Mr. Rangarajan elucidates the monetary and credit policy of the Reserve
Bank of India for the first half of the 1997-98 financial year Address by the Governor of the
Reserve Bank of India, Mr. C. Rangarajan, at the Madras Chamber of Commerce and Industry at
Chennai on 19/4/97.
I would like to take this opportunity given to me to speak to you this afternoon to
focus on the monetary and credit policy for the first half of 1997-98 which was announced a few
days ago. It may be useful at the outset to review the major developments during 1996-97.
2. The growth rate of broad money (M3) in 1996-97 was 15.6 per cent which was
within the targetted band of 15.5 - 16.0 per cent. The real GDP is expected to have grown by 6.8
per cent. The inflation rate as measured by the change in the Wholesale Price Index was 7.3 per
cent on a point-to-point basis. A notable feature of 1996-97 was that the money and foreign
exchange markets were generally calm in contrast with the turbulence witnessed in these markets
in the previous year. A strong growth in bank deposits, coupled with substantial reduction in
cash reserve requirements resulted in abundant liquidity in the system. However, the off-take of
bank credit was subdued. Short-term money market rates have moved down as a result of the
easy liquidity conditions. Lending rates are known for their stickiness and remained at high
levels during the first half of 1996-97 but softened later. There has been a strong accretion to the
foreign exchange reserves. The slow growth in non-food bank credit, the persistence of
relatively high lending rates despite comfortable liquidity in the banking system and the
acceleration of inflow of funds from abroad call for active monetary and exchange rate
management by the Reserve Bank.
3. While the overall growth momentum has been sustained in 1996-97, divergent
trends were observed in various sectors with agricultural output showing an impressive recovery
and industrial growth slowing down. Even within the industrial sector, the decline in growth
rates in mining and electricity sectors was sharp. The inflation rate at 7.3 per cent was a matter
of concern. While manufacturing prices rose only by 5.1 per cent, primary articles recorded an
increase of 8.3 per cent. During 1996-97, procurement of foodgrains was low, while the off-take
was high. With the result, buffer stocks of foodgrains fell from 23.3 million tonnes at the end of
March 1996 to 18.6 million tonnes at the end of January 1997. The decline in wheat stocks was
sharper.
4. The target for expansion in M3 during 1996-97 was set at 15.5 - 16.0 per cent.
During the financial year 1996-97, M3 increased by 15.6 per cent as compared with 13.7 per
cent in 1995-96. Aggregate deposits of scheduled commercial banks showed a strong growth of
Rs.697.8 billion (16.1 per cent) during 1996-97 as compared with a modest increase of Rs.469.6
billion (12.1 per cent) during 1995-96. However, the increase in non-food credit of scheduled
commercial banks by Rs.247.1 billion (10.1 per cent) during 1996-97 was substantially lower
than that of Rs.449.4 billion (22.5 per cent) during 1995-96. The depressed capital markets
seemed to have played a role inasmuch as there has to be some balance between debt and equity.
Equity raised by the corporates was significantly lower in 1996-97 than in 1995-96. Investments
by banks in bonds/debentures/shares of public sector undertakings and private corporate sector
and commercial paper increased by Rs.65.8 billion in 1996-97 as compared with a decline of
Rs.1.62 billion in the previous year. Thus, the total resource flow from banks to the commercial
sector inclusive of loans and advances as well as investments in bonds/debentures/shares
amounted to Rs.312.9 billion as against Rs.447.7 billion in 1995-96. Investments by scheduled
commercial banks in Government securities showed a quantum jump with an increase of
Rs.268.6 billion during 1996-97 as compared with the increase of Rs.145.4 billion during
1995-96.
5. One of the major objectives of financial sector reform has been to eliminate
financial repression which is inherent in an administered interest rate structure and significant
strides have been made in this direction. This process of change which began in late 1980s has
not been abrupt but gradual. During this period, considerable degree of freedom has been given
to banks to determine both deposit and lending rates. Following moderation in the inflation rates
in 1995-96 and 1996-97 and the reductions in cash reserve ratio, there has been a conspicuous
reduction in both deposit rates and lending rates of banks as also spreads over the prime lending
rates (PLR). In July 1996, some public sector banks reduced their PLR by 0.5 percentage point.
However, as a number of banks were charging lending rates far higher than PLR, banks were
directed in the monetary policy announcement of October 1996 that along with the
announcement of their PLR, they should, with the approval of their respective Boards, also
announce the maximum spread over the PLR for all advances other than consumer credit. The
public sector banks have since reduced their PLR further from 16.5 per cent in March 1996 to
14.0 - 15.5 per cent by March 1997 and spreads in the rate of 2.5 - 4.0 percentage points were
announced. During 1996-97, many banks had also brought down interest rates on term deposits
by 1 to 2 percentage points on the shorter end of their maturity spectrum with a view to reducing
the average cost of deposits.
6. Reflecting the easy liquidity conditions during 1996-97, there has been a
significant softening of money market interest rates. At the short end of the market, the rates
have come down sharply and have ruled generally low as compared with the levels prevailing in
1995-96. The typical call money rates ruled low in the range of 2.00 - 5 per cent in the recent
period. The rate on 91-day Treasury Bills came down from 12.97 per cent at the beginning of
April 1996 to 7.96 per cent in March 1997. Similarly, the rate on 364 day Treasury Bills
declined from 13.12 per cent in April 1996 to 10.10 per cent in March 1997. The typical rates of
discount on Certificates of Deposits (CDs) and Commercial Paper (CP) have also declined
sharply since end-March 1996. There was also some softening of coupon rates on long-term
Government bonds.
7. The stance of monetary policy in 1997-98 would be to achieve the twin
objectives of maintaining reasonable price stability and ensuring availability of adequate bank
credit to support the growth of the real sector. The economy is still subject to inflationary
pressures. There is need for continued caution on the price front and this would require a
moderation in monetary expansion consistent with the expected real growth. There is also the
need for developing the Bank Rate as reference rate to signal policy stance of the Reserve Bank.
This would require rationalisation of the interest rate structure and linking of interest rates to the
Bank Rate. There is an urgency to step up the flow of bank credit. This would need streamlining
and improving credit delivery system by giving greater freedom to banks. Besides, banks must
endeavour to bring down the interest rates by reducing the spreads. The money, foreign
exchange and government securities markets need to be further developed and integrated.
8. In regulating money supply growth in the coming year, the Reserve Bank will
have to reckon with the impact of capital inflows. If capital inflows remain strong, the Reserve
Bank must take care to see that the resultant reserve money expansion after taking into account
the net RBI credit to the Central Government does not exceed a level that is consistent with the
expansion in money supply justified by the growth of the real sector.
9. Given the real Gross Domestic Product (GDP) growth of 6.0 - 7.0 per cent,
monetary policy would seek to maintain the expansion in M3 in the range of 15.0 - 15.5 per cent
to keep the inflation rate at around 6 per cent in 1997-98. The projected increase in money
supply may be reviewed and revised depending upon macro-economic developments. On the
basis of the projected increase in M3, the working estimate of the growth of aggregate deposits
of scheduled commercial banks is placed at Rs.800 billion (16.0 per cent). The expansion in net
scheduled commercial bank credit including such investments as in bonds/debentures/shares of
Public Sector Units (PSUs) and private corporate sector, is envisaged to be of the order of 20.0
21.0 per cent. The policy measures which are being announced have been so framed that banks
will have adequate resources to meet all the genuine productive requirements of the economy.
10. Broadly speaking, the current monetary and credit policy seeks to achieve
four objectives. The various measures announced as part of the policy can be brought under
these four objectives. The first objective of course is to maintain a reasonable degree of price
stability and moderate inflationary pressures in the system by regulating money supply. As
indicated earlier, the target rate of growth of M3 is set in the range of 15 - 15.5 per cent. With a
real rate of growth between 6 and 7 per cent, this would enable us to keep the inflation rate
around 6 per cent.
11. The second objective is to expand the lendable resources of banks and also to
bring about a reduction in the lending rates. The Cash Reserve Ratio (CRR) was lowered at
different points of time during the previous year. The full impact of the reductions in the CRR
effected last year will be seen in the current year. The CRR on inter-bank liabilities has been
withdrawn as part of the policy. Apart from the impact this will have on the creation of an
appropriate term deposit market, this will release about Rs.9500 million of lendable resources to
banks. We have also introduced a general refinance facility which will be available to banks and
this facility will be equivalent to one per cent of the demand and time liabilities of banks. All of
these measures will have the impact of expanding the lendable resources of banks. The bank rate
has been reduced from 12 per cent to 11 per cent to signal a reduction in the interest rate. We
want the bank rate to emerge as an effective signal rate as well as a reference rate. To coincide
with the reduction in bank rate, the term deposit rate for maturity of 30 days and upto one year
has been reduced by one percentage point. The same rate has been made applicable to rates on
term deposits of Non-Resident (External) Rupee Deposit accounts of maturity of over six
months and upto one year. On Foreign Currency Non Resident Accounts (Banks) deposits,
banks are free to determine interest rates subject to a ceiling prescribed by the RBI from time to
time. Thus the various measures announced will have the effect of expanding the lendable
resources of banks on the one hand and bringing about on the other a reduction in the deposit
rates and consequently lending rates.
12. Responding to the policy announcement, a number of banks in the public
sector banks have already reduced their PLR by 50-100 basis points to take it to 14 per cent.
Needless to say the only enduring way to bring about a reduction in the interest rate is by
keeping the inflation rate low and breaking inflationary expectations.
13. The third objective relates to the revamping of the credit delivery system
which has become necessary for accelerating the credit flow from the banking system. A number
of measures announced fall in this category. I would like to list the most important among them.
The mandatory consortium requirements for credit limits of Rs.500 million and more has been
dispensed with. Banks and their customers can now enter into a variety of arrangements
including syndication subject of course to the exposure limits. Banks have been given full
freedom to evolve their own methods of assessing the working capital requirements of
borrowers. This should result in quicker decision making and speedier flow of funds from banks
to their borrowers. The loan component of the working capital limits is being gradually
enhanced. However, banks are now free to fix the maturity period of the loans on their own. The
limits set on the extent of bank credit that can be made available to Non-Banking Financial
Companies (NBFCs) has been removed. This, however, applies only to NBFCs which have
complied with the requirements of registration, credit rating and prudential norms. Banks
hitherto have been permitted to invest 5 per cent of their incremental deposits of the previous
year in shares and debentures. Debentures are now excluded from this limit so that this limit
would be available exclusively for shares of corporates including PSUs. In the context of the
present condition of the capital market, banks have been allowed to extend loans to corporates
against shares held by them to enable such corporates to meet the promoters' contribution to the
equity of new companies in anticipation of raising resources. The credit delivery system is thus
sought to be improved.
14. The fourth objective is the improvement in the functioning of the various
markets - money market, government securities market and the foreign exchange market. The
important measures that relate to the money market are: removal of cash reserve ratio on the
inter-bank liabilities; reduction in the minimum period of maturity for the commercial paper to
30 days; reduction in the minimum size of certificates of deposit and improved access to cash
surplus entities through primary dealers. The Government securities market will benefit by the
enlargement of instruments eligible for Repo transactions, allowing the entry of non-bank
entities who are holders of SGL accounts with the Reserve Bank to enter into reverse Repo
transactions and the introduction of Treasury Bills of varying maturities. In order to deepen and
widen the foreign exchange market, certain measures have been taken. These include permission
to book forward contracts on the basis of declaration of exposure, permission to Authorised
Dealers to borrow upto US$ 10 million from abroad as well as to invest up to US$ 10 million
abroad and permission given to Authorised Dealers to engage in Forex-Rupee current swap
without the prior approval of RBI. The various measures taken in the area of market
improvement will lead not only to the efficient functioning of the individual markets but also
bring about a greater integration among them.
15. In order to facilitate greater flow of credit to agriculture, the share capital of
National Bank for Agriculture and Rural Development (NABARD) as well as the General Line
of Credit granted to NABARD by RBI have been increased. The simplified procedure of
assessing the working capital needs on the basis of 20 per cent of the projected turn over is being
extended to borrowers having working capital limits up to Rs.20 million as against Rs.10 million
earlier. This should benefit a large number of Small Scale Industrial Units.
16. The measures announced cover a wide range and touch almost every part of
the financial system. Some of the measures are directed towards improving the functioning of
the various markets and bringing about a greater integration among them, which should reduce
the volatility of the rates in these markets. These measures are in the nature of institutional and
structural reforms. The improvements in the credit delivery system should remove the 'chokes'
in the flow of credit.
17. All in all, the measures announced should have the effect of accelerating
economic growth, keeping inflationary pressures under control and improving the flow of credit
from the banking system to the various segments of the Indian economy.