It is my pleasure to be part of the Annual FIMMDA1-PDAI2
Conference today. I would like to place on record the Reserve Bank's
appreciation of the critical role played by FIMMDA and PDAI in the
development of financial markets in India over the years, and more
recently, in partnering with the RBI in guiding the markets and the
economy through the turbulent times of COVID-19, the war in Ukraine
and the turmoil in financial markets.
2. Today, as I speak before keen market players, veterans and
experts, I thought this would be an opportune moment to recapture the
journey of our financial markets in the last decade or so and reflect on
where we are and what we think about the course ahead. An attempt
to draw from the past and forge ahead, so to speak.
3. From the global financial crisis to the Eurozone sovereign debt
crisis; from the taper tantrum to Brexit; from unprecedented quantitative
easing to among the most accelerated monetary tightening in recent
memory; from a pandemic which brought humankind to a standstill to a
geopolitical crisis which threatens the world order as it exists today - it
would not be an exaggeration to say that the world has moved from one
storm to another in the years since the global financial crisis.
4. Against this backdrop, the journey of Indian financial markets has
been driven by two key objectives - stability and development. Crisis
management has been a key component of this journey. Nonetheless,
the pursuit of developmental reforms, with the key objective of widening
and deepening of financial markets was continued even amidst the
worst storms.
The Journey so far
5. Let me take a moment to reflect on the journey of Indian financial
markets over the past few decades. Right up to the end of the 1980s,
the Indian economy was characterised by an administered interest rate
regime, fixed exchange rates, a captive government securities market
and current and capital account restrictions. Policy measures during the
decade of the 1990s set the stage for a transition to market-determined
interest and exchange rates, shift to a multiple indicator approach and
eventually to flexible inflation targeting in the conduct of monetary
policy, convertibility in the current account and gradual liberalisation of
the capital account. The policy measures were bolstered by several key
legislative changes: the Foreign Exchange Management Act (FEMA),
1999; the Government Securities Act, 2006; the amendments to the
RBI Act in 2006 to give explicit regulatory powers to the Reserve Bank
over government securities, derivatives, and money market
instruments; and the Payment and Settlement Systems Act, 2007. The
Clearing Corporation of India Ltd. was set up in 2001 to provide clearing
and guaranteed settlement for money, government securities, forex
and derivative markets. A Real Time Gross Settlement System (RTGS)
and the NDS-OM platform were operationalised. A Trade Repository
was put in place for derivatives. Some of these initiatives became
important at a global level only after the G20 rolled out its reforms
agenda in the 2009 Pittsburgh Summit.
6. After the global financial crisis (2008), the Indian financial markets
were nascent but growing. The approach to foreign participation in most
market segments was cautious. Derivative markets, the markets for the
purpose of hedging risks, were limited in terms of participants and
products. Meanwhile, the BIS Triennial survey published in 2013
showed that there was growing interest in the Indian Rupee overseas.
The onshore and offshore markets for the Rupee, however, remained
segmented, with the spreads between the onshore and offshore forex
and interest rates being wide.
Headwinds and Tailwinds
7. Coming to more recent times, many of our policies over the last
decade have been guided by the learnings from crisis management as
well as the developmental objectives our country aspires to achieve.
As the world moved through one storm after another, we were
compelled to navigate through the spillovers of major global headwinds.
8. Equally compelling in guiding policy were the needs of the
economy. As the real sector grew over the last decade, expectations
from the financial markets also grew. The needs of the economy reflect
these developments. To place this in perspective, let's look at some
figures. Nominal GDP increased four-fold from ₹64 lakh crore for FY
2010 to ₹273 lakh crore for FY 2023.3 External trade also increased
over four-fold from ₹29 lakh crore to ₹137 lakh crore during the same
period.4 The ratio of trade to GDP5 has risen to 45% in 2021 from 25%
in 2000. Foreign Direct Investment (FDI)6 in the country has risen
sharply by two and a half times since 2010. The flow of resources to
the commercial sector in India almost doubled from ₹12 lakh crore in
FY 2012 to ₹22 lakh crore in FY 2022.7 While banks continue to be a
dominant source of financing, market borrowings8 of the commercial
sector increased from ₹74,000 crore in FY 2012 to ₹3,16,000 crore in
FY 2022. As our economy and financial markets grew, the integration
with the world economy and global financial markets has also risen.
The growing economy and our aspirations to be and remain among the
fastest growing economies has expanded our funding needs. All these
necessitate larger and deeper financial markets.
The policy response to headwinds
9. It is relevant to look at some of our policy responses in recent
times, especially to major global headwinds. Each successive episode
of turmoil over the last decade and half has posed a specific set of
challenges for the economy. Each has warranted a specific response.
10. In 2008, policy actions were aimed at ensuring comfortable
system liquidity; augmenting forex reserves and maintaining a crisis
management framework to support the economy through the global
financial crisis. Conventional tools such as policy interest rates and
cash reserve ratio (CRR) were used. Measures to manage forex
liquidity included, inter alia, relaxing the interest rate ceiling on foreign
currency deposits by non-resident Indians and external commercial
borrowings (ECB) for corporates. Unconventional measures included a
rupee-dollar swap facility for Indian banks, a refinance window for
mutual funds and a special purpose vehicle for supporting nonbanking
financial companies.
11. Post the announcement of early taper of quantitative easing by
the Federal Reserve in 2013, the need for restoring confidence of
market participants and containing the pressure on the Rupee guided
the Reserve Bank's policy responses. Monetary conditions were
tightened through unconventional tools. Forex market measures
included both direct intervention and administrative measures to
manage capital flows. These included import restrictions of non-
essential items, opening of a special dollar swap window for PSU oil
companies, a concessional swap window for Foreign Currency Non-
Resident (FCNR-B) deposits, increased overseas borrowing limits of
banks, enhanced foreign investment limits in government debt and
restrictions on outward investment flows, Liberalised Remittance
Scheme (LRS) entitlements as well as exchange-traded derivatives.
12. The outbreak of the COVID-19 pandemic in March 2020
necessitated swift and focussed policy responses to address the
emerging or potential market dislocations. As in the past, policy rates
were reduced and systemic liquidity was expanded. But, this time, the
policy corridor was asymmetrically widened and the fixed rate reverse
repo became the effective anchor for the evolution of short and longer-
term interest rates. To improve transmission of policy rates and ensure
flow of credit to the affected sectors, unconventional measures were
used viz., the Long-Term Repo Operations (LTROs), targeted LTROs
and special refinance facilities to All India Financial Institutions. A
special liquidity facility for mutual funds aimed at assuaging redemption
pressures was also instituted. For the first time, the Reserve Bank
pledged its balance sheet to revive the economy through a Government
Securities Acquisition Programme (G-SAP) which provided an upfront
commitment on the amounts to be purchased. Special open market
operations involving simultaneous purchase and sale of securities
(Operation Twist) were undertaken for orderly evolution of the yield
curve and liquidity management. Forward guidance gained prominence
with the emergence of time and state-contingent guidance, with
assurances on the Reserve Bank's commitment to maintain congenial
financial conditions. Communication became a significant part of our
monetary policy toolkit.
13. The onset of the war in Ukraine again weakened risk sentiment,
with commodity prices and inflation rising to multi-decade highs. As
major central banks accelerated policy rate hikes and tightened liquidity
to tackle inflationary pressures, financial market volatility spiralled, and
the Rupee came under considerable pressure. The policy response this
time eschewed administrative measures to contain outflows and
instead focused on measures to enhance inflows through incentivising
non-resident deposits, foreign investments in debt instruments and
ECBs. To promote exports and support the increasing global interest in
the Rupee, an additional arrangement for invoicing, payment and
settlement of exports/ imports in Rupees was put in place.
14.
The point I want to emphasise here is that while there were clear
common strands in the Reserve Bank's response to various episodes
of turmoil, the response was customised to each episode in terms of
policy objectives and choices, and use of toolkits. Every response was
a function of the underlying macroeconomic conditions and reflected
learnings from earlier crises. In this context, I would like to mention
three distinctive features of our policy responses. First, all liquidity
management operations by the Reserve Bank, including measures for
mutual funds and NBFCs, have always been through banks which are
the liquidity conduits for the Reserve Bank even in peace times.
Second, the measures entailed no dilution of collateral standards and
ensured that the central bank remained cushioned from counterparty
risks. Third, most of the measures this time around were time-bound
and expired as per their originally defined maturity. Illustratively, the G-
SAP was discontinued, relaxations with respect to CRR were allowed
to normalise and the liquidity management framework was tweaked in
April 2022 to operationalise the standing deposit facility (SDF). This
approach has enabled us to get out of a potential liquidity trap, the
Chakravyuh.
15.
Interestingly and perhaps paradoxically, the measures to reform
and develop financial markets have taken place at an unprecedented
pace during a decade of unprecedented challenges. The reforms were
aimed at deepening onshore financial markets and increasing the
efficiency of price discovery. The more recent reforms sought to (i)
remove market segmentation by simultaneously easing access of non-
residents to domestic markets and permitting residents to access
offshore markets; (ii) expand the participation base by encouraging
non-resident participation in financial markets and retail participation
through the provision of easy access, for example through the Retail
Direct and FX Retail platforms; (iii) facilitate more sophisticated users
to access markets for their hedging needs and to express their views
on market movements; (iv) promote innovation through the introduction
of a larger suite of products which can be customised to the needs of
individual market participants;9 and (v) ensure fair user conduct through
protection of the retail user and a sound, receptive and a customer
suitability framework. A robust infrastructure and conduct framework
has been put in place through efficient clearing and settlement
arrangements, benchmark reforms, transparency requirements and
stipulations on market abuse, among others.
16. India has also come a long way towards achieving higher levels
of capital account convertibility. Liberalisation of Foreign Direct
Investment (FDI) flows continued over the last decade, with FDI
becoming unrestricted except in certain sensitive / strategic sectors.
Limits for non-resident investments in domestic market markets were
liberalised. The Voluntary Retention Route (VRR) was introduced to
facilitate non-resident investment in government and corporate bonds.
A Fully Accessible Route (FAR) which places no limit on non-resident
investment in specified benchmark government securities was
introduced as part of further liberalisation of portfolio debt inflows. The
ECB framework was comprehensively liberalised and is now subject
only to an overall soft limit and a few "end use" restrictions. Regulations
for Overseas Direct Investments (ODI) have also been rationalised and
liberalised. The LRS is now available for both current and capital
account transactions.
Where do we stand today?
17. In the aftermath of multiple shocks, the global economy is
projected to contract significantly in 2023. The worst for the global
economy, both in terms of growth and inflation, seems to be behind us.
Lately, with some ebbing of COVID-related restrictions and cooling of
inflation in various countries, though still elevated, central banks have
started what appears to be a pivot towards lower rate hikes or pauses.
At the same time, they continue to emphatically reiterate their resolve
to bring inflation down closer to targets. High policy rates for a longer
duration appear to be a distinct possibility, going forward. On the growth
front, projections are now veering around to a softer recession as
against a severe and more widespread recession projected a few
months back.
18. In this hostile and uncertain international environment, the Indian
economy remains resilient, drawing strength from its macroeconomic
fundamentals. Our financial system remains robust and stable. Banks
and corporates are healthier than before the crisis. Bank credit is
growing in double digits. India is widely seen as a bright spot in an
otherwise gloomy world. Our inflation remains elevated, but there has
been a welcome softening during November and December 2022. Core
inflation, however, remains sticky and elevated.
19.
On the external front, de-globalisation and protectionism are
gaining ground as witnessed during the recent global supply-chain
shock. It is thus necessary to build and strengthen bilateral trade
relations to deal with such challenges. India has recently signed
bilateral trade agreements with the UAE and Australia and more such
agreements are works in progress. The average current account deficit
to GDP ratio stands at 3.3 per cent during H1:2022-23. The slowing
global demand is weighing on merchandise exports; but our exports of
services and remittances remain strong. The net balance under
services and remittances remains in a large surplus, partly offsetting
the trade deficit. Consequently, the current account deficit is eminently
manageable and within the parameters of viability.
20. On the financing side, net FDI flows remain strong and foreign
portfolio flows have resumed since July 2022, with intermittent outflows
from time to time The size of forex reserves is comfortable and has
gone up from USD 524 billion on October 21, 2022 to USD 572 billion
as on January 13, 2023. Further, India's external debt ratios are low by
international standards. This has enabled the Reserve Bank to eschew
measures to control capital flows and take steps to further
internationalise the domestic currency, even during episodes of
significant capital outflows.
21. Every global risk-off episode resulted in an appreciating US dollar
imposing downward pressures on most other currencies. Comparison
of the performance10 of the Rupee across successive crisis episodes
tells its own tale. During the global financial crisis, the Rupee witnessed
its worst depreciation - between April 1, 2008 and March 3, 2009 -
when it lost 23% against the US dollar. Similarly, it depreciated by 22%
during the taper tantrum between May 01, 2013 and Aug 28, 2013.
However, the extent of Rupee depreciation was lower in each
subsequent episode of turbulence. In the initial days of the pandemic,
i.e., between February 17, 2020 and April 21, 2020, the Rupee
depreciated by only 7%. Even during the period of geopolitical tensions
emerging out of Ukraine in 2022, while the Rupee lost 9% against the
US dollar between February 24, 2022 and October 19, 2022, it
outperformed the currencies of most advanced and many emerging
market economies.
22. Importantly, the Rupee's performance in terms of volatility
remained impressive. For example, the 1-month implied volatility of the
Rupee touched a high of 25% during the global financial crisis on
October 10, 2008 and 20% during the taper tantrum period on August
29, 2013. During the COVID-19 pandemic, however, the implied
volatility peaked at 10% on March 24, 2020 and has remained well
anchored11 thereafter, despite the uncertainties associated with the war
and monetary tightening by major central banks. The Government bond
market has also remained resilient, with average bid-ask spreads being
the lowest among peer nations. The yield curve has also evolved in an
orderly manner without any undue volatility, despite the significantly
higher government borrowing.
Looking ahead
23.
Today, when we look ahead, we still see challenges, but we can
prepare for them with optimism and confidence. The Indian financial
markets have developed appreciably over the years. Liquidity in the
government securities and the overnight money markets have grown.
Bid-ask spreads remain narrow, reflecting efficiency in price discovery.
In the forex market, overall trading volumes have grown, and a suite of
hedging products have emerged. Volumes in the interest rate swap
market have grown consistently and new products in these markets are
also developing. Onshore and offshore markets are getting increasingly
integrated with narrowing of forex and interest rates across the markets.
Non-resident participation in markets is growing, albeit gradually.
24. The global economy is still marred by shocks and uncertainty.
Financial markets remain volatile and the geopolitical situation
continues to be tense. International food, energy and commodity prices
have eased but uncertainties do remain. Inflation remains high and
broad-based across countries. The IMF has projected contractions in
over one-third of the global economy.
25. In India, we have come a long way in the development of financial
markets, but this remains work in progress. The Reserve Bank and
stakeholders like FIMMDA and PDAI need to work together and focus
on certain specific areas. Secondary market liquidity in g-secs is
concentrated in a few securities and tenors. The MIBOR-based OIS
remains the only major liquid product in the interest rate derivative
market. A term money market remains absent, notwithstanding a host
of facilitative policy measures. Access of the retail segment to markets,
especially derivative markets, needs to improve further. In the forex
markets, while corporates benefit from the tight bid-ask spreads,
smaller users continue to face pricing disadvantages notwithstanding
regulatory requirements for fair and transparent pricing. Likewise, there
remains a need for improvement in ensuring liquidity for retail investors
in the government securities markets.
Conclusion
26. The journey of Indian financial markets through the last decade
has been a story of steady progress with stability. We have been
steadfast in our commitment and consistent in our approach to keep
the ship stable while continuing to move ahead. Going forward, greater
challenges will emerge as the footprints of Indian banks increase in the
offshore markets, the range of products expand, non-resident
participation in domestic markets grows and as capital account
convertibility increases. Market participants will have to prepare
themselves to manage the changes and the risks associated with
globally integrated markets. The achievement of desired outcomes is
contingent on financial institutions and market participants taking
forward the reform agenda so that we have more vibrant and resilient
financial markets.
Thank you.