Financial Market Reforms: Approach and Expectations
Address by Shri Shaktikanta Das, Governor, Reserve Bank of
India at FIMMDA Annual Event, September 05, 2022
1. I am happy to be part of this FIMMDA1 event today. I take this
opportunity to place on record the RBI's appreciation of the key role
played by FIMMDA in the development of financial markets in India.
2. In my address this evening, I propose to reflect upon some recent
financial market developments and our efforts to navigate through them
in the prevailing global and domestic environment. I shall then touch
upon some of our recent initiatives for the development of domestic
financial markets and then go on to conclude by expressing our
expectations from market participants and market bodies in the way
ahead.
Recent Financial Market Turmoil
3. The recent commentary from the US Fed at Jackson Hole on the
future trajectory of US monetary policy has infused substantial volatility
into global financial markets, with large spillovers and knock-on effects
on emerging market economies (EMEs). This episode is yet another
demonstration of the point made in my media interview on August 23,
2022 that while forward guidance can be a useful policy instrument in
an accommodative monetary policy phase, it can be quite difficult to
provide coherent and consistent guidance in a tightening cycle. The
difficulty gets further compounded in the current environment of high
uncertainty. Such forward guidance may even have destabilising
effects on financial markets, especially if the subsequent policy actions
are at variance with earlier pronouncements. Central bank
communication in the current context has thus become even more
challenging than the actual policy actions. Notably, however, financial
markets in India have recovered from the lows that they fell to in the
immediate aftermath of the Jackson Hole event.
4. In this turbulent global environment, the resilience exhibited by
Indian financial markets reflects the robust macroeconomic
fundamentals of the economy, and the proactive and strategic policy
interventions to mitigate the impact of the two black swan events that
have occurred in quick succession - the COVID-19 pandemic and the
war in Europe.
5. Experience tells us that markets often tend to overreact to new
information, which also amplifies volatility. Especially in times such as
now, when geopolitical tensions and synchronised monetary policy
tightening come together, overshooting often precedes subsequent
realignment with the underlying fundamentals. Hence, it is useful to
take stock of India's macroeconomic fundamentals and buffers, and
assess them in the current and evolving conditions. First, India is widely
perceived to be among the fastest growing major economies in the
world in 20222, when the other major economies may encounter
recession or considerable moderation in their growth momentum. The
favorable growth differential of India provides confidence to investors.
This is amply reflected in the surge of portfolio flows into India since
July 2022. Inflows in August alone at US$ 7.5 billion are more than 16
times the net inflows in July. Second, the recent softening of commodity
prices and supply chain pressures have eased the terms of trade shock
that India faced in the aftermath of the pandemic and the war. With the
consequent easing of imported inflation pressures, India's CPI inflation
has peaked in April 2022. Further, the average Indian basket crude
price in August at USD 97.4 per barrel has turned out to be lower than
what we had assumed for the full year - USD 105 per barrel - in the
monetary policy resolution of August 5. In fact, India's inflation is lower
than a large number of its trading partners. Third, the shift in the
commodity price outlook is also altering the assessment of India's
current account deficit in 2022-23, which is now expected to remain well
within sustainable levels. Fourth, at a time when food security is
threatened the world over by shortages and soaring prices, India's large
buffer stocks of food grains supplement domestic supply and assure
food security domestically. Fifth, India's foreign exchange reserves of
US$ 561 billion (as on August 26) provide a cushion against external
shocks, as is being demonstrated on a day-to-day basis. Moreover, the
reserves are also reinforced by forward assets. Sixth, the health of our
banking system is sound. It is well capitalised and well provisioned, with
improved asset quality. This constitutes a key pillar of financial stability
and is expected to provide positive spillovers for the financial markets.
6. Reflecting these fundamental factors, the Indian rupee has moved
in an orderly manner in the current financial year so far. It has held its
own in a world of sharp depreciation across other EME and AE
currencies. While the US dollar has appreciated by 11.8 per cent during
the current financial year so far, the INR has depreciated by 5.1 per
cent, which is among the lowest in the world. The RBI is in the market
on a regular basis, providing liquidity and confidence so as to facilitate
its smooth and normal functioning.
7. Exchange rate stability is an intrinsic element of our overall
macroeconomic and financial stability. Our endeavour amidst the
extraordinary events unfolding globally on an ongoing basis has been
to anchor expectations and allow the exchange rate to reflect the
fundamentals rather than overshoot. Avoiding undue and excessive
volatility is a desirable policy objective for all stakeholders, while
reaping the benefits of a market determined exchange rate regime.
8. Price stability provides the anchor for exchange rate stability in
the medium-run. The flexible inflation targeting (FIT) regime provides
credibility to the RBI's monetary policy mandate of assigning priority to
containing inflation and keeping inflation expectations anchored while
keeping in mind the objective of growth. While the incoming monthly
inflation prints in the near-term could be bumpy, we expect it to
moderate in the second half of 2022-23, and then move within the
tolerance band in Q4 and then even lower in Q1:2023-24.
Response to the Pandemic and the War in Europe
9. In response to the pandemic, as you are well aware, the RBI
deployed conventional and unconventional monetary policy tools. The
financing conditions were kept easy. Normal functioning of various
segments of the financial market was ensured. Our communications
and forward guidance provided the much-needed clarity and
confidence to the markets - both financial and non-financial.
10. As we adapted to the pandemic, the policy approach has been
gradually normalised. Even as the Indian economy was recovering from
the pandemic, it faced a setback from the war in Europe, which caused
fresh supply disruptions and accentuated the earlier ones. Inflation
became globalized. Consequently, the response from Central banks
has been aggressive leading to synchronized monetary tightening
across the world. In India, the MPC re-prioritised price stability as the
foremost objective of monetary policy and began a process of
withdrawal of accommodation.
11. Going forward, our monetary policy will remain watchful, nimble-
footed and calibrated in order to ensure price stability while supporting
growth. The RBI remains committed to support the market with two-way
operations, as warranted, in line with the revised liquidity management
framework. The RBI will also strive to ensure stable money market
conditions, the smooth conduct of the primary auctions in G-secs and
facilitate the orderly evolution of the yield curve.
Reforms in Regulatory Framework and Financial Markets
12. In spite of the two black swan events that have dominated the
recent discourse, the RBI has steadfastly persevered with regulatory
reforms aimed at the development of the domestic financial markets.
Our approach is based on the principle of adapting to the needs of a
modernising financial market as it integrates with the rest of the world.
13. Let me touch upon on some of the regulatory changes which have
taken place during the last three years. The orderly development of the
sovereign yield curve needs significant market liquidity at important
benchmark tenor points and supply of G-Secs of various tenors to
diverse class of market participants matching with their investment
requirements. To this end, the Benchmark Security Issuance Strategy
was introduced during 2020-21 under which government securities (g-
secs) of specific benchmark tenors of 2, 5, 10, 14, 30 and 40-years are
issued. This year, g-secs with a 7-year tenor have also been introduced
after market consultation.
14. Issuance of green bonds provides a strong signal of a country's
commitment to a low-carbon economy. It also helps in bringing down
the cost of capital for green projects. Following the announcement in
the Union Budget for 2022-23, the Government and the RBI are putting
in place a framework for issuance of Sovereign Green Bonds, in line
with global standards.
15. As part of our continuing efforts to increase retail participation in
G-secs, the 'RBI Retail Direct Scheme' was launched in November
2021 to facilitate individual investors to conveniently invest in G-secs,
state development loans (SDLs) and sovereign gold bonds. Further, to
ensure liquidity to the retail investor, the "Retail Direct Scheme - Market
Making" was notified on January 04, 2022. The scheme requires
primary dealers to respond to buy/sell requests from the retail investors
throughout market hours.
16. The RBI has continuously engaged in ensuring state-of-the-art
infrastructure for trading, settlement and timely dissemination of
information in the g-sec market. An important initiative in this context is
the introduction of the Request for Quote (RFQ) dealing mode on NDS-
OM in October 2020. The RFQ mode aims to enable market
participants to negotiate trades on the NDS-OM platform itself for better
price discovery.
17. Derivative markets play an important role in allowing entities to
hedge their risks and improving liquidity for the underlying product.
Several measures have been taken to rationalise the regulatory
framework for forex, credit and interest rate derivative markets.
Principle-based regimes have been implemented in place of
prescriptive regulations in a bid to provide greater flexibility and
operational freedom to market participants. Access of non-residents to
these markets has been eased. The access of institutional users to the
markets has been facilitated both for hedging and for expressing their
views on market movements.
18. With these reform measures, product due diligence assumes
greater importance. It would ensure that market-makers offer products
that match the requirement of the users and avoid exposing their clients
to excessive risk. Considering the recent changes in the regulations
relating to OTC derivatives and in line with international standards, a
regulatory framework for market-makers in OTC derivatives3 has been
put in place to ensure high standards of governance, risk management
and conduct by market makers.
19. We have also continued our efforts towards integrating domestic
and offshore INR markets. Banks in India with operative IFSC Banking
Units were permitted to access the offshore non-deliverable rupee
derivative market in 2020. To facilitate integration of offshore and
onshore markets for Overnight Indexed Swaps (OIS) - the most active
rupee interest rate derivative in the domestic market - Banks in India
and standalone primary dealers (SPDs) have been permitted to
undertake settlement of OIS transactions with non-residents in foreign
currency.
20. Broadly, the recent regulatory and institutional reforms have been
aimed at enabling the domestic financial markets to face the challenges
of the next decade. Cutting across market segments, these reforms
seek to usher in a simplified, principle-based regulatory framework that
seeks to broadbase markets by easing access, enhancing participation,
facilitating innovation, protecting users and promoting fair conduct.
Market Participants and Market Bodies as Reform Partners
21. It is important to note that achievement of the desired outcomes
from the significant changes in the regulatory framework for financial
market and its infrastructure is contingent upon market participants
taking forward the reform agenda. It is heartening to see the market
participants rising to the occasion and partnering with the Reserve Bank
to meet the challenges of recent years. One such instance was the
smooth completion of the government borrowing programme, despite
the increased issuances in the last two years.
22. Similarly, the move towards normalisation of liquidity conditions in
the market has also taken place without any disruption. In response to
changes in regulation, we are seeing our banks becoming active and
visible in global markets and coming up with new products to meet the
hedging needs of the real sector. The transition away from LIBOR has
also been achieved with relative smoothness. Of course, the efforts
towards complete transition need to continue as we approach the
deadline for the cessation of all US dollar LIBOR settings less than a
year away. In all of these areas, market bodies such as the FIMMDA,
PDAI4, FEDAI5 and the Indian Banks Association (IBA) have continued
to play an important role in acting as bridges between the market
participants and the regulator, proactively conveying the views of the
market and providing timely inputs for policy making.
Expectations from Market Participants
23. There are, however, some areas where performance of market
participants can improve further. One area has been the delivery of
services to the small / retail customers. While there has been a steady
increase in the quantum of secondary market trades under the RBI
Retail Direct Scheme, there remains considerable scope for
improvement in ensuring liquidity for the retail investors throughout
market hours on the NDS-OM platform. We continue to get
representations from customers - particularly, those undertaking forex
transactions with small ticket sizes - about fair pricing of forex products.
A research study by some officers in the RBI found empirical evidence
of the presence of considerable price discrimination in the OTC
currency derivatives market. The services provided by banks on the FX-
Retail platform need special attention. The response time and
onboarding of customers on the platform can be faster.
24. The revised product regulations in OTC derivative markets now
permit market-makers to deal in derivative products of varying
complexity and to offer these products only to non-retail/institutional
customers who have the ability to handle the risks associated with such
products. It has been reassuring to note that market participants and
users have been taking a prudent approach in the use of complex
products. The valuation and the risk management systems of the
market-makers may need to be continually updated. Customers also
need to be made aware of the unique risks associated with these
products.
25. The recent reform measures have facilitated greater linkages of
the domestic market with the global markets. As the footprints of banks
in India increase in the offshore markets, it is expected that price
discovery of rupee products will also consolidate in the onshore market.
To realise this potential, banks need to put in place adequate
supporting infrastructure backed by expertise in risk management.
More so, because integrated financial markets can also facilitate faster
propagation of shocks which require appropriate risk management
processes.
Conclusion
26. Let me now conclude by stating that market development ultimately
is a shared goal of both the regulator and the market participants. The
RBI has taken steps towards liberalising markets, removing barriers
and putting in place a facilitative regulatory framework. Adoption of new
products requires participation from market participants in terms of
providing liquidity, contributing to price determination and easing
operational constraints. It is upon the market participants to take the
baton forward to develop the market and offer innovative financial
products to a broader set of clients. The RBI will remain constantly
engaged with the market bodies and participants. Together, we should
remain future ready at all times. I firmly believe that we can do this.
I wish FIMMDA all success in its future endeavours and look forward to
our continued partnership.
Thank you.