RBI Hopeful Of Higher GDP, Lower Inflation

Updated: Nov 4 2003, 05:30am hrs
2. This Statement follows the pattern already set in the previous years - both in outline and in substance. As has been the practice in the past, and as emphasised by my predecessor, Dr Bimal Jalan, monetary measures have to be taken promptly and effectively, to respond to the rapid developments in both the domestic and global markets. At the same time, the Annual Monetary and Credit Policy announced in April/May and the Mid-term Review in October/ November serve several purposes: as a framework for or supplement to the monetary and other relevant measures that are taken from time to time to capture events affecting macroeconomic assessments, in particular relating to fiscal management as well as seasonal factors; and to set out the logic, intentions and actions related to the structural and prudential aspects of the financial sector in our country. Further, the biannual Statements add to greater transparency, better communication and contribute to an effective consultation process. I. Mid-term Review of Macroeconomic and Monetary Developments in 2003-04 Domestic Developments 3. The annual Statement on monetary and credit policy released on April 29, 2003 projected GDP growth of about 6.0 per cent for the year 2003-04, based on the assumption of rainfall at around 96 per cent of its long period average, recovery in agricultural output by over 3.1 per cent coupled with continuance of the upturn in the industrial sector. There have been a number of developments since then that are likely to have a positive impact on the growth rate. First, according to the India Meteorological Department (IMD), the South-West monsoon this year has been widespread and better than that anticipated earlier. Second, industrial growth continues to remain satisfactory. Third, export growth appears to have been sustained, although at a rate lower than the high rate of last year; however, improved prospects for global recovery should provide fresh impetus to export growth. It is noteworthy that non-oil imports have increased reflecting strengthening of domestic demand. Fourth, business expectations are positive. In addition, the underlying financial conditions of inflation, interest rates and liquidity, supported by the current policy stance, are expected to provide a favourable environment for higher growth.

4. The official estimate of the Central Statistical Organisation (CSO) for GDP growth available for the first quarter of 2003-04 (5.7 per cent) is marginally higher than that in the corresponding quarter of the previous year (5.3 per cent). The behaviour of the South-West monsoon this year was better than that in the last four years: cumulative rainfall was 102 per cent of normal and spatial distribution showed that 33 out of 36 meteorological sub-divisions received normal or excess rainfall. Taking into account the performance of the South-West monsoon, it is expected that agricultural GDP during the current year would exhibit a high growth after the decline of 3.2 per cent last year. During April-August 2003, the Index of Industrial Production (IIP) increased by 5.6 per cent, which is higher than 5.2 per cent recorded in the corresponding period of the previous year. There are indications of sustained growth in the production of basic goods, capital goods and consumer goods. During April-September 2003, while growth in exports at 10.0 per cent in US dollar terms was lower than 18.0 per cent in the corresponding period of the previous year, growth in imports was higher at 21.4 per cent as against 9.2 per cent in the corresponding period of the previous year.

5. On current reckoning, based on the growth prospects across the sectors of the economy, and assuming the continuance of good performance in industry and some acceleration in exports reflecting the anticipated global economic recovery, it is reasonable to expect an overall GDP growth of 6.5 to 7.0 per cent, with an upward bias, for the year 2003-04, as compared with the earlier projection of around 6.0 per cent.

6. Scheduled commercial banks credit increased by 3.2 per cent (Rs.23,196 crore) up to October 17, 2003 as compared with an increase of 6.5 per cent (Rs.38,571 crore), net of mergers, in the corresponding period of last year. Food credit declined by Rs.15,328 crore as compared with a decline of Rs.1,273 crore in the previous year. Non-food credit increased by 5.7 per cent (Rs.38,524 crore) as compared with an increase of 7.4 per cent (Rs.39,844 crore), net of mergers, in the corresponding period of the previous year. Some new trends in the credit market are noteworthy. In recent years, retail credit has grown significantly, particularly to the housing sector. The Reserve Bank has also recently removed the interest rate restriction of the prime lending rate (PLR) being the floor rate for loans to the retail and personal segment. This measure should provide further impetus to retail lending. Nevertheless, keeping in view the intense competition in this sector, banks need to sharpen their risk assessment techniques so as to guard against any adverse impact on credit quality.

7. As regards industrial credit, the feedback on industry-wise credit flows received from banks for April-September 2003 reveals that, at a disaggregated level, there was a discernible increase in credit to tea, jute textiles, gems & jewellery, computer software and infrastructure. On the other hand, decline in credit was observed in coal, petroleum, iron & steel, mining, rubber and rubber products, automobiles and food processing.

8. Scheduled commercial banks investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper (CP) etc., declined by 2.6 per cent (Rs.2,432 crore) up to October 17, 2003 as compared with an increase of 10.6 per cent (Rs.8,561 crore) in the corresponding period of the previous year. Together with such investments, the total flow of resources from scheduled commercial banks to the commercial sector increased by 4.7 per cent (Rs.36,631 crore) as against a higher increase of 7.8 per cent (Rs.48,071 crore), net of mergers, in the corresponding period of the previous year. The year-on-year growth in resource flow was also lower at 13.9 per cent as against 16.0 per cent, net of mergers, a year ago. Scheduled commercial banks investments in instruments issued by financial institutions and mutual funds this year (up to October 17, 2003) increased by Rs.6,423 crore as compared with a lower increase of Rs.4,626 crore in the corresponding period of the previous year. At Rs.55,045 crore, the total resource flow to the commercial sector including capital issues, Global Depository Receipts (GDRs)/American Depository Receipts (ADRs) and borrowings from financial institutions during the financial year so far (up to October 17, 2003) is comparable with increase of Rs.55,697 crore in the corresponding period of the previous year.

9. In the current financial year up to October 17, 2003, money supply (M3) increased by 7.4 per cent (Rs.1,27,747 crore) as compared with 8.1 per cent (Rs.1,21,384 crore) in the corresponding period of the previous year, after adjusting for mergers. On an annual basis, growth in M3 at 11.9 per cent was within the projected level, but lower than that of 14.0 per cent in the previous year. The aggregate deposits of scheduled commercial banks rose by 8.2 per cent (Rs.1,04,988 crore) as compared with an increase of 9.1 per cent (Rs.1,00,635 crore) in the corresponding period of the previous year. On an annual basis, growth in aggregate deposits at 11.7 per cent was lower than that of 14.5 per cent a year ago. Overall, the growth in M3 and deposits has been within the projected level envisaged at the beginning of the year in the annual policy Statement.

10. RBIs net foreign currency assets (adjusted for revaluation), increased significantly by Rs.63,873 crore up to October 24, 2003, a figure much higher than the increase of Rs.38,452 crore during the corresponding period of the previous year. Despite such large inflows, reserve money increased by only 3.5 per cent (Rs.12,762 crore) in this year so far, as against an increase of 0.4 per cent (Rs.1,191 crore) in the corresponding period of the previous year. This was mainly due to substantial open market operations (OMO) by the Reserve Bank. Consequently, the net RBI credit to the Central Government showed a larger decline of 41.0 per cent (Rs.46,300 crore) than the decline of 15.7 per cent (Rs.22,219 crore) in the corresponding period of the previous year. RBIs credit to banks and commercial sector also declined due to their reduced reliance on the standing facilities emanating from comfortable liquidity conditions.

11. As regards the components of reserve money, bankers deposits with RBI decreased by 13.4 per cent (Rs.11,160 crore) up to October 24, 2003 as compared with a decline of 14.2 per cent (Rs.11,956 crore) in the corresponding period of the previous year reflecting the impact of reduction in cash reserve ratio (CRR). Currency in circulation increased by 8.1 per cent (Rs.22,893 crore), a rate higher than the 5.1 per cent (Rs.12,688 crore) in the previous year.

12. It may be recalled that the annual policy Statement had projected, for policy purposes, the inflation rate to be in the range of 5.0-5.5 per cent, on a point-to-point basis, at the end of 2003-04. This projection was made at a time when inflation was accelerating and had touched 6.7 per cent during the first week of April 2003. Moreover, there were considerable uncertainties over the movements of international oil prices in the aftermath of the Iraq war, and the behaviour of the South-West monsoon was unclear. Notwithstanding these concerns, the Reserve Bank had assessed that the inflation rate would moderate. Accordingly, the Reserve Bank had proposed to continue with the policy stance of maintaining adequate liquidity in the system and a soft interest rate environment. On the price scenario, the developments have been in the direction visualised through a forward-looking approach by the Reserve Bank in April 2003.

13. The annual rate of inflation as measured by variations in the wholesale price index (WPI), on a point-to-point basis, remained high in the range of 6.3-6.9 per cent during the first two months of this year. Thereafter, it has declined to 5.0 per cent by October 18, 2003. Annual inflation for fuel, power, light and lubricants group (weight: 14.2 per cent) at 4.8 per cent this year was similar to last year. Prices of primary articles (weight: 22.0 per cent) increased by 5.1 per cent as against 2.5 per cent last year. Among primary articles, the increase in prices was mainly observed in non-food articles such as oilseeds and fibres. Prices of manufactured products (weight: 63.7 per cent) increased by 5.1 per cent as compared with 2.7 per cent last year. Among manufactured products, increase in prices was observed in edible oils, tea & coffee, cotton textiles, basic metals and alloys.

14. The annual policy Statement had identified certain commodities (weight:15.4 per cent) where prices were affected by either drought conditions or external supply shocks. Excluding the price increases due to such items (mineral oils, oilseeds, edible oils, oil cakes and fibres) from the WPI basket, the inflation rate worked out to 4.3 per cent as on October 18, 2003 as against 2.9 per cent at end-March 2003. Annual inflation, as measured by variations in the Consumer Price Index (CPI) for industrial workers, on a point-to-point basis, has remained moderate at 2.9 per cent in September 2003 as against 4.3 per cent a year ago. 15. On an annual average basis, WPI inflation was 4.9 per cent as on October 18, 2003 as against 2.3 per cent a year ago. The annual average CPI inflation was 3.9 per cent by September 2003 as against 4.6 per cent a year ago.

17. The Union Budget for 2003-04 placed the net and gross market borrowings of the Central Government at Rs.1,07,194 crore and Rs.1,66,230 crore, respectively. The Central Government completed net market borrowings of Rs.67,317 crore (62.8 per cent of the budgeted amount) and gross borrowings of Rs.1,01,035 crore (60.8 per cent of the budgeted amount) up to end-October 2003. Further, an amount of Rs.14,434 crore was raised in lieu of the securities bought back under the buyback auction of high-coupon government securities. Taking into account the amount of Rs.32,602 crore received from States under the debt-swap scheme, the market borrowing programme as per the indicative calendar of the Central Government for the second half of 2003-04 has been reduced. Prevailing liquidity conditions facilitated the Government to borrow at a substantially lower cost during 2003-04 than in the previous year. The weighted average yield on government borrowings through dated securities at 5.87 per cent this year, so far, has been significantly lower than 7.34 per cent last year by 147 basis points. As part of the debt management strategy, RBI combined auction issues with acceptance by private placement of dated securities consistent with market conditions.

18. The gross fiscal deficit of the Central Government at Rs.81,014 crore up to September 2003 was higher by about 40.3 per cent over the corresponding period of last year and constituted 52.7 per cent of the budget estimate for the current year. Revenue deficit of the Central Government at Rs.65,427 crore up to September 2003 was higher by about 37.4 per cent over the corresponding period of last year and accounted for about 58.3 per cent of the budget estimate for the whole year. The state governments have prepaid Rs.32,602 crore of central government debt by borrowing from the market (Rs.22,089 crore) and also utilising a part of the additional receipts under small savings (Rs.10,513 crore). Such market borrowings by the state governments were in addition to the normal market borrowings of Rs.16,663 crore (up to end-October 2003). The persistence of large aggregate borrowing of the Central and state governments continues to be a matter of concern. Such concerns arise both out of a possible adverse impact on the desired acceleration in growth that is consistent with stability, and also from possible implications for efficient monetary and debt management. It is, therefore, essential to pursue, promptly and with resolve, fiscal consolidation from a medium-term perspective. There is need for efforts in the direction of widening the revenue base, rationalisation of expenditures, and above all enhancing productivity of public investments, already made or to be made, in both commercial and social sectors. In this regard, the highest priority being accorded to eliminate revenue deficits at the Centre and States is welcome.

19. Scheduled commercial banks investment in government and other approved securities at Rs.87,754 crore this year (up to October 17, 2003) has been higher than Rs.72,110 crore, net of mergers, in the corresponding period of the previous year. Commercial banks hold government and other approved securities much in excess of the prescribed statutory liquidity ratio (SLR). The excess holding of SLR securities at Rs.2,53,474 crore, constitutes 16.6 per cent of net demand and time liabilities (NDTL) of banks. Thus, for the banking system as a whole, the effective SLR investment at 41.6 per cent of NDTL is much higher relative to the statutory minimum of 25 per cent. 20. During 2003-04 so far, financial markets have remained generally stable and interest rates have softened further with liquidity in the system. First, average daily absorption through repo transactions under LAF during the year (up to end-October 2003) was higher at Rs.29,310 crore as against Rs.13,836 crore in the corresponding period of the previous year. Second, the average call money rate moved down from 5.86 per cent in March 2003 to 4.64 per cent by October 2003. Third, the 91-day and the 364-day Treasury Bill rates have declined from 5.89 per cent each to 4.94 and 4.72 per cent, respectively. Fourth, the yield on government securities with 10-year residual maturity declined from 6.21 per cent to 5.11 per cent. Fifth, the public sector banks have reduced their deposit rates over one year from a range of 5.25-7.00 per cent in March 2003 to 5.0-6.0 per cent by October 2003. However, while lending rates for prime corporates and activities like housing have declined significantly, noticeable reduction is yet to take place in regard to other segments.

External Developments
24. The prospects for the world economy have improved since April 2003 when the annual policy Statement was presented. Several uncertainties relating to the Iraq war, impact of SARS, and volatility in oil prices have turned out to be short-lived. Reflecting these developments, oil prices reverted to lower levels although they have recovered somewhat thereafter. Financial markets, which were in a state of flux, especially equity markets, have also rebounded in many countries. Interest rates in several countries have continued to decline to historically low levels. While the outlook on Euro area remains flat, there are signs of pick up in growth in the US and recovery in Japan. Emerging markets in Asia are staging a strong recovery and both India and China are expected to record large expansion in output. Some acceleration in growth is also anticipated for Africa and Latin America. Notwithstanding these favourable developments, the world economic outlook continues to face some downside risks. While uncertainties in the world economy have persisted for some time now, the Indian economy in recent times has not only showed considerable resilience to shocks but also demonstrated good economic performance on the domestic and external fronts.

25. The Indian forex market generally witnessed orderly conditions during the current financial year (April-October 2003). The exchange rate of the rupee which was Rs. 47.50 per US dollar at end-March 2003 appreciated by 4.8 per cent to Rs.45.32 per US dollar by end-October 2003 but depreciated by 2.3 per cent against Euro, 2.5 per cent against Pound sterling and 4.2 per cent against Japanese yen during the period. Foreign exchange reserves increased by US $ 17.2 billion from US $ 75.4 billion in end-March 2003 to US $ 92.6 billion by end-October 2003. 26. In recent years, the annual policy Statements as well as mid-term Reviews have attempted to bring into sharper focus the main lessons emerging from our experience in managing the external sector during periods of external and domestic uncertainties. The broad principles that have guided exchange rate management are:

Careful monitoring and management of exchange rates without a fixed target or a pre-announced target or a band. Flexibility in the exchange rate together with ability to intervene, if and when necessary.

A policy to build a higher level of foreign exchange reserves which takes into account not only anticipated current account deficits but also liquidity at risk arising from unanticipated capital movements.

A judicious policy for management of capital account.

27. As pointed out in the recent policy Statements, the overall approach to the management of Indias foreign exchange reserves in recent years has reflected the changing composition of the balance of payments, and has endeavoured to reflect the liquidity risks associated with different types of flows and other requirements. The policy for reserve management is thus judiciously built upon a host of identifiable factors and other contingencies. Taking these factors into account, Indias foreign exchange reserves are at present comfortable and consistent with the rate of growth, the share of the external sector in the economy and the size of risk-adjusted capital flows.

28. During this period, the payments obligation on account of redemption of Resurgent India Bonds (RIBs) of US $ 5.5 billion was discharged without any adverse impact either on Indian financial market or on reserves. The management of RIB redemption was carefully weaved into Indias reserve management policy in close co-ordination with the State Bank of India (SBI). Accordingly, redemption of these bonds was carried out smoothly on October 1, 2003 without causing any stress on domestic liquidity, interest rates and exchange rate. While RBI made available the foreign currency requirements of SBI on the date of redemption, SBI had built up adequate amount of rupee resources to fund foreign currency purchases from RBI. In order to smoothen the impact of the redemption over time, RBI had contracted forward foreign currency assets which took care of a major portion of the requirements. The balance requirements were met out of the foreign exchange reserves. Overall, although RIB redemption was large in magnitude, it had little impact on the reserves as well as domestic markets including money, foreign exchange and securities markets.

29. Indias exports during the first half of the current financial year increased by 10.0 per cent in US dollar terms as compared with 18.0 per cent in the corresponding period of the previous year. During the same period, imports rose faster by 21.4 per cent as against an increase of 9.2 per cent in the corresponding period of last year. Oil imports increased by 6.3 per cent in US dollar terms as compared with 12.6 per cent in the corresponding period of the previous year. Non-oil imports increased by 28.0 per cent as against an increase of 7.8 per cent in the corresponding period of the previous year. As a result, the overall trade deficit at US $ 7.1 billion during April-September 2003 was higher than the deficit of US $ 3.5 billion in the corresponding period of the previous year. The higher trade deficit this year, in substantial part, reflects growth in import demand emanating from a pick-up in economic activity as reflected in higher capital goods imports.

30. The current account of the balance of payments, which had remained in surplus consecutively in the previous six quarters, showed a deficit of US $ 1.2 billion during April-June 2003. The trade deficit (on payment basis) of US $ 5.9 billion was offset to a large extent by private transfers of US $ 4.2 billion. In addition, there was a significant increase of US $ 6.4 billion in net capital inflows comprising mainly foreign investment (US $ 2.8 billion), NRI deposits (US $ 1.7 billion) and external loans (US $ 1.2 billion). As a result, the net accretion to foreign exchange reserves, including valuation change, amounted to US $ 6.7 billion during the first quarter of 2003-04. While for well-known reasons it is difficult to anticipate the behaviour of capital flows, the positive sentiment on India should augur well for continued buoyancy, but some moderation should not be ruled out if the stance of monetary policies in leading industrial economies were to transit from soft or neutral to a relatively tighter regime.

II. Stance of Monetary Policy for the Second Half of 2003-04

33. The annual policy Statement of April 2003 had indicated that, according to the present assessment and barring the emergence of any adverse and unexpected developments in the various sectors of the economy, the overall stance of monetary policy for 2003-04 will be: Provision of adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level. In line with the above, to continue with the present stance of preference for a soft and flexible interest rate environment within the framework of macroeconomic stability.

34. Monetary management in the first half of 2003-04 was largely in conformity with the monetary policy stance announced in the annual policy Statement. A steady increase in net foreign currency assets of RBI in the face of subdued credit demand created a situation of excess liquidity throughout the first-half of the year posing a major challenge for liquidity management. The Reserve Bank, therefore, had to manage liquidity actively through open market operations (OMO) and through the liquidity adjustment facility (LAF) in order to maintain a stable interest rate environment.

The average daily absorption through repo transactions under LAF during the year so far (up to end-October 2003) amounted to Rs.29,310 crore as against an average of Rs.13,836 crore in the corresponding period of the previous year. The interest rates in money market and government securities market ruled lower than at the beginning of the financial year. More than 60 per cent of the market borrowing programme of the Government could be completed at a much lower cost, with longer maturities and without any adverse impact on the general interest rate structure. In tandem with market trends and with the anticipation of better growth and inflation prospects, the LAF repo rate was reduced from 5.0 per cent to 4.5 per cent on August 25, 2003. Notwithstanding the comfortable liquidity position emanating from the foreign exchange build up, RBI made further progress towards its medium-term objective of reduction in the cash reserve ratio (CRR). The CRR was reduced from 4.75 per cent to 4.5 per cent in June 2003 augmenting the lendable resources of banks by about Rs.3,500 crore.

35. In the Part I of this Review, detailed discussions on the likely levels of major monetary aggregates have been presented after assessing the relevant factors. In the light of the discussion, for the purpose of monetary management, (i) GDP growth in 2003-04 is placed at 6.5 to 7.0 per cent, with an upward bias, as against 6.0 per cent envisaged earlier; (ii) inflation, on a point-to-point basis could be in the range of 4.0-4.5 per cent, with a downward bias, as against 5.0 to 5.5 per cent projected earlier; (iii) expansion in M3 would be around 14.0 per cent as projected earlier; (iv) growth in aggregate deposits would be Rs.1,79,000 crore as projected earlier; and (v) non-food bank credit including investments in bonds/debentures/shares of public sector undertakings and private corporate sector, commercial paper (CP) etc., is expected to increase by about 15.5 -16.0 per cent, as projected earlier.

36. Since announcement of the annual policy Statement in April 2003, the world economic outlook has improved; GDP growth is placed higher; the outlook for inflation is more benign; expansion in money supply is within the trajectory; and financial markets, especially forex markets, are stable though they displayed more than usual activity. The flow of credit has been less than anticipated so far though more recent indications point towards improvement in the remaining part of the year. While capital flows are stronger, current account is possibly turning to deficit. Consistent with these developments, it is proposed to continue with the overall stance of monetary policy announced in the annual policy Statement for the remaining half of the current year.

III. Financial Sector Reforms and Monetary Policy Measures

37. The annual policy Statements as well as mid-term Reviews of RBI have been focusing on the structural and regulatory measures to strengthen the financial system. These measures have been guided by the objectives of increasing operational efficacy of monetary policy, redefining the regulatory role of the Reserve Bank, strengthening prudential norms, and developing technological and institutional infrastructure. This section reviews the progress of implementation of the measures initiated so far and proposes some further measures to meet the emerging challenges in the financial sector.

38. The emphasis at this stage is on continuance of measures already taken with an accent on implementation, facilitating ease of transactions by the common person, further broadening of the consultative process and continued emphasis on institutional capacity to support growth consistent with stability in a medium-term perspective. It is also proposed to consider strengthening of the credit delivery system within the existing institutional framework so that financing gaps do not seriously constrain the desired acceleration in growth.

Monetary Measures
(a) Bank Rate

39. In the annual policy Statement of April 2003, the Bank Rate was reduced from 6.25 per cent to 6.0 per cent with effect from the close of business on April 29, 2003. It was also indicated that unless the domestic and international circumstances change, the policy bias in regard to the Bank Rate is to keep it stable until the mid-term Review of 2003-04.

40. On a review of the macroeconomic developments, it is considered desirable to leave the Bank Rate unchanged (at 6.0 per cent) at present. (b) Cash Reserve Ratio 41. In the annual policy Statement of April 2003, the cash reserve ratio (CRR) was reduced from 4.75 per cent to 4.50 per cent effective fortnight beginning June 14, 2003.

42. While the Reserve Bank continues to pursue its medium-term objective of reducing the CRR to the statutory minimum level of 3.0 per cent, on a review of the current liquidity situation, it is felt desirable to keep the present level of CRR (4.50 per cent) unchanged. (c) Review of Liquidity Adjustment Facility

43. Pursuant to the recommendations of the Narasimham Committee on Banking Sector Reforms (1998), the liquidity adjustment facility (LAF) was operationalised on June 5, 2000 following its announcement in the annual policy Statement of April 2000. It was envisaged at that time that the LAF would help the short-term money market interest rates to move within a corridor and impart stability, facilitating emergence of a short-term rupee yield curve. It was also indicated therein that the LAF would be reviewed in the light of actual experience.

44. Keeping in view subsequent developments in the financial market as also in technology, an Internal Group reviewed the operations of LAF in a cross-country perspective. The draft Report of the Internal Group was discussed in the Technical Advisory Committee on Money and Government Securities Markets (TAC) recently and has been revised in the light of discussions. In view of the fact that LAF has emerged as a monetary policy instrument of RBI for modulating system liquidity, the Report of the Internal Group on Liquidity Adjustment Facility is being placed on the RBI website www.rbi.org.in for wider dissemination and comments. The guidelines on LAF will be finalised taking into account the suggestions received on the Report.

Interest Rate Policy
Prime Lending Rate and Spread

46. Accordingly, the issues relating to the implementation of the system of benchmark PLR were discussed with select banks and the Indian Banks Association (IBA). The IBA has made the following suggestions: (i) permitting separate PLRs for working capital and term loans, (ii) continuation of the practice of multiple PLRs, (iii) flexibility in offering fixed or floating rate loans based on time-varying term premia and market benchmarks, (iv) flexibility in pricing of consumer loans, and (v) accounting for transaction costs for different types of loans.

Credit Delivery Mechanism
49. In continuation of several initiatives taken, and keeping in view the recent developments in credit flows to different sectors, some specific measures are proposed as under:

(a) Priority Sector Lending

(i) Credit Facilities for Small Scale Industries

50. In the annual policy Statement of April 2002, the loan limit for dispensation of collateral requirement was increased from Rs.5 lakh to Rs.15 lakh. In order to further improve the flow of credit to small scale industries (SSIs), it is proposed that:

Banks may, on the basis of good track record and the financial position of the SSI units, increase the loan limit from Rs.15 lakh up to Rs.25 lakh (with the approval of their Boards) for dispensation of collateral requirement.

(ii) Deposits of Foreign Banks with SIDBI

51. At present, foreign banks are required to deposit an amount equivalent to the shortfall in their priority sector target with Small Industries Development Bank of India (SIDBI) at an interest rate of 6.75 per cent. In order to increase the flow of credit to SSIs and to rationalise the interest rates, it is proposed that:

The interest rate on the deposits of foreign banks placed with SIDBI towards their priority sector shortfall will be at the Bank Rate. SIDBI will take appropriate steps to ensure that priority sector funds are utilised expeditiously and benefits of reductions in interest rates passed on to the borrowers.

(iii) Lending by Banks to NBFCs

52. As indicated in the annual policy Statements of April 1999 and 2000, bank loans to non-banking financial companies (NBFCs) for the purpose of on-lending to agriculture, tiny sector and small road and water transport operators are reckoned under priority sector lending. On a suggestion from a Chamber of Commerce, and with a view to further enhancing the credit flow to SSI sector, it is proposed that: All new loans granted by banks to NBFCs for the purpose of on-lending to SSI sector would also be reckoned under priority sector lending.

(b) Advisory Committee on Flow of Credit to Agriculture and Related Activities

53. It has been the endeavour of RBI to improve the agricultural credit delivery mechanism by simplifying procedures, encouraging decentralised decision-making and enhancing competition. In order to progress further in meeting the credit needs of the agricultural sector, it is proposed to constitute an Advisory Committee to suggest short-term and medium-term measures to enhance credit flow to this sector. While assessing the progress made in implementation of Vyas Committee, the Committee would, inter alia, look into the role of National Bank for Agriculture and Rural Development (NABARD) in the development of the sector; the present structure and deployment of rural infrastructure development fund (RIDF); role of RRBs; and incentive and attitudinal aspects of credit delivery. It would suggest appropriate changes in the institutional and procedural arrangements for the smooth flow of credit to agriculture. The Committee is expected to address the issue of credit delivery to farmers, especially small farmers, tenants, labourers, supplies of inputs to agriculture and purchases of output. The Committee would explore the scope for involving innovative location-specific catalytic agents to bridge the gap between banking institutions and the demand for timely credit in rural areas, for investment in working capital and consumption smoothing. The Committee is also expected to help in capturing new technological developments in the cause of improving credit delivery.

(c) Working Group on Flow of Credit to SSI Sector

54. The small scale industries (SSI) sector occupies an important position in the Indian economy and provides employment and income generation. Keeping in view the credit needs of this sector, it is proposed to constitute a Working Group to assess the progress made in implementation of Kapur Committee and Gupta Committee recommendations and suggest ways to improve credit flow considering, in particular, the backward and forward linkages of this sector with large corporates. The Group will also look into methods of utilisation of priority sector shortfall deposits with SIDBI and suggest appropriate institutional arrangement for enhancing the credit delivery on a timely basis and in adequate measure to SSIs.

(d) Micro-finance

55. As indicated in the annual policy Statement of April 2003, RBI constituted four informal groups to examine various issues concerning micro-finance delivery. On the basis of the recommendations of the groups, it is proposed that: (i) banks should provide adequate incentives to their branches in financing the self help groups (SHGs) and establish linkages with them making the procedures absolutely simple and easy while providing for total flexibility in such procedures to suit local conditions; (ii) the group dynamics of working of the SHGs may be left to themselves and need neither be regulated nor formal structures imposed or insisted upon; (iii) the approach to micro-financing of SHGs should be totally hassle-free and may include consumption expenditures to enable smoothing of consumptions as needed relative to time-profile of income flows; (iv) NABARD should reinforce its commitment to maintaining and enhancing the flow to micro-finance while simplifying the process; and (v) NABARD should devise mechanisms to ensure sharing of experiences among the bank branches that are closely involved in extending micro-finance. (e) Survey on Kisan Credit Card (KCC)

(f) Infrastructure Financing

57. As indicated in the annual policy Statement of April 2003, on account of the high priority accorded by the Government to the infrastructure sector, RBI has taken a number of measures with a view to providing incentives to banks to increase their credit flow to the infrastructure sector. These measures have given the initial impetus to the infrastructure sector as evident from a sharp increase in flow of bank credit to this sector during this year. Though financing requirement is large, the long-term potential for larger investments and better credit-recycling would, no doubt, depend on commercial viability based on assured systems of cost recovery.

Money Market
58. A number of money market reforms were undertaken in recent years to preserve the integrity of the financial market and to enable a balanced development of various segments of the financial market. Some further steps in the implementation of measures already announced are now proposed:

(a) Moving towards Pure Inter-bank Call/Notice Money Market

59. Following the recommendations of Narasimham Committee II, in the annual policy Statement of April 2001, the intention to move towards a pure inter-bank call/notice money market by gradually phasing out the non-bank participation was announced. In the annual policy Statement of April 2003, daily lending of non-bank participants in call/notice money market was reduced from 85 per cent to 75 per cent.

In view of further market developments as also to move towards a pure inter-bank call/notice money market, it is proposed that: With effect from the fortnight beginning December 27, 2003, non-bank participants would be allowed to lend, on average in a reporting fortnight, up to 60 per cent of their average daily lending in call/notice money market during 2000-01. The time-table for further phasing out of non-bank participation will be announced in consultation with market participants.

60. In case a particular non-bank institution has genuine difficulty in developing proper alternative avenues for deployment of excess liquidity because of its size, RBI may consider providing temporary permission to lend a higher amount in call/notice money market for a specific period on a case-by-case basis.

(b) Rationalisation of Standing Facilities

61. Banks are eligible for standing facility (export credit eligible for refinance) and PDs are eligible for collateralised liquidity support from RBI subject to certain limits. These limits are split into normal facility and back-stop facility. With the emergence of the liquidity adjustment facility (LAF) as an effective instrument in modulating system liquidity, in the mid-term Review of October 2002, the apportionment between normal and back-stop facilities was changed to one-half each. In view of current liquidity conditions, the utilisation of these facilities by banks and PDs has been negligible. In order to move further towards phasing out sector-specific standing facilities as also to rationalise the rates at which liquidity is injected into the system, it is proposed that:

The normal and back-stop standing facilities will be available in a ratio of one-third to two-thirds (33:67) from the fortnight beginning December 27, 2003.

(c) Primary Dealers Access to Call/Notice Money Market

62. Following the annual policy Statement of April 2002, it was announced in July 2002 that access of PDs to borrow in call/notice money market would be gradually reduced in two stages subject to certain market developments. With a view to develop further the repo market as also to ensure a balanced development of various segments of money market, it is proposed that:

With effect from February 7, 2004 PDs will be allowed to borrow, on average basis in a reporting fortnight, upto 200 per cent of their net owned funds (NOF) as at end-March of preceding financial year.

63. Any PD which has genuine difficulties in adhering to the above schedule may approach RBI for appropriate reasonable dispensation with full justification for extension of period of compliance sought.