• GDP growth for 2004-05 projected at 6.5-7.0 per cent.
• Assuming no significant supply shocks and appropriate management of liquidity, the inflation rate projected for policy purposes at around 5.0 per cent during 2004-05.
• Growth in reserve money and Money supply (M₃) were higher during 2003-04 reflecting capital inflows; the expansionary impact of foreign currency assets, however, was neutralised to a large extent by substantial open market operation (OMO) including sustained repo operations under LAF.
• Sustained pick-up in non-food credit since September; total flow of resources to the commercial sector was higher than last year.
• Government market borrowing programme in 2003-04 completed at a much lower cost; while noting reduction in fiscal deficit, need to step up capital expenditure stressed.
• Further reduction in interest rates in money and government securities markets observed in 2003-04.
• Public sector banks have reduced their BPLR in the range of 25-100 basis points.
• RBI to continue with its policy of active liquidity management; Market Stabilisation Scheme (MSS), is an additional tool.

• Global economic recovery has broadened and strengthened faster than expected despite some uncertainties.
• The exchange rate of the rupee appreciated vis-à-vis US dollar but depreciated against the Euro, Pound sterling and Japanese yen in 2003-04.
• India’s foreign exchange reserves increased by US $ 37.6 billion during fiscal 2003-04 and are at US $ 118.6 billion by May 7, 2004.
• India’s exports in US dollar terms increased by 17.1 per cent while imports by 25.3 per cent; the current account expected to register surplus during 2003-04 for the third year in succession.
• Exchange rate management, as in the past, based on flexibility, without a fixed or pre-announced target, but with ability to intervene.
• The most distinguishing feature of the external sector during 2003-04 relates to the large capital flows with its inevitable implications for the conduct of domestic monetary policy and exchange rate management.

• Despite uncertainties, India’s position among the top performers globally in terms of GDP growth is expected to continue during 2004-05.
• As regards prices, despite overhang of problems on account of oil prices and large domestic liquidity, price situation unlikely to cause concern to macro stability during 2004-05.
• Need to overcome the bottlenecks in flow of bank credit to agriculture and small & medium enterprises emphasised.
• Restructuring of rural banking sector stressed for enhancing the quality, purposiveness and reach of banking in India.
• Whereas the Reserve Bank will continue to provide a policy environment that avoids excessive and destabilizing volatility as a public good, market participants were urged to take into account the portfolio risks arising from any unexpected developments and provide adequately for them.
• The outlook for the external sector accords comfort to the conduct of public policies.

• Monetary management during 2003-04 broadly in conformity with the stance of the policy set out for the year.
• Projected expansion of money supply (M₃) at 14.0 per cent with credit growth by 16.0-16.5 per cent during 2004-05.
• Noticeable uncertainties including geopolitical risks impacting on international oil economy reckoned while designing the stance of monetary policy. As such, the inflationary situation needs to be watched closely and there could be no room for complacency on this count.
• The overall stance of monetary policy for 2004-05 will be: (i) provision of adequate liquidity to meet credit growth and support investment and export demand while keeping a very close watch on the movements in the price level. (ii) Consistent with the above, while continuing with status quo, RBI to pursue an interest rate environment that is conducive to maintaining momentum of growth and, macroeconomic and price stability.

• Bank Rate kept stable at 6.0 per cent.
• Repo Rate unchanged at 4.5 per cent.
• Revised LAF scheme operationalised.
• The entire export credit refinance was made available at reverse repo rate.
• Almost all banks have adopted the new system of BPLR and the rates are lower from their earlier PLRs.
• Banks are encouraged to align the pricing of credit to assessment of credit risk to improve credit delivery and credit culture.
• RBI accepted some recommendations of the interim Report of Vyas Committee for implementation, e.g., loans for storage facilities under priority sector, securitised agricultural loans as priority sector lending, waiving margin/security requirements for certain agricultural loans up to a limit, NPA norms for crops loans aligned to crop seasons.
• Development of mechanism for debt restructuring for medium enterprises on the lines of corporate debt restructuring.
• Definition of infrastrucutre lending broadened.
• Working Group constituted on Credit Enhancement by State Governments for financing infrastructure.
• A Gold Card Scheme for creditworthy exporters drawn up.
• Various restructuring options being considered by the Government and other stakeholders for rationalising the structure of RRBs - Vyas Committee is also looking into restructuring of RRBs.
• Limit on the lending of non-bank participants in the call/notice money market reduced to 45 percent effective June 26, 2004.
• Automated value-free transfer of securities proposed between market participants and the CCIL under CBLO.
• RBI constituted Working Group to review the performance of negotiated dealing system (NDS).
• Clearing of OTC derivatives through CCIL being considered.
• CCIL to work out arrangement for settlement of trades in non-SLR debt instruments for NDS members.
• Discussion paper on Capital Indexed Bonds being put in public domain.
• The ECB limit already enhanced to US $ 500 million under the automatic route for investment in the real sector.
• Resident individuals already permitted to remit freely up to US $ 25,000 per calendar year.
• Indian corporates and partnership firms allowed to invest overseas upto 100 per cent of their net worth.
• Banks allowed to raise long-term bonds to finance infrastructure.
• The extant limit on unsecured exposures for banks withdrawn.
• Exposures on all public financial institutions (PFIs) to attract a risk weight of 100 per cent.
• Banks required to maintain capital charge for market risk in a phased manner.
• Banks to draw a road map for migration to Basel II.
• Banks to make higher provisioning according to the age of NPAs.
• Banks/FIs to provide credit information to CIBIL.
• Banks to fully adhere to the KYC policy for opening new accounts.
• Report of the Working Group on Financial Conglomerates is being put in public domain.
• Risk based supervision extended to more banks.
• Fresh licences to UCBs only after a comprehensive policy.
• Report of the Working Group on Development Finance Institutions is being put in public domain.
• Technical Group to evaluate the regulatory and supervisory systems deployed by refinancing institutions (RFIs).
• Waiver of service charges on banks for electronic funds transfer and electronic clearing services.
• RBI sets up a Board for Payment and Settlement Systems.
• RBI expects most commercial banks to join the RTGS system by June 2004.
• A Working Group on Electronic Funds Transfer for Capital Market constituted.
• Single window services for all transactions in RBI cash department.
• Operationalisation of On-line Tax Accounting System by June 2004.
• Standing Committee on Procedures and Performance Audit on Public Services has submitted four Reports, being put in the public domain.
• The recommendations of the Advisory/Technical Groups on International Financial Standards and Codes are being pursued.

Dr. Y.Venugopal Reddy, Governor, in a meeting with Chief Executives of major commercial banks today presented the annual policy Statement for 2004-05. At the outset, Governor mentioned that the Statement follows the pattern already set in the previous years. Broadly, the Statement covered a review of macroeconomic and monetary developments with several analytical and structural issues concerning financial sector and monetary policy. It delineated and elaborated on various areas in which RBI has been taking measures from time to time and provided a focus on broad policies that are intended to be pursued for the year 2004-05, while retaining the flexibility to take specific measures promptly and effectively as the evolving circumstances warrant. He announced a number of measures for strengthening the financial system, improving the credit delivery mechanism and indicated measures addressing institutional improvements to support growth consistent with stability in a medium-term perspective. He also underscored the need to deepen the consultative process to achieve further social good.

Reviewing GDP growth for 2003-04, Governor said that the advance estimate released by the CSO in February 2004 has placed the GDP growth much higher at 8.1 per cent as against 4.0 per cent in the previous year reflecting, inter alia, a rebound in agricultural production.

The annual inflation rate as measured by variations in the wholesale price index (WPI), on a point-to-point basis, declined from 6.5 per cent at end-March 2003 to 4.5 per cent by end-March 2004. The annual rate of inflation during 2003-04, on an average basis, was, however, higher at 5.4 per cent as compared with 3.4 per cent in the previous year. The point-to-point inflation declined to 4.2 per cent as on May 1, 2004 as compared with 6.9 per cent a year ago. On an average basis, it was 5.2 per cent as compared with 3.9 per cent.

Referring to monetary developments, Governor said that money supply (M₃) increased by 16.4 per cent during 2003-04 as compared with 12.8 per cent in the previous year, net of mergers. The growth in aggregate deposits of scheduled commercial banks at 17.3 per cent was higher than that of 13.4 per cent in the previous year, adjusted for mergers. The increase in reserve money during 2003-04 at 18.3 per cent was higher than that of 9.2 per cent in the previous year essentially because RBI’s foreign currency assets increased by Rs.1,41,428 crore on top of an increase of Rs.82,089 crore in the previous year. The expansionary impact of foreign currency assets was neutralised to a large extent by substantial OMO including sustained repo operations under LAF. As per the latest data, year-on-year increase in reserve money was 13.3 per cent, as on May 7, 2004 as compared with 8.9 per cent a year ago.

Non-food credit increased by 17.6 per cent during 2003-04 led by the housing and retail sectors as compared with an increase of 18.6 per cent, net of mergers, in the previous year. According to the latest data, the year-on-year increase in non-food bank credit was 20.5 per cent by end-April 2004 as compared with 16.4 per cent a year ago.

Governor stated that the Central Government revised the net market borrowings downwards in the Interim Budget to Rs.82,982 crore as against the originally budgeted net borrowings of Rs.1,07,194 crore. During 2003-04, the combined net market borrowings of the Centre and States were Rs.1,35,192 crore (gross Rs.1,98,157 crore). The weighted average cost of Central Government borrowings through dated securities declined from 7.34 per cent in 2002-03 to 5.71 per cent during 2003-04. The weighted average maturity of dated securities issued during 2003-04 at 14.94 years was higher as compared with 13.83 years in the previous year. During 2003-04, the state governments’ net market borrowings at Rs.46,376 crore were significantly higher than in the previous year (Rs.30,933 crore) mainly on account of Rs.26,623 crore towards the debt swap scheme mutually agreed between the Central Government and state governments towards repayment of high cost debt of the States to the Centre.

Governor observed that the banking system already holds government securities to the extent of 41.5 per cent of its net demand and time liabilities which entail significant interest rate risk as the yields on government securities are already at their historically low levels. It is, therefore, essential to pursue fiscal consolidation, promptly and with resolve, from a medium-term perspective.

Interest Rates

Governor observed that interest rates have softened further in the system. The weighted average call money rate declined from 5.86 per cent in March 2003 to 4.37 per cent in March 2004 and further to 4.28 per cent by mid-May 2004. Similarly, the cut-off yields on 91-day and 364-day Treasury Bills also declined from 5.89 per cent each in March 2003 to 4.42 per cent and 4.45 per cent, respectively, as on May 12, 2004. The yields on government securities with 1-year residual maturity declined by 96 basis points from 5.50 per cent to 4.54 per cent over the period. The yields on 5-year and 10-year residual maturities declined from 5.92 and 6.21 per cent in March 2003 to 4.87 and 5.20 per cent, respectively, by mid-May 2004. The term deposit rates of public sector banks for maturities up to 1-year moved down from a range of 4.00-6.00 per cent in March 2003 to 3.75-5.25 per cent by April 2004. Overall, Governor noted that there has been a considerable flattening of the term structure of deposit rates.

Governor stated that almost all commercial banks have announced their BPLR in place of the earlier system of tenor-linked PLR. Public sector banks have reduced their rates by 25 to 100 basis points while announcing their BPLR. The range of BPLR for public sector banks is lower at 10.25-11.5 per cent. The compression in the range of PLRs of foreign and private sector banks is more evident.

As at end-March 2004, public sector banks’ median (representative) lending rate for demand and term loans (at which maximum business is contracted), in the range of 11.0-12.75 per cent and 11.0-13.25 per cent, respectively, exhibited some moderation as compared with their corresponding levels of 11.5-14.0 per cent and 12.0-14.0 per cent, respectively, in March 2003.

Tracing the movement in interest rates during 2003-04, Governor exhorted bankers to take steps to build up investment fluctuation reserves (IFR) in a smooth and phased manner for better risk management.

Considerable progress has been made in developing the Indian banking sector into a vibrant, sound and well-functioning system. The Reserve Bank’s persistent efforts towards strengthening of regulatory and supervisory norms to induce greater accountability and market discipline amongst the participants, adoption of international benchmarks as appropriate to Indian conditions, improvement in management practices and corporate governance, and upgradation of the technological infrastructure have enabled the banking system to emerge as a stronger, efficient and resilient system to meet global competition. While certain changes in the legal infrastructure are yet to be effected, the developments so far have brought the Indian financial system closer to global standards.

Referring to the dynamics of monetary management in an increasingly open economy which was clearly evident during 2003-04, Governor said that even when the domestic interest rates remained consistent with domestic inflation, it engendered large capital flows in the wake of expectations over promising economic gains. Substantial liberalisation of capital and current account transactions further reinforced capital inflows, he added. However, he assured bankers that in order to ensure that appropriate liquidity is maintained in the system, RBI will continue with its policy of active management of liquidity through OMO including LAF, and using other policy instruments. The operationalisation of Market Stabilisation Scheme (MSS) has given an additional instrument for liquidity and monetary management.

Governor said that according to the latest update on world economy in April 2004 by the IMF, the world output growth for 2004 was placed higher at 4.6 per cent and at 4.4 per cent for 2005. He noted that the global economic recovery has broadened and strengthened faster than expected last November. He also noted that, in recent years, emerging markets have been major drivers of growth. However, he cautioned that several uncertainties still persist, which include firmness in global oil prices, volatility among major currencies and cyclical factors arising out of a pick-up in economic activity.

Drawing the attention of bankers to the possible global implications of interest rate uncertainties, the volatility among major currencies and their impact on capital flows and on the financial sector, Governor said these issues would remain the major concern for the emerging economies.

Governor noted that during 2003-04, the Indian foreign exchange market witnessed orderly conditions despite payments of US $ 5.2 billion in October 2003 on account of redemption of Resurgent India Bonds. The exchange rate of the rupee at Rs.47.50 per US dollar in March 2003 appreciated by 9.5 per cent to Rs.43.39 per US dollar by March 2004, but depreciated by 3.1 per cent against the Euro, 5.9 per cent against Pound sterling and 4.4 per cent against Japanese yen during the period.

Governor said RBI’s policy to build a higher level of foreign exchange reserves takes into account anticipated current account deficits and 'liquidity at risk' arising from unanticipated capital movements and added that India’s foreign exchange reserves increased by US $ 37.6 billion from US $ 75.4 billion at end-March 2003 to US $ 113.0 billion by end-March 2004 and further to US $ 118.6 billion by May 7, 2004. Governor emphasised that exchange rate management was based on flexibility without a fixed target or a pre-announced target or a band with ability to intervene.

During 2003-04, India’s exports in US dollar terms increased by 17.1 per cent as compared with 20.3 per cent in the previous year. Imports showed a higher increase of 25.3 per cent as compared with 17.0 per cent in the previous year.

The current account of the balance of payments, which had remained in surplus consecutively in the previous two years, showed a surplus of US $ 3.2 billion during April-December 2003. The net accretion to foreign exchange reserves, including valuation changes, amounted to US $ 26.4 billion during April-December 2003. Going by current indications, India would register a current account surplus during 2003-04 for the third year in succession.

The most distinguishing feature of the external sector during 2003-04 relates to the large capital flows with its inevitable implications for the conduct of domestic monetary policy and exchange rate management. Delving at length on the various modes of policy intervention (categorised as market based vs non-market based), their pros and cons, Governor said that the primary objective of the monetary authorities in this context is to offset the impact of such foreign exchange market intervention, partly or wholly, so as to retain the intent of monetary policy. The degree of impact of such flows on domestic monetary policy, however, depends largely on the kind of exchange rate regime that the authorities follow. While in practice, the central banks do intervene in the forex markets in all countries, in emerging markets, a more intensive approach to intervention may be warranted in the context of large inflows. He also added that the key issue before the monetary authority is to determine whether the capital inflows are of a permanent and sustainable nature or whether such inflows are temporary and subject to reversal. In practice, however, such determination is difficult to achieve.

Stating that while OMO involving sale of securities as the commonly used instrument of sterilisation, he cited the availability of several other instruments to offset the impact of capital inflows on domestic money supply. Among the other important policy responses that can be used to manage large capital inflows are trade liberalisation, investment promotion, liberalisation of the capital account, management of external debt, management of non-debt flows, taxation of inflows and use of foreign exchange reserves.

Governor said that the recent movement of the exchange rate of the rupee has drawn attention to the external competitiveness of the economy and hence, a reference to the real effective exchange rate (REER) is appropriate and added that REER may not be relevant for day-to-day operations of RBI, but it cannot be ignored when considered in the medium to longer-term.

From an overall policy perspective and a qualitative assessment of major developments during the fiscal year 2003-04, Governor observed that assuming normal monsoon conditions, in spite of several uncertainties especially in the global economy, and unless there are totally unanticipated shocks, there are reasons to expect that in terms of growth in GDP in 2004-05, India will continue to be among the top performers globally.

On the price situation, Governor observed that there is an overhang of problems on account of oil prices and large domestic liquidity. However, in view of India’s proven resilience to shocks, reasonable levels of food stocks coupled with prospects for a good monsoon, and the comfortable foreign exchange reserves, the price situation during 2004-05 is unlikely to cause concern to macro stability; but both on welfare considerations and impact on inflationary expectations, a very close watch is needed on the implications of global and other developments for India.

With regard to credit, Governor mentioned that there is a need for significant efforts to overcome the bottlenecks in flow of bank credit to agriculture and small & medium enterprises. Also, a step-up in investment activity in infrastructure would augment the prospects for credit off-take for productive sectors. He also indicated that the restructuring of Development Finance Institutions is under way and the contemplated restructuring of rural banking sector should help the process of enhancing the quality, purposiveness and reach of banking in India.

With regard to the global financial markets, Governor observed that the major issue that has now arisen for 2004-05 relates to the continuing macroeconomic imbalances in the United States, and their possible consequences on the rest of the world in addition to geopolitical uncertainties. These concerns include the impact on asset prices that could emerge internationally from any tightening of monetary policy that may take place in the coming months and on commodity prices, particularly oil. While the Reserve Bank will continue to provide a policy environment that avoids excessive and destabilising volatility as a public good, market participants are expected to take into account the portfolio risks arising from any unexpected developments and provide adequately for them. Further, the external sector has strengthened over the years. The outlook for the external sector accords comfort to the conduct of public policies.

Governor said that monetary management during 2003-04 was conducted broadly in conformity with the stance of the policy set out for the year and observed that the overall assessment of the developments during 2003-04 and the outlook for 2004-05, on a qualitative basis, provide grounds for optimism. He said that the stance of monetary policy will depend on several factors, and among them are: (a) prospects for the real sector, especially growth in GDP; (b) inflationary expectations; and (c) global developments. As regards GDP growth, he said that India may continue to be among top performers globally. For the purpose of monetary policy formulation, real GDP growth for 2004-05 may be placed in the range of 6.5 to 7.0 per cent, assuming sustained growth in the industrial sector, normal monsoon and good performance of exports. The realisation of such a rate of growth would signify a structural acceleration in growth rate of the economy. On the price situation, he observed that in view of the current trends, assuming no significant supply shocks and appropriate management of liquidity, the inflation rate in 2004-05, on a point-to-point basis, may be placed at around 5.0 per cent.

As regards the global developments, Governor said that the recovery appears more sustainable now and there is greater resilience in emerging economies. However, he noted that there are noticeable uncertainties and risks that should be reckoned with while designing the stance of monetary policy. In particular, the policy should take cognisance of the prospect that a significant trade deficit would continue with accelerated exports as well as imports, while recognising that its impact on the current account will, as in the past, be compensated by the remittances. The policy should also be prepared for the persistence of large capital flows.

Consistent with the real growth of GDP and inflation, the projected expansion of money supply (M₃) and aggregate deposits of scheduled commercial banks for 2004-05 are placed at 14.0 per cent and 14.5 per cent, respectively. Taking into account the market borrowings programmes of the Centre and State Governments, RBI expects to conduct debt management without serious pressure on overall liquidity and interest rates within the monetary projections for 2004-05.

In sum, the Governor observed that according to the present assessment, barring the emergence of any adverse and unexpected developments in the various sectors of the economy and assuming that the underlying inflationary situation does not turn adverse, the overall stance of monetary policy for 2004-05 will be:

• Provision of adequate liquidity to meet credit growth and support investment and export demand in the economy while keeping a very close watch on the movements in the price level.
• Consistent with the above, while continuing with the status quo, to pursue an interest rate environment that is conducive to maintaining the momentum of growth and, macroeconomic and price stability.

Governor pointed out that the financial sector now operates in a more competitive environment than before and intermediates relatively large volumes of international financial flows. Consequently, he said that the monetary policy formulation has become complex and, in particular, has to be alert to a possible build-up of financial imbalances and thus needs to explore ways and means of containing such shocks.

Reiterating the need for maintaining a conducive credit culture, Governor said that as financial institutions expand and grow more complex, it is also necessary to ensure that the quality of service to customers, especially the common person, is focused on and improved.

In order to ensure timely and effective implementation of the measures, RBI has been adopting a consultative approach before introducing policy measures so that the benefits of financial efficiency and stability percolates to the common person and the services of the Indian financial system can be benchmarked against international best standards in a transparent manner.

(a) Bank Rate - Kept stable at 6.0 per cent.

(b) Repo Rate – Kept unchanged at 4.5 per cent.

Taking into account the recommendations of the Internal Group on LAF and the suggestions from the market participants and experts, the revised LAF scheme was operationalised effective March 29, 2004 through, inter alia, (i) 7-day fixed rate repo conducted daily and (ii) overnight fixed rate reverse repo conducted daily, on weekdays.

Considering the prevailing situation, the rate for the 7-day repo was retained by RBI at 4.50 per cent per annum. The reverse repo rate continues to be linked to the repo rate though at a lower spread of 150 basis points and was reduced to 6.00 per cent per annum with effect from March 29, 2004. Simultaneously, in order to rationalise the existing structure of provision of liquidity facility from RBI, the entire amount of export credit refinance to banks and liquidity support to primary dealers was made available at a single rate, at the reverse repo rate.

The Internal Group had proposed introduction of a standing deposit facility to provide more flexibility to RBI’s repo facility as also to impart a floor to the movement of call money rates. The Reserve Bank agrees with the proposal, but this has to await amendment to the relevant provisions of the RBI Act, 1934.

Referring to the advice by the Indian Banks’ Association (IBA), Governor said that almost all commercial banks have adopted the new system of BPLR and the rates are lower in the range of 25-200 basis points from their earlier PLRs.

Governor observed that while there is intense competition among banks to lend to large top-rated borrowers, other borrowers with long standing relationship with banks and good credit record do not get the benefit of lower rates. Governor advised banks to take steps for putting in place comprehensive and rigorous risk assessment of borrowers using the database available with them, as also other internal and external factors so that the pricing of credit is related to risk more appropriately.

Referring to the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System (Chairman: Prof. V.S. Vyas) constituted by RBI, Governor said that the Committee has submitted its interim Report and some of the recommendations made therein have been accepted by RBI for implementation.

In order to further enhance credit flow to build up storage facilities, Governor proposed that: