NOMINAL MONETARY POLICY RATE

 REAL MONETARY POLICY RATES (normal rate – WPI inflation)

PURCHASE AND SALE OF USD BY RBI

 During this period of the rupee came down 56.8 to 67.9

 There has been sluggish growth since 2009 in India’s export market

 Sluggish growth but the global commodity level has increased (due to near zero
interest rates)

 Increase in coal import from 0.5 to 0.9

OPERATING FRAMEWORK

The weighted average overnight call money rate (WACMR), the only one independently varying
policy rate, became the operating target of monetary policy.

The reverse repo rate continued to be operative but it was pegged at a fixed 100 basis points below
the repo rate.

A new Marginal Standing Facility (MSF) was instituted from which banks can borrow overnight (on a
non- collateralised basis) up to one per cent of their respective Net Demand and Time Liability
(NDTL); the rate of interest on amount accessed from this facility was 100 basis points above the
repo rate.

As per the above scheme, the revised corridor would have a fixed width of 200 basis points. The
repo rate will be in the middle. The reverse repo rate will be 100 basis points below it and the MSF
rate 100 basis points above it.

While the width of the corridor is fixed at 200 basis points, the RBI would have the flexibility to
change the corridor, should monetary conditions so warrant.

MONETARY POLICY 2013-18 (TOWARDS INFKATION TARGETING)

This method of Inflation Targeting (IT) came for the first time in the country and in the reports of
Financial Sector Reforms (CFSR) made in effect by the government of India the committee argued
that “the RBI can work more efficiently towards growth by focussing on the inflation control” and
recommends them “The RBI should formally have a single objective, to stay close to a low inflation
number, or within a range, in the medium term, and move steadily to a single instrument, the short-
term interest rate (repo and reverse repo) to achieve it” because of the emergence of double digit
inflation in the time oeriod of 2009-2013.

“After considerable discussion a Monetary Policy Framework Agreement (MPFA) was finally signed
between the Government of India and the RBI on February 20, 2015, specifying the following”:
“Government has set a target for RBI to bring down inflation below 6 per cent by January 2016, 4%
for financial year and all subsequent years with band of +/- 2%”. If RBI fails to meet the target, it will
report to the government with the reasons for the failure to achieve the target and propose
remedial actions to be taken. “The RBI will further estimate the time period within which the failed
target would be achieved”.

There are a number of inter-related critiques on RBI’s strategy and implementation of IT.

1. Some analysts have expressed doubts about the accuracy of RBI’s inflation forecasts and
expectations (Sharma and Bichhal, 2017 and Goyal, 2017) arguing that this affects RBI’s
credibility and hence, the effectiveness of IT.

2. There have been concerns expressed, particularly by the government, that the RBI’s IT
strategy has been less mindful of the growth and investments imperatives of a growing
economy like India. Chief Economic Adviser Arvind Subramanian (2015) showed that real
policy rates (i.e., repo rate less inflation rate) have diverged significantly for consumers and
producers, being unusually high for the latter which could have constrained growth.

3. Issues with the transmission of monetary policy have continued even under the IT
framework. RBI’s internal Study Group to “Review the Working of the Marginal Cost of
Funds Based Lending Rate System”.

The system revealed,

 “The transmission has been slow and incomplete (although it has improved
since November 2016 under the pressure of large surplus liquidity in the
system post demonetisation)”.

 “It was signification fresh loans, but muted for outstanding loans (base rate
and Marginal Cost of Funds Based Lending Rate or MCLR)
  “It was uneven across borrowing categories”.

 “It was asymmetric over monetary policy cycles (higher during the tightening
phase and lower during the easing phase)”.

CURRENCY AND DEPOSITS: LONG TERM TRENDS

The shift from deficit to surplus liquidity posed many challenges to monetary policy and the
management of liquidity the post demonetisation period had different phases of liquidity:

 From November 10 to 25 RBI used variable repo rates. The reverse repo rate reached peak
due to the surplus liquidity and was noted to be 5,242bn on November 25.

 100% incremental CRR was applied from November 26 to December 9, 2016 which drained
the liquidity (about 4000bn).

 Surplus liquidity was managed by applying mix of reverse repo rate and CMB (Cash
Management Skills). This was done in between 10 December 2016 to 13 January 2017 and
about 7956bn outstanding liquidity was absorbed.

 RBI returned the conventional reverse repo as the key to absorb the outstanding liquidity.
The liquidity was then released through the matured CMBs under MSS. This was done
between 14 January 2017 to the end of March 2017

 The next phase began in april 2017 with the auction of T-bills (treasury bills) liquidity was
then managed by insurance of T-bills under MSS and the auctioning of reverse repo rate.
 DAILY TREND IN NET LIQUIDITY ABSORPTION (NOV 16 – JUN 17)

RBI profits went down from 659bn to 307bn and the RBI and central bank transfer came down by
the same amount. Also the cost of printing the notes for currency went up and was almost about
80bn.

There was a decrease in the rate of interest income and it can down from 5bn in the fiscal year 2015-
16 to 174bn in 2016-17.

ACCUMULATION OF STRESSED ASSETS AND MONETARY POLICY

 ANNUAL TREND IN NPL OF INDIAN BANKING SECTOR (AS% OF TOTAL LOANS)

“Indian banking, led predominantly by public sector banks, had experienced a very substantial fall in
“non-performing loans” (NPLs) from the late 1990s to around 2009, as a consequence of tightened
regulation and supervision and high overall economic growth”. “This trend in NPLs got reversed after
2009, with NPLs increasing steadily to almost 10 per cent of total advances by March 2017. More
recent RBI data on stress tests indicates that even in the baseline scenario, NPLs may rise to 11.1 per
cent of advances by September 2018”.

“For the U.S., it has been found that that declines in bank capital have contributed to the slowdown
in lending (Bernanake and Lown, 1991). In a similar vein, the April 2017 Monetary Policy Report of
the RBI noted for India, “it is found that the gross non-performing asset”. Capital to risk-weighted
assets ratio CRAR) significantly influence credit growth. “While better capitalised banks exhibit
higher credit growth, banks with higher GNPAs experience weaker credit growth”. Thus in presence
of increasing non-performing loans, banks might not be able to pass on the benefits of monetary
policy actions designed to increase credit activity through lower policy rates”.

CONCLUSION

In this report the historical factors of the monetary policy have been studied with deep analysis on
the years between 2007 to 2018 and the effect of demonetisation on the countries monetary policy
along with the different conventional and unconventional factors that were being used by the Indian
government and how the manage the liquidity in the Indian market and also found out that after
having so many non-performing loans the lending rates of the financial institution has shown
improvement in the recent times.