1.14 In recent years, the objective of industrial policy in India has been to infuse competitive efficiency into Indian industry while promoting its restructuring with a focus on core competencies, organisational change and a growing exposure to the cutting edge of international competitiveness.

1.15 The Competition Act, 2002 was enacted in December 2002 to promote competition through prohibition of anti-competitive practices and abuse of dominance and through regulation of companies beyond a particular size. This Act will replace the Monopolies and Restrictive Trade Practices Act, 1969 (MRTP).

1.16 A moderate rate structure and complete CENVAT chain to promote compliance and encourage modernisation in the textile sector is envisaged in the Union Budget, 2003-04. A special package for the power loom sector is likely to enlarge the Technology Upgradation Fund Scheme to cover the modernisation of the sector. The introduction of the revised Textile Sector Infrastructure Development Scheme is expected to improve working conditions, productivity and to provide insurance cover to weavers. A Centrally Sponsored Scheme ‘Apparel Parks for Exports Scheme’ was launched for setting up of apparel manufacturing units of international standards at potential growth centres. Under this scheme, nine Apparel Parks have been identified. A cluster-based approach to the implementation of schemes/ programmes in handlooms, powerlooms, sericulture and other decentralised industries has been adopted.

1.17 The Export Import (EXIM) Policy, 2003-04 exempted domestic sales undertaken by the units located in Special Economic Zones (SEZs) from levy of the 4 per cent special additional customs duty. Special purpose vehicles (SPVs) are proposed to be set up to develop industrial clusters. The SPVs, which have no identifiable revenue stream, will be funded entirely by the Central Government and beneficiaries. The SPVs are expected to create a world class physical infrastructure in industrial clusters with a high growth potential and convert static local efficiency into dynamic competitiveness. Ten industrial clusters would be selected under the Industrial Infrastructure Upgradation Scheme announced in the Exim Policy 2002-07. The cap on the number of investment companies being floated by companies would no longer apply to SPVs set up to route funds into new ventures.

1.18 De-reservation of 51 items for the small scale industries (SSI) sector was effected in May 2002. For technology upgradation and quality improvement in the SSI sector, the scope of the on going ISO 9000 reimbursement scheme was enlarged to include reimbursement of expenses for ISO 14001 Environment Standard with effect from October 28, 2002. The Union Budget for 2003-04 announced de-reservation of 75 items for the SSI sector. The de-reserved items include laboratory chemicals and reagents, plastic, leather and paper products. The Government raised the SSI investment limit on 10 drugs and pharmaceutical items from Rs.1 crore to Rs.5 crore in June 2003. The composite bank loan limit for SSI was raised from Rs.25 lakh to Rs.50 lakh in June 2003 to meet their term loan as well as working capital requirements.

1.19 Noteworthy changes in the policy environment are expected to provide a strong impetus for the development of the physical infrastructure. The Union Budget, 2003-04 envisages innovative funding mechanisms principally in respect of roads, railways, airports and seaports. The objective is to leverage public money through private sector partnership, wherever possible. In February 2003, the Reserve Bank allowed banks to finance promoters’ contribution to equity capital in infrastructure projects. Risk weight for the purpose of reckoning capital adequacy was halved to 50 per cent for core sector funding. This is applicable to banks’ investments in securitised paper pertaining to an infrastructure facility. These measures are expected to give a boost to core sector funding.

1.20 The Electricity Bill, 2003 was approved by Parliament in 2003. The Bill seeks to delicense power generation and to permit captive power plants. It would help to facilitate private sector participation in the transmission sector and would provide open access to the grid sector. In April 2003, the Union Cabinet approved a six level intervention plan for the power sector involving a financial assistance of Rs.40,000 crore to State Electricity Boards (SEBs) in the next five years for power distribution reforms. The intervention strategy would encompass initiatives at the national level, State level, SEB and utility level, distribution circle level, feeder level and the consumer level to focus on accountability, deliverability and performance at all levels. The Ministry of Power, the Reserve Bank and States entered into a tripartite agreement in March 2003 for a one-time settlement plan of dues of Rs.42,000 crore payable by SEBs to central public sector undertakings.

1.21 In the telecommunications sector, the monopoly of Videsh Sanchar Nigam Ltd (VSNL) over long distance telephony ceased with its privatisation in 2002. Policies for opening up of international long-distance telephony, setting up of Universal Service Obligation, permitting a fourth operator in the cellular mobile segment and commissioning of internet backbone were put in place. In the Union Budget, 2003-04 the benefit of tax holiday to the telecom and domestic satellite service companies was extended till March 31, 2004. In June 2003, the Department of Telecommunication notified changes in the licence conditions of the cellular and basic service operators to enable greater consolidation in the telecom sector through merger, de-merger and acquisition.

1.22 In the road sector, private parties were allowed to apply for tenders either singly or through a consortium restricted to four members. The Ministry of Road and Surface Transport has short listed 23 build, operate and transfer (BOT) projects under this new bidding process. Airport handling was opened to foreign direct investment up to 49 per cent.

1.27 The Union Budget for 2003-04 contains several measures to facilitate foreign trade, such as, reduction/ rationalisation of customs duties, simplification and modernisation of customs clearance procedures, and strengthening export infrastructure. The peak rate of customs duty has been reduced from 30 per cent to 25 per cent, excluding agriculture and dairy products.

1.28 The report of the Task Force on Indirect Taxes (headed by Dr. Vijay Kelkar) submitted to the Ministry of Finance in December 2002 contained various recommendations relating to Drawbacks, SEZs, EOUs and Advance Licensing Scheme. Some of the recommendations of the Task Force have been accepted and implemented by the Government, subsequent to the Budget announcements. These include acceptance of self-declaration certificate of non-availment of CENVAT credit for grant of drawback, release of an amount equivalent to all industry drawback entitlement in cases of shipments under brand rate of drawback, acceptance of exporters’ declaration regarding the weight of constituent material in case of composite item and payment of interest in cases of delayed sanction of drawback beyond one month.

1.29 Significant easing of payments restrictions were effected in respect of current and capital remittances abroad. Domestic entities were allowed to retain significant proportions of their earnings abroad to meet future foreign exchange requirements. Relaxations were effected in the movement of inward and outward capital flows in the form of foreign direct investment, foreign portfolio investment, NRI deposits and external commercial borrowings. Notable among them were:

• Norms on release of foreign exchange for purposes such as medical treatment abroad, private visits abroad, use of payment cards abroad, procurement of books and other items through internet liberalised including use of funds held in Non-Resident Ordinary (NRO) accounts for educational and medical purposes.

• Repatriation of proceeds from sale of immovable properties allowed after a minimum of 10 years lock in period and subject to annual limits and existing taxation. Repatriation of assets of foreign nationals and assets of non-resident Indians (NRIs)/persons of Indian origin (PIOs) by way of inheritance/legacy allowed up to a yearly limit.

• Up to 100 per cent of export earnings can be credited to Exchange Earners’ Foreign Currency Account (EEFC).

• Norms for prepayment of external commercial borrowings (ECBs) simplified.

• Foreign institutional investors (FIIs) allowed to hedge the market value of their entire investment in equity.

• Rules for issue of ADRs/GDRs simplified to allow sponsoring, listing on overseas exchanges, retention of proceeds abroad and free conversions and repatriability.

• Listed Indian companies permitted to invest in companies abroad under conditions; ceiling for mutual funds’ overseas investment raised to US $ 1 billion; banks’ investment abroad enhanced to 50 per cent of Tier I capital; improvement in the automatic route for Indian joint ventures/ wholly owned subsidiaries abroad.

• Resident individuals permitted to open domestic foreign currency accounts.

1.30 From September 2002 India became a member of the IMF’s Financial Transaction Plan (FTP) in view of its strong balance of payments and comfortable reserves. Effective participation in FTP would amount to India becoming a creditor member of the IMF. Depending on the extent of its participation in the FTP, India’s Reserve Tranche Position (RTP) in the Fund would increase on which the IMF would pay remuneration at market related rates. The IMF prepares a quarterly FTP indicating the expected total amount that all creditor countries may have to provide during any quarter. In the quarters September-November 2002 and December 2002-February 2003, planned transfers indicated in the FTPs were SDR 6.6 billion and SDR 6.0 billion. Actual transfers effected by all the creditors taken together were about SDR 1.8 billion and SDR 3.3 billion, respectively. In those two quarters, India was allocated SDR 156 million and SDR 128 million, respectively. Since actual transfers under the FTP were far less than the planned transfers, India was not required to effect any actual transfer during those two quarters. This situation changed in the subsequent quarters. India was allocated SDR 140 million under the FTP for March-May, 2003 quarter out of a total planned transfer of SDR 6.2 billion (by all creditor members) and was requested to effect an actual transfer to the IMF for the first time, amounting to SDR 5 million. For June-August 2003, India was allocated SDR 303 million out of a total planned allocation of 13 billion for all FTP members, and actual transfers effected by India during this period amounted to SDR 200 million.

1.32 The stance of fiscal policy set out in the Union Budget for 2003-04 was indicated in a renewal of commitment to five basic objectives ('Panch Priorities'): poverty eradication, infrastructure development, fiscal consolidation, development of agriculture including irrigation and enhancing manufacturing sector efficiency. The process of fiscal consolidation is being carried forward through tax reforms and progressive elimination of budgetary drags, including reform of the additional excise duty and expansion of service tax. Debt restructuring and the cash management as part of expenditure management are envisaged as integral elements of fiscal consolidation.

1.33 Cash management has been proposed to be initiated on a pilot basis in some major spending ministries so as to facilitate the release of budgetary allocations in a phased manner to permit convergence with the availability of resources within the year. Improvement in cash flow matching is expected to have salutary effects on expenditure management.

1.34 Debt restructuring would be undertaken on three fronts, viz., pre-payment of external debt, buy-back of illiquid high interest rate loans from banks, and allowing State Governments to swap high cost Central Government debt with lower cost new borrowings. With regard to external debt repayment, the Union Budget expressed the intention to continue with the policy of prudently managing external liabilities and proactively liquidating relatively higher cost components of the external debt portfolio. As regards domestic debt, Government would offer to buy back high interest loans from banks on an entirely voluntary basis. The buy back scheme would enable the banks to improve their liquidity position. Furthermore, better NPA management is being encouraged through tax incentives if the banks make profits from the buy back for provisioning. Under the debt-swap scheme between the Central Government and the States, all State loans from Government of India bearing coupons in excess of 13 per cent would be swapped over a three-year period ending in 2004-05. The States are expected to save an estimated Rs.81,000 crore in interest and deferred loan repayments over the residual maturity period of the loans. The scheme would also help restrain the debt build-up in States through the small saving schemes.

1.35 Tax reforms proposed in the Union Budget emphasise six important aspects: (i) Value Added Tax (VAT) for States; (ii) integration of services into the tax net; (iii) improvements in tax administration through greater application of information technology (IT); (iv) rationalisation of excise duties; (v) reduction in customs duty; and (vi) fiscal consolidation through expenditure reprioritisation and revenue augmentation.

1.36 Under direct taxes, measures taken to provide relief to taxpayers and to improve tax compliance include raising of standard deduction for salaried employees; relief to employees by exempting voluntary retirement scheme (VRS) payments from income tax up to Rs.5 lakh; rebate for education expenses up to Rs.12,000 per child for two children made eligible for rebate under Section 88 of the Income Tax Act; and tax rebate for senior citizens is increased to Rs.20,000, thereby making their income up to Rs.1.53 lakh fully exempt from income tax. For individuals, the surcharge is removed entirely; however, for incomes above Rs.8.5 lakhs, a 10 per cent surcharge on the tax has been imposed. On pension, the effective exemption limit becomes Rs.1.83 lakh per annum. The measures for simplification and rationalisation of tax regime include general deductions for individuals tax payers under section 80L on income from dividends, interest etc. up to Rs.15,000. In order in give a boost to investment, the corporate tax rate is left unchanged and the 5 per cent surcharge has been halved. The tax deductibility of interest on housing loans for construction or purchase of a self-occupied house property has been retained at Rs.1,50,000.

1.37 On the indirect tax front, rationalisation of excise rate structure and reduction of the multiplicity of rates are the main planks of tax reforms. In addition, more services have been put under the tax net and the general service tax rate has been enhanced from 5 per cent to 8 per cent. The peak rate of customs duty has been reduced to 25 per cent. In the case of excise duties, a three-tier excise duty structure - 8 per cent, 16 per cent and 24 per cent - has been implemented except for petroleum and tobacco products, pan masala and items attracting specific duty rates. The excise duty rate of 32 per cent, which applied to tyres, aerated soft drinks, polyester filament yarn, air-conditioners and motor cars has been reduced to 24 per cent.

1.38 With the objectives of minimising the cost of tax collection, encouraging voluntary compliance and to give better treatment to the existing taxpayers so as to encourage those outside the tax net to become taxpaying citizens, the budget announced certain measures to strengthen the tax administration, mainly drawing on the recommendations of the Kelkar Committee. Some of the principal measures announced in the budget are:

• outsourcing of non-core activities of the Income Tax Department;

• immediate abolition of present discretion-based system for selection of returns for scrutiny;

• expanding the scope of taxpayer services;

• direct crediting of all refunds to the bank account of the taxpayer through electronic clearance system,

• reduction in the compliance cost to the taxpayer - the Income Tax Act is being amended to enable electronic filing of returns; abolition of tax-clearance certificates for certain categories; and

• simplifying the procedures and methods employed during search and seizure, and during survey by the Income Tax department.

1.39 At present, primary health care, emergency life saving services, services under National Disease Control Programmes and National Family Welfare Programmes are being provided free of cost to all irrespective of their ability to pay. For a large majority of less advantaged citizens, however, access to good health services is still inadequate. In this regard, attempts are being made for utilisation of funds from Centrally Sponsored Schemes to improve functioning of primary health care institutions and minimise interState and inter-district differences.

1.40 A 100 per cent Centrally Sponsored Scheme called National Social Assistance Programme (NSAP) has been in existence since 1995 for providing social assistance benefit to poor households affected by old age, death of primary bread earner and maternity care. The programme has three components, viz., National Old Age Pension Scheme (NOAPS), National Family Benefit Scheme (NFBS) and National Maternity Benefit Scheme (NMBS). A scheme, viz., Annapurna was introduced on April 1, 2000, aimed at providing food security to meet the requirement of those senior citizens who though eligible for pensions under the National Old Age Pension Scheme, are not getting the same. Foodgrains are provided to the beneficiaries at subsidised rates of Rs.2 per kg of wheat and Rs.3 per kg of rice. The scheme is operational in 25 States and 5 Union Territories and more than 6.08 lakh families have been identified and are getting benefits of the scheme.

1.41 Public sector general insurance companies have been encouraged to design a community-based universal health insurance scheme during 2003-04. Under this scheme, a premium equivalent to Re.1 per day (or Rs.365 per year) for an individual, Rs.1.50 per day for a family of five, and Rs.2 per day for a family of seven will provide eligibility to get reimbursement of medical expenses up to Rs.30,000 towards hospitalisation, a cover for death due to accident for Rs.25,000 and compensation due to loss of earning at the rate of Rs.50 per day up to a maximum of 15 days. To make the scheme affordable to BPL families, the Government has decided to contribute Rs.100 per year towards their annual premium. In the first phase, at least an additional 50 lakh BPL families will be covered during 2003-04.

1.42 In order to provide relief to senior citizens and others, the Life Insurance Corporation of India (LIC) has introduced a special pension policy, following the announcement made in the budget, guaranteeing an annual return of 9 per cent in the form of a monthly pension scheme called Varishtha Pension Bima Yojana. Any citizen above the age of 55 years of age is eligible for the scheme which envisages a monthly return in the form of a pension for life. The difference between the actual yield earned by the LIC on the funds invested under the scheme and the assured return of 9 per cent, would be reimbursed to the LIC annually by the Government.

1.43 The 2001-02 budget had announced the restructuring of pensions for new Central Government employees and a scheme for the general public. The Union Budget, 2003-04 announced a new pension scheme, containing a basket of pension choices, which will be applicable to new entrants to Government service, except to the armed forces. The scheme will also be available, on voluntary basis, to all employers for their employees, as well as to the self-employed. The new scheme, when introduced, will be based on defined contributions and the contribution will be shared equally by the employees and the Government in case of Government employees. In case of individuals, who are not Government employees, there will be no contribution by the Government. The new pension scheme will allow transfer of benefits in case of change of employment, and will go into individual pension accounts with Pension Funds. The Ministry of Finance will oversee and supervise the Pension Funds through a new and independent Pension Fund Regulatory and Development Authority.

1.44 The monetary policy framework has undergone changes over the recent period in response to reforms in the financial sector and the growing external orientation of the economy. The endeavour of the policy has been to enhance the allocative efficiency of the financial sector, preserve financial stability and improve the transmission mechanism of monetary policy by moving from direct to indirect instruments. The stance of the monetary policy has been to ensure provision of adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on the movements in the price level, to continue with the present stance on interest rates including preference for softer interest rates and to impart greater flexibility to the interest rate structure in the medium-term.

1.45 Bank Rate changes, combined with CRR and repo rate changes, have emerged as important tools of liquidity and monetary management. The liquidity adjustment facility (LAF) has evolved as an effective mechanism for absorbing and/or injecting liquidity on a day-to-day basis in a more flexible manner and, in the process, providing a corridor for the call money market. In alignment with its accommodative stance in the context of stimulating industrial activity, a policy bias for soft interest rates and a flexible interest rate structure was indicated and in consonance, the CRR was reduced from 5.5 per cent to 5.0 per cent in June 2002, to 4.75 per cent in November 2002 and further to 4.5 per cent in June 2003, augmenting the lendable resources of banks by about Rs.13,500 crore. The Bank Rate and the LAF repo rate were reduced by 25 basis points each in October 2002 followed by a 50 basis point cut in the LAF repo rate on March 3, 2003. Comfortable liquidity conditions engendered by large capital inflows enabled a general reduction in market interest rates with varying sensitivity to policy signals across the maturity spectrum. Lending rates of banks exhibited, however, somewhat sluggish downward movements. The softening of interest rates was enabled by the benign inflation environment.

1.46 Monetary policy formulation for 2003-04 is based on conditional expectations of real GDP growth at about 6.0 per cent, inflation in the range of 5.0 to 5 per cent, projected expansion in broad money (M₃)at 14.0 per cent and non-food bank credit (including investments in commerical papers, shares/ debentures/ bonds of PSUs and private corporate sector) at 15.5-16.0 per cent. The overall stance of monetary policy for 2003-04 re-affirmed preference for a soft and flexible interest rate environment within a framework of macroeconomic stability and centred on a close monitoring of inflation. In pursuit of its stance, the Reserve Bank would continue to modulate market liquidity to meet the economy’s requirements of bank credit. The stance of monetary policy was indicated through a 25 basis point cut each in the Bank Rate and the CRR. The policy preference in regard to the Bank Rate is to keep it stable in the near-term. Measures were taken to increase the efficacy of LAF operations. This was accompanied by gradual phasing out of sector-specific refinance facility and rationalisation of interest rate structure at which liquidity is available from the Reserve Bank. Strengthening of credit delivery mechanisms continued to be a concurrent priority.

1.47 Strengthening of the financial sector and improving the functioning of the financial markets are the core objectives of financial sector reforms in India. The central plank of financial sector reforms is a set of prudential norms aimed at imparting strength to banks and financial institutions as well as inculcating greater accountability and market discipline. These norms include not only capital adequacy, asset classification and provisioning but also accounting standards, exposure and disclosure norms, investment and risk management as well as asset-liability management guidelines. The approach has been to benchmark the norms against international best practices. Financial sector reforms were carried forward during 2002-03 with the announcement of measures for streamlining banking operations, upgradation of risk management systems, operationalisation of consolidated accounting practices and enactment of a new Act to improve the recovery of non-performing loans.

1.48 The Reserve Bank’s approach to the institution of prudential norms has been one of incremental convergence with international standards and best practices. The internationally accepted 90-day norm for recognition of loan impairment would be applicable to commercial banks, co-operative banks and regional rural banks with convergence set for the year ending March 2004. For State Co-operative Banks and District Central Co-operative Banks, the convergence is set for the year ending March 2006. Beginning April 2002, banks began to move over to charging interest at monthly rests in order to achieve smooth convergence. The transition time for a sub-standard asset to be classified as a doubtful asset has been shortened from 18 months to 12 months with effect from March 31, 2005. The consequent additional provisioning is to be phased over a four-year period with a minimum of 20 per cent each year. The Reserve Bank participated in a Quantitative Impact Study (QIS) conducted by the Basel Committee to assess the impact of the new Capital Accord. A broader internal process of preparing banks for the complexity of the new Accord and the costs involved in adherence is also underway. The Reserve Bank forwarded its comments on the Third Consultative Paper of the New Basel Capital Accord to the Basel Committee of Banking Supervision in July 2003. The Reserve Bank has emphasised the need to take into account the structural characteristics of different economies as also preserving the spirit of simplicity and flexibility to ensure universal application of the New Accord. India has also shared the international concern on money laundering and financing of terrorism. 'Know Your Customer' procedures have been put in place to prevent the misuse of the financial system.

1.49 In January 2002 banks were advised to build up Investment Fluctuation Reserve (IFR) of a minimum of 5 per cent of the investment portfolio within a period of 5 years. IFR should be computed with reference to investment in two categories, viz., ‘Held for Trading’ and ‘Available for Sale’. It is not necessary for banks to include the investment under ‘Held to Maturity’ category while computing IFR. IFR was treated as Tier II capital up to a maximum of 1.25 per cent of total risk-weighted assets. Effective from March 31, 2003 this ceiling was removed. For capital adequacy purposes, Tier II capital including IFR would be considered up to a maximum of 100 per cent of Tier I capital.

1.50 In adherence to the Core Principles of Banking Supervision, guidelines on country risk management and provisioning thereof were provided to banks to encourage internal assessment of country risk. These guidelines are applicable only in respect of countries where a bank has net funded exposure of two per cent or more of its total assets. Depending on the risk category of the country of exposure, banks were directed to make provisions, with effect from the year ended March 31, 2003, on the net funded country exposures on a graded scale ranging from 0.25 to 100 per cent. Provisions held for country exposures are allowed to be treated on par with the ‘provisions held for standard assets’ for being reckoned for Tier II capital, subject to the ceiling of 1.25 per cent of the risk weighted assets.

1.51 Subordinated debt issued by banks in the nature of unsecured redeemable bonds currently qualify for inclusion in Tier II capital. Banks were able to utilise long-term resources raised from the market through subordinated debt to enable them to realign their portfolios for asset-liability management.

1.52 Several measures were taken to strengthen the financial position of the urban co-operative banking sector by extending the capital adequacy standards to urban co-operative banks (UCBs), prescribing an asset-liability management framework for the scheduled UCBs, enhancing the proportion of holding of Government and other approved securities by UCBs for the purpose of SLR, besides restriction on bank finance against the security of corporate shares and debentures.

1.53 Management and internal control systems are weak areas in the functioning of UCBs. New urban banks are required to have at least two Directors with requisite professional qualifications or adequate experience in banking. This requirement was extended to the existing UCBs as well. It has been proposed to impose a complete ban on advances by UCBs to Directors and their specified relatives and to concerns in which the Directors are interested effective October 1, 2003. UCBs which have fully/partially computerised their operations are required to introduce an electronic data processing (EDP) audit system and set up audit committee of the Board for overseeing and providing directions to internal audit/inspection machinery of the UCB. The Audit Committees would examine and follow up observations and suggestions made in the Reserve Bank’s inspection report and Statutory Audit reports.

1.54 A broad framework has evolved for the management of NPAs under which a menu of options are provided for debt recovery and restructuring. Banks and financial institutions have the freedom to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements. The menu of options available to banks included: (a) reschedulement/restructuring done at bank level; (b) reschedulement/restructuring done through the corporate debt restructuring (CDR) mechanism; (c) resolution/recovery through Lok Adalats, civil courts and debt recovery tribunals (DRTs); (d) compromise settlement as per management’s own schemes and the Reserve Bank’s guidelines for public sector banks; (e) sale of assets to reconstruction companies/ securitisation companies and (f) recovery through powers available under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

1.55 The quality and performance of advances have a direct bearing on the profitability and viability of banks. While several measures have been undertaken towards preventing the accumulation of non-performing loans, in the absence of creditor rights, the problem has persisted, despite the credit appraisal and disbursement mechanism in place. To address this aspect, the final guidelines and directions on SARFAESI Act issued in April 23, 2003 cover all aspects relating to asset reconstruction and securitisation. These include, inter alia, registration, owned funds, permissible business, operational structure for giving effect to the business of securitisation and asset reconstruction, deployment of surplus funds, internal control systems, prudential norms and disclosure requirements for asset reconstruction/securitisation companies. The Act empowers secured creditors to enforce any security interest created in its favour without any intervention of court or tribunal. The secured creditor may require the borrower to discharge the liabilities within a stipulated time frame from the date of notice, failing which the secured creditor is entitled to take possession or management of the secured assets. In addition to the guidelines and mandatory directions, the Reserve Bank also issued guidance notes of recommendatory nature covering aspects including acquisition of assets and issue of security receipts. It is envisaged that banks would be able to sell their non-performing loans (NPLs) to securitisation/ reconstruction companies at a considerable discount and the resultant shortfall, if any, in the net book value (total assets of banks less provisions held), would be required to be debited to the profit and loss account. Banks were accordingly advised to build up provisions, significantly above the minimum regulatory requirements for their NPAs, particularly for those assets which they propose to sell to securitisation/ reconstruction companies.

1.56 Yet another opportunity was provided to borrowers for compromise settlement of chronic NPLs of public sector banks/ FIs up to Rs.10 crore. Fresh guidelines were issued which provide a simplified, non-discretionary and non-discriminatory mechanism for compromise settlement of chronic NPLs. Public sector banks were directed to uniformly implement these guidelines in order to achieve maximum realisation of dues from the stock of NPLs. The processing under the revised guidelines would have to be completed by December, 2003.

1.57 Banks were advised to consider introduction of a new asset category of 'special mention accounts' in between 'standard' and 'sub-standard' accounts for their own internal monitoring and follow-up for assets with potential weaknesses which deserve close attention for resolution through timely remedial action.

1.58 The limitations of traditional supervisory practices in the swiftly changing financial environment has provoked supervisors the world over to continuously refine their approaches in consonance with advances in technology, innovations and globalisation. The Reserve Bank’s move towards risk-based supervision (RBS), which entails the allocation of supervisory resources and focus in accordance with risk profiles, is part of a forward-looking refinement of the supervisory function which will help in aligning supervised institutions with the New Basel Capital Accord when it is adopted. Drawing on assistance from international consultants and a study of the country-specific requirements as well as the cross-country experience, management processes were initiated in 2002-03 for a smooth switchover to RBS. They covered a discussion paper and analysis of responses thereon, risk profiling, preparation of manuals, training and other requirements. RBS was introduced during April-June 2003 for a few select banks on a pilot basis. Based on the experience gained, RBS would be extended to all banks in a phased manner.

1.59 The scheme of prompt corrective action (PCA), developed as a tool with trigger points for prompt supervisory response was put in place in December 2002 initially for a period of one year. The PCA framework includes structured action by the Reserve Bank when banks hit the trigger points (capital adequacy, NPAs, return on assets). It does not, however, preclude other discretionary corrective steps by the Reserve Bank.

1.60 As a step towards consolidated supervision, guidelines were issued to banks on consolidated accounting and quantitative methods for compliance from the year ended March 31, 2003. Initially, consolidated supervision would be mandated for all groups where the controlling entity is a bank. Over time, entities in mixed conglomerates would be brought under its purview. A critical requirement for supervised entities would be the setting up of appropriate management information systems (MIS) to support compliance with the consolidated accounting and reporting requirements.

1.61 The Reserve Bank, in its endeavor to ensure convergence of its supervisory norms and practices with the international best practices and to align standards adopted by Indian banks with the global standards, constituted a Working Group to eliminate/ reduce gaps in compliance with the Accounting Standards issued by the Institute of Chartered Accountants of India. Based on the recommendations of the Working Group in respect of certain Accounting Standards where there were gaps in compliance, detailed guidelines were issued to banks.

1.62 To enable the regulated entities to manage their exposure to interest rate risk, scheduled commercial banks (excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs), Primary Dealers and specified All India Financial Institutions were allowed to deal in exchange traded interest rate derivatives. In the first phase, these entities are allowed to transact only in interest rate futures on notional bonds and Treasury Bills for the limited purpose of hedging the risk in their underlying investment portfolio.

1.63 Other supervisory initiatives during the year included development of macro-prudential indicators, managing the transition to risk-based internal audit, and computer and information systems audits for inspection in a computerised environment.

1.64 With a view to strengthening supervision of UCBs, the Reserve Bank introduced a system of off-site surveillance. A new system of grading UCBs based on their level of capital to risk weighted assets ratio (CRAR), level of net non perfroming loans (NPLs), record of losses and compliance with liquidity requirements was introduced. A system of supervisory rating for urban co-operative banks under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Systems) model is envisaged. In order to bring transparency in their balance sheets effective from the year ending March 31, 2003 all urban co-operative banks with deposits of Rs.100 crore and above are required to disclose in notes to their accounts additional specified information. They should also indicate the position of payment of deposit insurance premium to the Deposit Insurance and Credit Guarantee Corporation (DICGC) in their Directors’ Report.

1.65 Considerable progress has been made in consolidating the existing payment systems and in upgrading technology with a view to establishing an efficient, integrated and secure system functioning in a real-time environment. Major projects under implementation are electronic clearing, centralised funds management, structured financial messaging solutions and the Indian Financial Network (INFINET). Facilities under Electronic Funds Transfer (EFT) have been upgraded and their spatial reach expanded with multiple settlements in a day. Foreign exchange clearing has been initiated through the Clearing Corporation of India Limited (CCIL). Adequate security features are being incorporated into the EFT. Preparatory work for the real time gross settlement (RTGS) is complete. The live run of RTGS is scheduled towards the end of 2003.

1.66 A number of steps were taken during 2002-03 to ensure balanced development of various segments of the financial market with a forward-looking perspective. The Reserve Bank’s endeavour has been to develop a competitive and diversified financial market structure catering to various classes of instruments and participants of varying risk profiles, and with different market segments merging seamlessly into a continuum. A key priority is the development of the technological and institutional infrastructure for efficient financial intermediation.The operationalisation of the CCIL and the negotiated dealing system (NDS), introduction of collateralised borrowing and lending obligation (CBLO), collateralised repo transactions and interest rate options would increase the depth of the financial markets and prepare them for the operationalisation of RTGS.

1.67 A basic objective of money market reforms in the recent years has been to facilitate the introduction of new instruments and their appropriate pricing under orderly market conditions. A crucial prerequisite in this regard is the development of market segments which exclusively deal in specific assets and liabilities as well as participants. Accordingly, the call/notice money market is being transformed into a pure inter-bank market. Systemic stability is being ensured through prudential limits on exposures to the call money market. This was supported during 2002-03 through the rationalisation of standing liquidity support to banks from the Reserve Bank and facilities for exceptional liquidity support.

1.68 Initiatives for developing and deepening the government securities market were carried forward alongside a strengthening of regulation and surveillance. An enabling environment for proper investment planning by market participants was fostered by transparent dissemination of prospective issuances of government securities, introduction of new instruments to deal with risks associated with unanticipated market movements, and institution of anonymous screen-based order-driven trading in government securities on the stock exchanges.

1.69 Orderly development of the foreign exchange market was pursued in the form of easing of entry restrictions, expanding the freedom of market participants and by creating greater space for the market in general by ongoing liberalisation of international current and capital transactions. Authorised dealers (ADs) in foreign exchange were allowed to offer foreign currency – rupee options and to undertake swaps with residents with unlimited hedging of exchange risk. Forward cover was allowed in respect of a number of capital transactions with greater freedom in the booking of forward contracts.

1.70 Policies for the capital market during 2002-03 were directed towards enhancing market efficiency and achieving better investor protection through greater transparency and improved trading and settlement systems. Important legislative changes with far reaching implications for the functioning of the capital market were initiated by the Government of India. The Securities and Exchange Board of India (SEBI) was vested with search and seizure powers in cases relating to insider trading and market manipulations. The penalties to be imposed by the Adjudicating Officer were enhanced so as to serve as effective deterrents. The Companies (Second Amendment) Act, 2002 was enacted to provide for a new, modern, efficient and time-bound insolvency law for both rehabilitation and winding up of sick companies within a maximum time frame of two years.

1.71 The SEBI introduced compulsory rolling settlement on a T+3 basis effective April 1, 2002. The settlement cycle was further shortened to T+2 basis effective April 1, 2003 with a view to reducing risks in the market and protecting the interest of investors, in line with the international best practices.

1.72 The SEBI accepted the recommendations of the Group on Corporatisation and Demutualisation of Stock Exchanges which recommended, inter alia, a uniform model of corporatisation and demutualisation to be adopted for all stock exchanges. With the issue of the SEBI (Central Listing Authority) Regulations, 2003 and formation of Central Listing Authority (CLA), companies are now required to obtain recommendation from the CLA prior to their listing in stock exchanges. The existing list of stocks on which derivatives are traded was enlarged. With a view to developing the derivatives market further, interest rate derivatives were introduced on National Stock Exchange (NSE) with effect from June 24, 2003. Initially, the contracts have been introduced on a notional Government Security with a 10 year maturity and a Notional Treasury Bill with a maturity of 91 days or three months which would be cash settled. The SEBI put in place the risk containment measures to be adopted for such derivatives contracts. With a view to obviating the need for manual entry and re-entry of data on trade particulars which is time consuming and prone to errors, the Straight Through Processing (STP) for electronic trade processing with a common messaging standard was introduced. Based on the recommendations of the Bhagwati Committee, the SEBI made certain amendments to the Takeover Regulations which include inter alia removal of automatic exemption for acquisition through preferential allotment, increased frequency in disclosure of shareholding when it crosses 5 per cent, 10 per cent and 14 per cent. In order to enable the retail investors to participate in trading in government securities, the screen-based retail trading in government securities was launched on January 16, 2003. With this initiative, a major segment of the Indian fixed income securities market, which until recently was dominated by the wholesale investors like banks and insurance companies, was made accessible to the retail investors.

1.73 As part of the broader set of reforms aimed at improving the functioning of the securities market, the SEBI has initiated several measures to improve information flow from listed companies. It has also been the endeavour of SEBI to improve corporate governance practices for listed companies so as to infuse a sense of discipline and accountability in the Indian corporate sector.

1.74 During 2002-03, the SEBI amended the Listing Agreement to tighten disclosure norms for companies opting to publish audited results for the entire year within three months instead of publishing unaudited results for the last quarter within 30 days. Norms with regard to disclosure by listed companies in respect of loans/advances and investments, disclosure of audit qualifications and actions thereon, were strengthened. A clause was incorporated in the Listing Agreement requiring the companies to furnish statements and reports for the Electronic Data Information Filing and Retrieval (EDIFAR) system maintained by SEBI.

1.75 Various measures have been undertaken to improve the operations and governance of mutual funds. These include, inter alia, disclosure of performance of benchmarks, guidelines for valuation of unlisted equity shares, distribution of realisation from non-performing or illiquid assets to old investors after redemptions, emphasis on following the code of conduct and insider trading regulations, uniformity in calculation of sale and repurchase price, increasing the frequency of meeting of trustees, guidelines on risk management norms, increase in the investment limit on foreign securities and mandatory registration of intermediaries engaged in selling and marketing of mutual funds units.