great moderation ”. dealing with supply side sources of inflation posed challenges for the conduct of reserve bank ’ s monetary policy, particularly in the face of signs of cyclical slowdown on the one hand and the risk of spiralling headline inflation on the other. in the second half of the year, the global financial crisis and the subsequent global recession dramatically changed the nature of the challenge emanating from globalisation. impact on the financial markets 5. post - lehman, the impact of the global financial crisis unfolded in the indian financial markets, though reversal of capital inflows and significant correction in the domestic stock markets on the back of sell - off in the equity market by the foreign institutional investors ( fiis ). the withdrawal of funds from the indian equity markets and reduced access of the indian entities to raise funds from the international markets put significant pressure on the dollar liquidity in the domestic foreign exchange market. these developments created adverse expectations on the balance of payments ( bop ) outlook and led to depreciation pressures on the indian rupee and increased volatility in the foreign exchange market. 6. the banking sector was not affected as it had hardly any direct exposure to subprime assets. moreover, banks were well capitalised and inherently sound. the reduced foreign funding and the subdued domestic capital market, however, put pressure on some segments of the financial system, such as non - bank financial companies ( nbfcs ) and mutual funds. mutual funds were dependent on corporates for bulk funds. as liquidity needs of the corporates increased, redemption pressures on mutual funds rose. this translated into liquidity problems for nbfcs as mutual funds were important supplier of funds to nbfcs. further, the demand for bank credit also increased as external sources of credit dried up for corporates. against this background of increase in demand for liquidity, the reserve bank had to step in with liquidity augmenting measures such as cuts in cash reserve ratio ( crr ) and increase in refinance facilities. consequently, the pressure for funding liquidity came to rest on the banks. in this scenario, the banks continued to expand credit and meet the funds requirements of mutual funds and nbfcs aided by liquidity easing measures by the reserve bank. initially, though bank credit could not fully offset the shortfall in credit from other sources. subsequently, demand for bank credit came down as the contagion transmitted to the real economy and eroded private consumption and investment demand. impact on the

current monetary policy accommodation could, however, be different across countries depending on the balance of risk to growth and price stability, type of balance sheet adjustment that have taken place during the crisis and the position of the economy in the business cycle. in the case of advanced countries, where central bank balance sheets have expanded substantially including the portfolio comprising of mortgage backed securities, commercial papers and corporate bonds, the exit policies may be constrained by the speed of revival and developments in the specific market segments. in contrast, the central bank accommodation in india was mainly done through unwinding of mms and conduct of omo including laf and through special refinancing facilities in the banking system. thus, the withdrawal of monetary accommodation in india should be feasible without adverse impact on specific market segments. 24. the october 2009 review of monetary policy for the year 2009 – 10 brought forward the challenges. to quote : “ the precise challenge for the reserve bank is to support the recovery process without compromising on price stability. this calls for a careful management of trade - offs. growth drivers warrant a delayed exit, while inflation concerns call for an early exit. premature exit will derail the fragile growth, but a delayed exit can potentially engender inflation expectations …. the balance of judgment at the current juncture is that it may be appropriate to sequence the “ exit ” in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored. the “ exit ” process can begin with the closure of some special liquidity support measures. ” accordingly, the reserve bank has begun the first phase of “ exit ”, by withdrawal of most of the unconventional measure taken during the crisis. conclusion 25. to sum up, despite sound fundamentals and no direct exposure to the sub - prime assets, india was affected by global financial crisis reflecting increasing globalisation of the indian economy. the policy response has been swift. while fiscal stimulus cushioned the deficiency in demand, monetary policy augmented both domestic and foreign exchange liquidity. the expansionary policy stance of the reserve bank was manifested in significant reduction in crr as well as the policy rates. the contraction of the reserve bank ’ s balance sheet resulting from the decline in its foreign assets necessitated active liquidity management aimed at expanding domestic assets, which was ensured through omo including regular operations under the laf, unwinding of mss securities, introduction of new and scaling up of existing refinance facilities. in addition, sharp reductions in crr