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Report of the Central Board of Directors on the working of the Reserve Bank of Indiafor the year ended June 30, 2013 submitted to the Central Government in terms of

Section 53(2) of the Reserve Bank of India Act, 1934

RESERVE BANK OF INDIA ANNUAL REPORT2012-13

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CENTRAL BOARD / LOCAL BOARDS

GOVERNOR

D. Subbarao

DEPUTY GOVERNORS

K. C. Chakrabarty

Anand Sinha

H. R. Khan

Urjit R. Patel

DIRECTORS NOMINATED UNDER

SECTION 8 (1) (b) OF THE RBI ACT, 1934

Anil Kakodkar

Kiran S. KarnikM. V. Rajeev Gowda

Nachiket M. Mor

DIRECTORS NOMINATED UNDER

SECTION 8 (1) (c) OF THE RBI ACT, 1934

Y. H. Malegam

Azim Premji

Dipankar Gupta

G. M. Rao

Ela Bhatt

Indira Rajaraman

Y.C. Deveshwar

Damodar Acharya

DIRECTOR NOMINATED UNDER

SECTION 8 (1) (d) OF THE RBI ACT, 1934

Arvind Mayaram

Rajiv Takru

MEMBERS OF LOCAL BOARDS

WESTERN AREA

Kiran Karnik

K. Venkatesan

Dattaraj V. Salgaocar

Jayantilal B. Patel

EASTERN AREA

Nachiket M. Mor

Ms Anila Kumari

Sharif Uz-zaman Laskar

NORTHERN AREA

Anil Kakodkar

Ram Nath

Kamal Kishore Gupta

Mihir Kumar Moitra

A. Naveen Bhandary

SOUTHERN AREA

M.V.Rajeev Gowda

K. Selvaraj

Kiran Pandurang

As on August 8, 2013

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PRINCIPAL OFFICERS

EXECUTIVE DIRECTORS ....................................................................... G. Gopalakrishna ....................................................................... Deepak Mohanty ....................................................................... S. Karuppasamy

....................................................................... R. Gandhi

....................................................................... P. Vijaya Bhaskar

....................................................................... B. Mahapatra

....................................................................... G. Padmanabhan

....................................................................... Jasbir Singh ....................................................................... Deepali Pant JoshiCENTRAL OFFICECentral Vigilance Cell ................................................................................ Kaza Sudhakar, Chief Vigilance OfcerCustomer Service Department .................................................................. Supriya Pattnaik, Chief General ManagerDepartment of Banking Operations and Development .............................. Chandan Sinha, Principal Chief General ManagerDepartment of Banking Supervision .......................................................... G. Jaganmohan Rao, Principal Chief General ManagerDepartment of Communication .................................................................. Alpana I. Killawala, Principal Press Relation OfcerDepartment of Currency Management ...................................................... B.P. Vijayendra, Principal Chief General ManagerDepartment of Economic and Policy Research ......................................... B.M. Misra, Ofcer-in-ChargeDepartment of Expenditure and Budgetary Control .................................. S. Ganesh, Principal Chief General ManagerDepartment of External Investments and Operations................................ M. Sarkar Deb, Chief General ManagerDepartment of Government and Bank Accounts ....................................... S. Ganeshkumar, Chief General Manager-in-ChargeDepartment of Information Technology ...................................................... A.S. Ramasastri, Chief General Manager-in-ChargeDepartment of Non-Banking Supervision .................................................. N. S. Vishwanathan, Principal Chief General ManagerDepartment of Payment and Settlement Systems ..................................... Vijay Chugh, Chief General ManagerDepartment of Statistics and Information Management ............................ A.B. Chakraborty, Ofcer-in-ChargeFinancial Markets Department .................................................................. G. Mahalingam, Principal Chief General Manager

Financial Stability Unit .............................................................................. R.G. Warriar, Chief General ManagerForeign Exchange Department.................................................................. R.N. Kar, Chief General ManagerHuman Resource Management Department ............................................ U. S. Paliwal, Principal Chief General ManagerInspection Department .............................................................................. M. Sebastian, Principal Chief General ManagerInternal Debt Management Department .................................................... K.K. Vohra , Principal Chief General ManagerLegal Department ...................................................................................... G.S. Hegde, Principal Legal AdviserMonetary Policy Department ..................................................................... M. D. Patra, Principal AdviserPremises Department ................................................................................ K.R. Ananda, Principal Chief General ManagerRajbhasha Department ............................................................................. Ramakant Gupta, General ManagerRisk Monitoring Department ...................................................................... M. Rajeshwar Rao, Chief General ManagerRural Planning and Credit Department ..................................................... A. Udgata, Principal Chief General ManagerSecretarys Department ............................................................................. Bazil Shaikh, Principal Chief General Manager & SecretaryUrban Banks Department .......................................................................... A. K. Bera, Principal Chief General Manager

COLLEGES PRINCIPALSCollege of Agricultural Banking, Pune ....................................................... Meena HemchandraReserve Bank Staff College, Chennai ....................................................... Uma Subramaniam

OFFICES REGIONAL DIRECTORSChennai ..................................................................................................... J. SadakkadullaKolkata ....................................................................................................... B.P. KanungoMumbai ...................................................................................................... J.B. BhoriaNew Delhi .................................................................................................. Deepak Singhal

BRANCHESAhmedabad ............................................................................................... Sudarshan SenBangalore .................................................................................................. Uma ShankarBhopal ....................................................................................................... P.R. Ravi MohanBhubaneswar ............................................................................................. P. K. JenaChandigarh ................................................................................................ M. K. SinghGuwahati ................................................................................................... Pradyumna K. JenaHyderabad ................................................................................................. K.R. DasJaipur ......................................................................................................... Sathyan DavidJammu ....................................................................................................... K.K. SarafKanpur ....................................................................................................... Shekhar BhatnagarLucknow .................................................................................................... Arun PasrichaNagpur ....................................................................................................... Phulan Kumar

Patna ......................................................................................................... M.K. VermaThiruvananthapuram ................................................................................. Salim Gangadharan

OFFICERS-IN-CHARGEAgartala ..................................................................................................... A.K. Pandey, General ManagerBelapur ...................................................................................................... Ajay Michyari, General ManagerDehradun ................................................................................................... R.L. Sharma, General ManagerGangtok ..................................................................................................... E.E. Karthak, General ManagerKochi .......................................................................................................... C.V. George, General ManagerPanaji ......................................................................................................... Jaikish, General ManagerRaipur ........................................................................................................ Nirmal Chand, General ManagerRanchi ....................................................................................................... Saurav Sinha, General ManagerShillong ...................................................................................................... P. Shyam Sunder, Chief General ManagerShimla ........................................................................................................ I. S. Negi, General ManagerSrinagar ..................................................................................................... Ramesh Chand, Deputy General Manager

(As on August 8, 2013)

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PART ONE : THE ECONOMY: REVIEW AND PROSPECTS

I. ASSESSMENT AND PROSPECTS ............................................................................... 1

Assessment of 2012-13 ................................................................................................. 3

Prospects for 2013-14 .................................................................................................... 6

II. ECONOMIC REVIEW ..................................................................................................... 13

The Real Economy ......................................................................................................... 13

Price Situation ................................................................................................................ 26

Money and Credit ........................................................................................................... 38

Financial Markets ........................................................................................................... 43

Government Finances .................................................................................................... 54

External Sector ............................................................................................................... 59

PART TWO: THE WORKING AND OPERATIONS OF THE RESERVE BANK OF INDIA

III. MONETARY POLICY OPERATIONS ............................................................................. 67

Monetary Policy Operations: Context and Rationale ...................................................... 67

IV. CREDIT DELIVERY AND FINANCIAL INCLUSION ..................................................... 75

Credit Delivery ................................................................................................................ 75

Financial Inclusion .......................................................................................................... 79

Financial Literacy Activities ............................................................................................ 82

V. DEVELOPMENT AND REGULATION OF FINANCIAL MARKETS .............................. 84 Government Securities Market ....................................................................................... 84

Foreign Exchange Market............................................................................................... 86

Derivatives Market .......................................................................................................... 92

VI. REGULATION, SUPERVISION AND FINANCIAL STABILITY ..................................... 93

Financial Stability Assessment ....................................................................................... 93

Assessment of the Banking Sector ................................................................................. 95

Major Decisions Taken by Board for Financial Supervision ............................................ 97

Commercial Banks ......................................................................................................... 97

Customer Service ........................................................................................................... 104

Banking Codes and Standards Board of India ............................................................... 105

Urban Co-operative Banks ............................................................................................. 105

Rural Co-operatives ........................................................................................................ 109

Deposit Insurance and Credit Guarantee Corporation ................................................... 110

Non-Banking Financial Companies ................................................................................ 110

CONTENTS

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INDEX OF APPENDIX TABLES

1. Macroeconomic and Financial Indicators ....................................................................... 179

2. Growth Rates and Sectoral Composition of Real Gross Domestic Product .................. 1823. Gross Domestic Saving and Investment ......................................................................... 183

4. Financial Saving of the Household Sector (Gross) ......................................................... 184

5. Agricultural Production ................................................................................................... 185

6. Procurement, Off-Take and Stocks of Foodgrains .......................................................... 186

7. Trends in Index of Industrial Production ......................................................................... 187

8. Variations in Index Numbers of Wholesale Prices .......................................................... 188

9. Variations in Reserve Money .......................................................................................... 189

10. Variations In Money Stock .............................................................................................. 190

11. Sectoral Deployment of Gross Bank Credit .................................................................... 191

12. Capital Market - Primary and Secondary ....................................................................... 192

13. Turnover in Indian Derivatives Market ............................................................................ 193

14. Indices of Real Effective Exchange Rate (Reer) andNominal Effective Exchange Rate (Neer) of the Indian Rupee ....................................... 194

15. Key Fiscal Indicators ....................................................................................................... 195

16. Budgetary Operations of the State Governments ........................................................... 196

17. Indias Exports and Imports ............................................................................................ 197

18. Indias Overall Balance of Payments .............................................................................. 198

19. Foreign Direct Investment Flows to India: Country-Wise and Industry-wise................... 199

20. Indias Foreign Exchange Reserves ............................................................................... 200

21. Indias External Debt ...................................................................................................... 201

BOXES

II.1 Industrial Slowdown: Causes and Remedies ................................................................. 19

II.2 Indian Coal Sector: Issues & Strategies ......................................................................... 23

II.3 Pricing Power and Ination ............................................................................................. 31

II.4 Core Ination: Alternate Methodologies ......................................................................... 32

II.5 Producer Price Index: The Concept and Measurement .................................................. 33II.6 Role of Forward-looking Surveys in Monetary Policy Formulation ................................. 41

II.7 Unconventional Monetary Policy by Central Banks in Developed Economies:Impact on Financial Markets ........................................................................................... 44

II.8 Relationship between Exchange Rate Volatility and Futures Trading in India ................ 52

II.9 Non Deliverable Forward Market and Onshore INR Market:Evidence on Inter-linkages ............................................................................................. 53

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II.10 Cyclicality of Fiscal Policy: The Indian Experience ......................................................... 55

II.11 Recommendations of the Working Group to Study Issues relating to

Gold Imports and Gold Loan NBFCs in India ................................................................. 61III.1 Sensitivity of Investment and Growth to Change in Real Interest Rate .......................... 72

III.2 Measurement of Ination Expectations .......................................................................... 74

IV.1 Recommendations of Expert Committee to examine the Three-TierShort-Term Rural Co-operative Credit Structure (STCCS) ............................................. 79

IV.2 Guidelines on Basic Savings Bank Deposit Accounts for Financial Inclusion ................ 81

V.1 Buyback/ Switches for Liability Management ................................................................. 85

VI.1 India: Financial Sector Stability Assessment .................................................................. 94

VI.2 Impact of NPAs on protability of banks ......................................................................... 96

VI.3 Review of prudential guidelines on restructuring of advances by banks andnancial institutions Major recommendations of the Working Group ........................... 100

VI.4 Licensing of new banks in private sector ........................................................................ 103

VI.5 Deposit Insurance in the Financial System Some Observations ................................. 111

VI.6 NBFC-Factors ................................................................................................................. 112

VI.7 Legal developments in the banking sector ..................................................................... 113

VI.8 Major recommendations of the Financial Sector Legislative Reform Commission ......... 115

VII.1 Issuance of Ination Indexed Bonds ............................................................................... 118

VIII.1 Plastic Banknotes ........................................................................................................... 123

IX.1 Vision Document 2012-15 .............................................................................................. 130

IX.2 Technical Committee to Examine Uniform Routing Code andAccount Number Structure ............................................................................................. 131

IX.3 Committee to Recommend Implementation of GIRO-based paymentsystems in India .............................................................................................................. 134

IX.4 Cloud Computing - Trends, Issues and Concerns .......................................................... 136

X.1 RBIQ ............................................................................................................................... 146

X.2 Shashi Rajagopalan Memorial Awards ........................................................................... 147

X.3 Code of Ethics and Governance ..................................................................................... 150

XI.1 Technical Committee to review the form of presentation of the

Balance Sheet and Prot & Loss Account ...................................................................... 154

CHARTS

II.1 Real GDP Growth ........................................................................................................... 13

II.2 Expenditure Side of GDP ............................................................................................... 14

II.3 Rate of Saving and Investment ....................................................................................... 15

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II.38 Average daily volume and 10-Year Generic Yield ........................................................... 48

II.39 Yield on 5-Year Corporate Bond ..................................................................................... 48

II.40 Trading Value of the Central Government dated Securities and Corporate Bonds ......... 49

II.41 Resource Mobilisation through SME IPOs during 2012-13 ............................................ 49

II.42 Sectoral Pattern of SME IPOs ........................................................................................ 49

II.43 FII and Mutual Fund Investment in the Equity Market .................................................... 50

II.44 Movement of Sectoral Indices of BSE ............................................................................ 50

II.45 Turnover in Equity Derivative Segment in 2012-13 ......................................................... 51

II.46 House Price Indices ........................................................................................................ 54

II.47 Key Decit Indicators of the Central Government ........................................................... 57

II.48 Disinvestment ................................................................................................................ 57II.49 Major Subsidies of Central Government ......................................................................... 57

II.50 Trend in select expenditures ........................................................................................... 58

II.51 India's Merchandise Trade .............................................................................................. 59

II.52 GDP growth and Import .................................................................................................. 60

II.53 Trend in International Oil Prices and Quantum of POL Imports ..................................... 60

II.54 Trends in Major Components of Capital Flows (Net) ...................................................... 63

II.55 Spread between 10-year Sovereign Yield of India and USA .......................................... 64

II.56 Exchange Rate Movements and Current Account Decit ............................................... 64

II.57 Appreciation/Depreciation of Indian Rupee and Movement against US dollar ............... 65

III.1 Estimated Weighted Average Lending Rates - Real and Nominal .................................. 72

VII.1 Cash Balance of the Central Government ...................................................................... 119

TEXT TABLES

II.1 Changes in Employment................................................................................................. 26

II.2 Increases in Select Farm Input Prices ............................................................................ 29

II.3 Professional Forecasters WPI and CPI Ination Median Forecastfor 5 and 10 Years Ahead................................................................................................ 37

II.4 Bank Group Wise Asset Quality Indicators ..................................................................... 41

II.5 Primary Market Trends ................................................................................................... 50

II.6 Key Stock Market Indicators ........................................................................................... 51

II.7 External Sector Vulnerability Indicators .......................................................................... 65

III.1 Movement in Money Market Rates and Deposit/Lending Rates of Banks ...................... 70

III.2 Modal Deposit Rates, WALRs and NPAs of SCBs (Excluding RRBs) ............................ 71

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III.3 Sectoral Median Lending Rates of Scheduled Commercial Banks ............................... 71

IV.1 Priority Sector Advances ................................................................................................ 75

IV.2 Recovery of Direct Agriculture Advances ....................................................................... 76

IV.3 Credit to Micro and Small Enterprises by SCBs ............................................................. 77

IV.4 Financial Inclusion Plan - Summary progress of all banks including RRBs ................... 82

VI.1 Select Financial Indicators .............................................................................................. 96

VI.2 Year-wise progress in mergers/acquisitions as on March 31, 2013 ................................ 108

VI.3 State-wise progress in mergers/acquisition of UCBs ..................................................... 108

VII.1 Gross and Net Market Borrowings of the Central Government ...................................... 116

VII.2 Central Governments Market Loans - A Prole ............................................................. 116

VII.3 Issuance of GoI Dated Securities- Maturity Pattern ....................................................... 117VII.4 States' Market Borrowings .............................................................................................. 119

VII.5 Residual Maturity Prole of Outstanding State DevelopmentLoans and Power Bonds (as at end-March 2013) ......................................................... 119

VII.6 Utilisation of WMA/OD and Investment of State Governments(Average monthly outstanding) ....................................................................................... 120

VII.7 No. of Days States Availed of Special/ Normal WMA and OD ........................................ 120

VII.8 Investments in ITBs and ATBs by State Governments/UTs ............................................ 121

VIII.1 Banknotes in Circulation ................................................................................................. 123

VIII.2 Coins in Circulation ......................................................................................................... 123VIII.3 Currency Chests and Small Coin Depots as at end-December 2012 ............................ 124

VIII.4 Indent and Supply of Banknotes by the Presses to RBI (April-March) ........................... 124

VIII.5 Indent and Supply of Coins by the Mints to RBI (April-March) ....................................... 124

VIII.6 Disposal of Soiled and Supply of Banknotes by the Reserve Bank to the Currency Chests ............................................................................................................. 125

VIII.7 Number of Counterfeit Notes Detected (April-March) ..................................................... 125

VIII.8 Denomination-wise Counterfeit Notes Detected by the Banking System (April-March) . 126

IX.1 Payment System Indicators - Annual Turnover ............................................................... 128

X.1 Reserve Bank Training Establishments Programmes Conducted ............................... 146

X.2 Number of Ofcers Trained in External Training Institutions in India and Abroad ........... 147

X.3 Category-wise Actual Staff Strength (As on June 30, 2013) .......................................... 148

X.4 Reserve Bank's Ofce-wise Staff Strength (As on June 30, 2013) ................................ 149

XI.1 Holding of Gold ............................................................................................................... 155

XI.2 Deposits : Others ............................................................................................................ 157

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XI.3 Details of Other Liabilities ............................................................................................... 158

XI.4 Balances in Contingency Reserve and Asset Development Reserve ............................ 159

XI.5 Balances in Currency and Gold Revaluation Account (CGRA),

Exchange Equalisation Account (EEA) and InvestmentRevaluation Account (IRA) ............................................................................................. 160

XI.6 Details of Foreign Currency Assets ................................................................................ 161

XI.7 Investments of the Banking Department ........................................................................ 161

XI.8 Holdings in subsidiaries/associates ................................................................................ 162

XI.9 Details of Other Assets ................................................................................................... 163

XI.10 Gross Income ................................................................................................................. 163

XI.11 Earnings from Foreign Sources ...................................................................................... 164

XI.12 Earnings from Domestic Sources ................................................................................... 164

XI.13 Expenditure .................................................................................................................... 165

XI.14 Agency Charges ............................................................................................................. 166

XI.15 Trends in Gross Income, Expenditure and Net Disposable Income ............................... 167

XI.16 Contingency and Asset Development Reserves ............................................................ 173

XI.17(a) Foreign Exchange Reserves(in Rupees) ........................................................................ 173

XI.17(b) Foreign Exchange Reserves(in USD)............................................................................. 173

XI.18 Assumptions made for arriving at actuarial valuation of superannuation liabilities ......... 174

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LIST OF ABBREVIATIONS

ACP - Annual Credit PlanACP (Ch VI) - Autorit de Contrle PrudentielADF - Automated Data FlowADR - American Depository Receipt

ADWDRS - Agricultural Debt Waiver and Debt ReliefScheme

AEs - Advanced EconomiesAFA - Additional Factor of AuthenticationAGL - Aggregate Gap LimitAIFI - All India Financial InstitutionsAIRB - Advanced Internal Rating BasedASA - Alternative Standardised ApproachASBA - Applications Supported by Blocked

Amount

AMA - Advanced Measurement ApproachAMC - Asset Management CompanyAML - Anti Money LaunderingANBC - Adjusted Net Bank CreditAPMC - Agricultural Produce Marketing

Committee

ARCH - Autoregressive ConditionalHeteroskedasticity

ARMS - Auditing and Risk ManagementSub-Committee

ATBs - Auction Treasury BillsATM - Automated Teller MachineBC - Business CorrespondentBCBS - Basel Committee on Banking SupervisionBCM - Bank for Currency Management

BCPs - Basel Core PrinciplesBCSBI - Banking Codes and Standards Board of

India

BE - Budget EstimatesBFS - Board for Financial Supervision

BIC - Bayesian Information CriteriaBKC - Bandra Kurla ComplexBIA - Basic Indicator ApproachBO - Banking OmbudsmanBoJ - Bank of JapanBoP - Balance of PaymentsBPM6 - Balance of Payments Manual 6

BPO - Business Process OutsourcingBSBDA - Basic Savings Bank Deposit AccountBSE - Bombay Stock ExchangeCAB - College of Agricultural BankingCAD - Current Account DecitCAFRAL - Centre for Advanced Financial Research

and Learning

CBLO - Collateralised Borrowing and LendingObligation

CBS - Core Banking SolutionCCB - Central Cooperative BankCCI - Cabinet Committee on InvestmentsCCIL - Clearing Corporation of India Ltd.CCP - Cheque Collection Policies

CD - Certicate of DepositCDS - Credit Default SwapsCDS - Centre for Development StudiesCERC - Central Electricity Regulatory

Commission

CERSAI - Central Registry of Securitisation AssetReconstruction and Security Interest ofIndia

CEO - Chief Executive Ofcer

CFSA - Committee on Financial SectorAssessment

CFT - Combating Financing of TerrorismCFM - Carbon Footprint Mapping

CIC - Central Information Commission

CIC - Core Investment CompanyCISO - Chief Information Security Ofcer

CIT - Cash in Transit

CNP - Card Not PresentCNX - CRISIL NSE IndexCoR - Certicate of RegistrationCP - Commercial PaperCP (Ch IX) - Card PresentCPGRAMS - Centralised Public Grievances

Redressal and Monitoring System

CPI - Consumer Price IndexCPSS - Committee on Payments and

Settlements System

CRAR - Capital to Risk Weighted Assets RatioCROMS - Clearcorp Repo Order Matching System

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CRR - Cash Reserve RatioCSD - Customer Service Department

CSF - Consolidated Sinking FundCSO - Central Statistics OfceCTS - Cheque Truncation SystemCVA - Credit Valuation Adjustment

CWC - Central Warehousing Corporation

DARPG - Department of Administration Reformsand Public Greviences

DBT - Direct Benet TransferDCC - District Consultative CommitteeDCCB - District Central Cooperative BankDCCO - Date of Commencement of Commercial

Operations

DFC - Dedicated Freight CorridorDGCA - Director General of Civil AviationDICGC - Deposit Insurance and Credit Guarantee

Corporation

DIF - Deposit Insurance FundDLRC - District Level Review CommitteeDMIC - Delhi Mumbai Industrial CorridorDOTS - Direction of Trade StatisticsDP - Dynamic ProvisionsDR - Disaster Recovery

DRG - Development Research GroupDTA - Domestic Tariff AreaDTC - Direct Tax CodeDTL - Demand and Time LiabilitiesDvP - Delivery versus PaymentEBT - Electronic Benet TransferECB - European Central BankECBs - External Commercial BorrowingsECCS - Express Cheque Clearing SystemECM - Error Correction ModelECS - Electronic Clearing ServiceEEFC - Exchange Earners Foreign CurrencyEGARCH - Exponential Generalised Autoregressive

Conditional Heteroskedasticity

EKP - Enterprise Knowledge PortalEMDEs - Emerging Market and Developing

Economies

EL - Expected Loss

EOI - Expression of Interest

EOU - Export Oriented UnitEPC - Engineering, Procurement and

Construction

EPZ - Export Processing ZoneERM - Enterprise-wise Risk Management

ETC - Electronic Toll CollectionETF - Exchange Traded FundEWG - Early Warning GroupEU - European UnionF & O - Future & Options

FAO - Food and Agriculture OrganisationFASB - Financial Accounting Standards Board

FCCB - Foreign Currency Convertible BondsFCNR(B) - Foreign Currency Non-Resident(B)FC-XIII - Thirteenth Finance CommissionFCs - Financial ConglomeratesFCI - Food Corporation of India

FDI - Foreign Direct InvestmentFED - Foreign Exchange DepartmentFEMA - Foreign Exchange Management ActFETERS - Foreign Exchange Transactions

Electronic Reporting System

FIAC - Financial Inclusion Advisory CommitteeFII - Foreign Institutional InvestorFIMMDA - Fixed Income Money Market and

Derivatives Association

FIP - Financial Inclusion PlanFIRB - Foundation Internal Rating-BasedFLC - Financial Literacy Centre

FMCG - Fast Moving Consumer GoodsFRA - Forward Rate AgreementFSA - Fuel Supply AgreementFSAP - Financial Sector Assessment

Programme

FSB - Financial Stability BoardFSDC - Financial Stability and Development

Council

FSI - Financial Soundness IndicatorFSLRC - Financial Sector Legislative Reforms

Commission

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FSR - Financial Stability Report

G20 - Group of 20GAAR - General Anti-Avoidance Rule

GARCH - Generalised Autoregressive ConditionalHeteroskedasticity

GDCF - Gross Domestic Capital FormationGRF - Guarantee Redemption FundGDP - Gross Domestic ProductGDR - Global Depository ReceiptGDS - Gold Deposit SchemeGFCE - Government Final Consumption

Expenditure

GFCF - Gross Fixed Capital Formation

GFD - Gross Fiscal Decit

GHG - Green House GasGoI - Government of IndiaGSDP - Gross State Domestic ProductG-sec - Government SecuritiesGST - Goods and Services TaxGVA - Gross Value AddedHCL - Hindustan Copper Ltd.HLFC - High Level Steering Committee

HP - Hodrick PrescottHTM - Held to Maturity

IASB - International Accounting StandardsBoard

IBAN - International Bank Account NumberIBPS - India Bill Payment SystemICCL - Indian Clearing Corporation Ltd.ICERT - Indian Computer Emergency Response

Team

ICT - Information and CommunicationTechnology

IDRBT - Institute for Development and Researchin Banking Technology

IFC - Indian Financial CodeIFRS - International Financial Reporting

Standards

IFSC - Indian Financial System CodeIGIDR - Indira Gandhi Institute of Development

Research

IIB - Ination Indexed Bond

IIBM - Indian Institute of Bank Management

IIM - Indian Institute of Management

IIP - Index of Industrial ProductionIMA - Internal Models ApproachIMF - International Monetary FundINR - Indian RupeeInd AS - Indian Accounting Standards

IOSCO - International Organisation of SecuritiesCommissions

IP - Internet ProtocolIPA - Issuing and Paying AgentIPO - Initial Public OfferingIRAC - Income Recognition and Asset

Classication

IRB - Internal Ratings-BasedIRDA - Insurance Regulatory and Development

Authority

IRF - Impulse Response FunctionIRF - Interest Rate FuturesIRF - Inter Regulatory Forum

IRS - Interest Rate SwapsIS - Information SystemsISACA - Information Systems Audit and Control

Association

ISO - International Organisation forStandardisation

iSOC - Information Security Operations CentreIT - Information TechnologyITBs - Intermediate Treasury BillsITEs - Inter-group Transactions and ExposuresITP - India-IMF Training Programme

ITSC - Information Technology Sub-CommitteeIVRS - Interactive Voice Response SystemJV/WOS - Joint Venture/Wholly Owned Subsidiary

KAs - Key AttributesKCC - Kisan Credit CardKYC - Know Your CustomerLAB - Local Area BankLAF - Liquidity Adjustment FacilityLBS - Lead Bank SchemeLCR - Liquidity Coverage Ratio


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LGD - Loss Given DefaultLIC - Life Insurance Corporation of India

LPA - Long Period AverageLPG - Liqueed Petroleum GasLRM - Liquidity Risk ManagementLSAP - Large Scale Asset PurchaseLTV - Loan to ValueMA & ST - Management Audit & System Inspection

MCA - Ministry of Corporate AffairsMCX-SX-CCL - MCX-SX Clearing Corporation LimitedMDR - Merchant Discount RateMF - Mutual FundMIBOR - Mumbai Interbank Offer Rate

MICR - Magnetic Ink Character RecognitionMoU - Memorandum of UnderstandingMMoU - Multilateral Memorandum of

Understanding

MSCI - Morgan Stanley Capital InternationalMSE - Micro and Small EnterprisesMSF - Marginal Standing FacilityMSME - Micro, Small and Medium EnterprisesMTSS - Money Transfer Service SchemeNABARD - National Bank for Agriculture and Rural

Development

NACH - National Automated Clearing HouseNALCO - National Aluminium Company Ltd.NBCC - National Buildings Construction

Corporation Ltd.

NBFC-IFC - Non-Banking Financial Companies-Infrastructure Finance Companies

NBFC-MFI - Non-Banking Financial Companies-Micronance Institutions

NBFCs - Non-Banking Financial CompaniesNCD - Non-Convertible Debenture

NCFE - National Centre for Financial EducationNDF - Non-Deliverable ForwardNDS-OM - Negotiated Dealing System- Order

Matching System

NECS - National Electronic Clearing ServiceNEER - Nominal Effective Exchange RateNEFT - National Electronic Fund Transfer

NGO - Non-Governmental OrganisationNG-RTGS - Next Generation RTGSNHAI - National Highway Authority of India

NHB - National Housing BankNIBM - National Institute of Bank ManagementNIM - Net Interest MarginNIMZ - National Investment and Manufacturing

Zone

NMDC - National Mineral DevelopmentCorporation

NMP - National Manufacturing Policy

NOC - No Objection CerticateNOF - Net Owned Funds

NOFHC - Non-Operative Financial HoldingCompany

NOOP - Net Overnight Open PositionNOOPL - Net Overnight Open Position Limited

NPA - Non Performing AssetNPCI - National Payments Corporation of IndiaNPV - Net Present ValueNR(E)RA - Non-Resident (External) Rupee AccountNRE - Non Resident ExternalNREGA - National Rural Employment Guarantee

Act

NRI - Non Resident IndianNRO - Non Resident OrdinaryNSCCL - National Securities Clearing Corporation

Ltd.

NSE - National Stock ExchangeNSFE - National Strategy for Financial EducationNSM - Note Sorting MachineNSSO - National Sample Survey OrganisationNTPC - National Thermal Power CorporationOBC - Other Backward Class

OBE - Off-Balance sheet ExposureOBO - Ofces of the Banking Ombudsman

OD - OverdraftOEA - Ofce of Economic AdviserOECD - Organisation for Economic Cooperation

and Development

OIL - Oil India Ltd.


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OIS - Overnight Index SwapOMC - Oil Marketing CompaniesOMO - Open Market OperationOPEC - Organisation of Petroleum Exporting

Countries

OFRS - Online Return Filing SystemOTC - Over the CounterOVL - Oil and Natural Gas Corporation Videsh

Ltd.

PACS - Primary Agricultural Credit SocietiesPAN - Permanent Account NumberPB - Price to BookPDO-NDS - Public Debt Ofce-Negotiated Dealing

System

PD - Primary DealerPE - Price EarningsPFCE - Private Final Consumption Expenditure

PFMIs - Principles for Financial MarketInfrastructures

PPRDA - Pension Fund Regulatory andDevelopmental Authority

PIO - Persons of Indian Origin

PLF - Plant Load Factor

PMLA - Prevention of Money Laundering ActPMO - Prime Ministers Ofce

POL - Petroleum, Oil and LubricantsPOS - Point of SalePPI - Producer Price IndexPPI - Prepaid Payment InstrumentPPP - Public Private PartnershipPSB - Public Sector BankPSS - Perimeter Security SolutionPSU - Public Sector Undertaking

QE - Quantitative EasingQARC - Qualied Audit Report Review CommitteeQIP - Qualied Institutional PlacementQRB - Quality Review BoardR&D - Research and DevelopmentRBI - Reserve Bank of IndiaRBIA - Risk Based Internal Audit

RBIQ - RBI Inter-school QuizRBI WPS - RBI Working Paper Series

RBS - Risk Based SupervisionRBSC - Reserve Bank Staff CollegeRCF - Rashtriya Chemicals and Fertilisers Ltd.RD - Revenue DecitRE - Revised EstimatesRECS - Regional Electronic Clearing ServiceREER - Real Effective Exchange RateRFP - Request for Proposal

RIDF - Rural Infrastructure Development FundRMA - Royal Monetary Authority

RoA - Return on AssetRoE - Return on EquityRRB - Regional Rural BankRTGS - Real Time Gross Settlement SystemRTI - Right to InformationS&P - Standard and Poor'sSAARC - South Asian Association for Regional

Cooperation

SAIL - Steel Authority of India Ltd.SBC - Schwarz Bayesian CriterionSBS - Shredding and Briquetting System

SCB - Scheduled Commercial BankSDL - State Development LoansSEACEN - South East Asian Central BanksSEBI - Securities and Exchange Board of IndiaSEZ - Special Economic ZoneSHG - Self Help Group

SIDBI - Small Industries Development Bank ofIndia

SIFI - Systemically Important FinancialInstitution

SLBC - State Level Bankers' Committee

SLR - Statutory Liquidity RatioSME - Small and Medium EnterpriseSMM - Standardised Measurement MethodSOFTEX - Software Export DeclarationSP - Specic Provisions

StCB - State Cooperative BankSTCCS - Short Term Cooperative Credit Structure


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This Report can also be accessed on InternetURL : www.rbi.org.in

STCRC - Short Term Cooperative Rural CreditSTPI - Software Technology Parks of IndiaSWC - State Warehousing Corporation

SWIFT - Society for Worldwide InterbankFinancial Telecommunication

T-bill - Treasury BillTERI - The Energy and Resources Institute

TFYP - Twelfth Five Year PlanTSA - The Standardised ApproachUAE - United Arab EmiratesUCBs - Urban Cooperative BanksUCIC - Unique Customer Identication CodeUID - Unique Identication NumberUNCTAD - United Nations Conference on Trade

and DevelopmentUS - United StatesUVI - Unit Value IndicesVA-PT - Vulnerability Assessment-Penetration

Testing

VAR - Vector Autoregression

VaR - Value at Risk

VC - Video Conferencing

VECM - Vector Error Correction ModelWADR - Weighted Average Discount Rate

WAEIR - Weighted Average Effective Interest Rate

WDRA - Warehousing Development andRegulatory Authority

WEF - World Economic Forum

WLAs - White Label ATMs

WMA - Ways and Means Advances

WPI - Wholesale Price Index

XBRL - eXtensible Business ReportingLanguage

XML - Extreme Markup Language

YTM - Yield to Maturity

ZTC - Zonal Training Centre


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compensatory supply response in the short run

amid unclear regulatory environment. Mining of coaland iron ore were particularly affected and theconsequent coal shortages spilled over as an inputsupply constraint for the power sector, adverselyimpacting both its current output and investments.Manufacturing output nearly stagnated, recordinga dismal 1.0 per cent growth y-o-y during 2012-13,as structural constraints and governance issuesclogged production activity. Growth also slowed dueto cyclical factors in both external and domesticdemand. Subdued growth in world trade kept exportdemand low. Domestic demand deceleration waspartly due to the lagged impact of monetarytightening during January 2010October 2011 in

ASSESSMENT AND PROSPECTSI

THE ANNUAL REPORT ON THE WORKING OF THE RESERVE BANK OF INDIA

For the Year July 1, 2012 to June 30, 2013 *

PART ONE: THE ECONOMY - REVIEW AND PROSPECTS

I.1 Growth decelerated further in 2012-13 to a

10-year low of 5.0 per cent. The slowdown alsobecame more pervasive across sectors, includingservices. Growth had averaged 8.8 per cent during2005-06 to 2010-11, despite a low of 6.7 per centin 2008-09 due to the external shock. Thesubsequent slowdown was primarily exacerbatedby structural bottlenecks and governance issues,although high ination, monetary tightening andglobal factors also played a role.

I.2 In terms of industrial performance, mining

output contracted for the second consecutive year,as structural constraints came to fore with theclampdown on illegal mining and an inadequate

Macroeconomic conditions deteriorated during 2012-13, posing several challenges in 2013-14 so far. Growth slowed further in 2012-13, due to structural constraints and weak external demand. Also, vulnerabilities surfaced with the widening current account deficit (CAD), high fiscal deficit earlier in the year and deterioration in asset quality. Reflecting these developments, the Reserve Bank undertook calibrated monetary easing, allowing transmission to complete from the past two years of monetary tightening. Consequently, headline inflation moderated in the later

part of the year, helped in part by the negative output gap. Concerted efforts in the second half of the year helped correct fiscal deficit to a significant extent. However, macroeconomic risks have since amplified, as the global interes rate cycle is reversing following the US Feds indications of likely tapering of quantitative easing (QE). Emerging market economies, particularly those with CAD, have come under pressure due to capital outflows. The Reserve Bank and the Government have taken several steps to address volatility in the foreign exchange market and narrowthe CAD. However, global risks coupled with domestic structural impediments have dampened prospects of a recovery

in 2013-14 and posed immediate challenges for compressing CAD and staying on the fiscal consolidation path. Inthis milieu, it is important to preserve macro-financial stability to rebuild growth on a sustainable basis.

* While the Reserve Bank of Indias accounting year is July-June, data on a number of variables are available on a nancial year basis, i.e. ,AprilMarch, and hence, the data are analysed based on the nancial year. Where available, the data have been updated beyond March2013. For the purpose of analysis and to provide proper perspective on policies, reference to past years as also prospective periods,wherever necessary, has been made in this Report.

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response to high ination. Agricultural growth alsodecelerated to below trend, due to the spatially andtemporally decient monsoon that impacted kharif production. Two years of industrial slowdown anddampened demand has slowed down servicessector activity as well.

I.3 The negative output gap that emerged withgrowth staying below potential and past monetarytightening helped moderate headline wholesaleprice index (WPI) ination towards the end of theyear. Headline ination, which had risen sharply inH2 of 2009-10 to reach double digits had promptedReserve Bank to assume an anti-inflationarymonetary policy stance. As ination averaged close

to double digits during 2010-11 and 2011-12, theReserve Bank persisted with this stance. DuringJanuary 2010 and October 2011, monetary policywas tightened through a cumulative increase ineffective policy rate by 525 basis points (bps) (fromreverse repo rate of 3.25 per cent to repo rate of8.5 per cent) and an increase in the cash reserveratio (CRR) by 100 bps from 5.0 per cent to 6.0 percent. Monetary tightening was spread over anextended period, as policy rates had to be raisedfrom the low levels that they reached consequent

to the crisis-driven stimulus and ination expectationsremained elevated.

I.4 Though growth began decelerating in H1 of2011-12, inflation stayed near double digits,prompting Reserve Bank to keep monetary policyin tightening mode. However, with inflationprojections suggesting that it would start recedingin Q4 of 2011-12, the Reserve Bank pausedtightening in its December 2011 mid-QuarterReview. With signs that ination was moderating inline with projections and with demand-sidepressures starting to ebb, the Reserve Bankprepared grounds for a policy-easing cycle byimparting more liquidity through aggressive CRRcuts of 125 bps in Q4 of 2011-12. This was followedup with 100 bps cuts in the policy rate, another 75bps reduction in the CRR on a cumulative basisduring 2012-13 and a 100 bps reduction in the SLR

besides a liquidity injection of ` 1.5 trillion throughOMOs. The accentuation of risks to macroeconomicstability arising from the twin decits in the form ofwide scal and current account decits and inationpersistence inhibited the Reserve Bank from takinga more pro-active growth-supportive stance despitegrowth slowing down more than anticipated, mainlyon account of structural constraints and governanceissues. The expected scal correction came laterin the year, by which time worries on the CAD fronthad mounted and emerged as the biggest macro-economic risk.

I.5 The Reserve Bank cut the repo rate byanother 25 bps to 7.25 per cent in early May 2013

in continuation of its growth-supportive monetarypolicy stance. However, the Federal ReserveChairmans comments subsequent on May 22,indicating likely tapering of quantitative easing (QE)altered global nancial conditions in a signicantway. It triggered global bond sell-offs that generatedlarge capital outflows from emerging markets,including India, and imparted signicant downwardpressures on emerging market currencies acrossthe world. Considering the global and domesticmacro-nancial conditions and the risks to the CAD,

the Reserve Bank paused in its mid-quarter reviewon June 17, 2013. Financial market pressuresexacerbated after further indications from the Fedthat it could completely wind down QE by the middleof 2014 precipitating sudden stop and a reversal ofportfolio investment ows. With continued capitaloutows, mounted concerns over the nancing ofthe CAD during 2013-14. Amid these strains, therupee depreciated by 7.5 per cent against the USdollar during May 22July 15 and large volatilitywas observed in the foreign exchange market.

There have been signicant FII outows of aboutUS$ 14.6 billion during May 27 to August 9, 2013which extended sharp downwards pressure onexchange rate.

I.6 In response, on July 15, 2013, the ReserveBank announced a package of liquidity tighteningmeasures to contain volatility in the foreign

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exchange market. It also announced additionalmeasures on July 23, 2013 and on August 8, 2013.The measures included increasing the marginalstanding facility (MSF) rate and the bank rate by200 bps to 10.25 per cent, announcing an auctionof ` 120 billion in open market sales of governmentsecurities, capping LAF borrowing access for eachindividual bank at 0.5 per of its NDTL andincreasing the minimum daily maintenance of CRRfrom 70 per cent to 99 per cent of the daily averagerequirement on a fortnightly basis. Further, onreview of the earlier measures, the Reserve Bankon August 8, 2013 announced auction ofGovernment of India Cash Management Bills(CMBs). Accordingly, ` 220 billion of CMBs wereauctioned in the following week.

I.7 The strategy to restrain domestic liquidityhad the immediate impact of stabilising the rupee,although interest rates in the money and debtmarkets rose. During July 15-29, the rupeeappreciated by 1.3 per cent. Against this backdrop,the Reserve Bank continued to hold policy ratesand its stipulation on reserve requirements in itsFirst Quarter Review on July 30, 2013. In its forwardguidance it indicated its intention to roll back the

liquidity tightening measures in a calibrated manneras stability is restored to the foreign exchangemarket, so that the monetary policy could revert tosupporting growth with continued vigil on ination.Post-policy review, the rupee came under freshpressure and it depreciated by 3.0 per cent withintwo days till end-July 2013.

I.8 Amidst continuing rupee volatility in Augustand easing liquidity conditions during July and earlyAugust 2013 along with forward looking assessment

of liquidity conditions, the Government and ReserveBank decided to auction CMBs.

I.9 The intensification of exchange marketvolatility has prompted the Reserve Bank toundertake unconventional measures in order torestore stability in the currency market so thatmacro-nancial conditions remain supportive of

sustainable growth. It is in this context that themeasures should be seen as part of an integratedpackage comprising policies to create a conduciveenvironment for capital inows and to discourageimports of gold. However, complementary action topush forward structural reforms to reduce the CADand accelerate growth, while increasing savingsand investment, will be needed to move towardsinternal and external balance.

ASSESSMENT OF 2012-13

I.10 The year 2012-13 was marked by slowinggrowth, lingering ination, large scal and currentaccount gaps and deteriorating asset quality. Thus,monetary policy was faced with a Hobsons choice.With growth decelerating further and staying belowtrend for the second consecutive year, ordinarilythe policy response would have been anaccommodative monetary policy. The ReserveBank did ease monetary policy, but in a calibratedmanner. There was clearly a demand from industryand financial markets for a more aggressiveeasing. At the same time, there were worries thatconsumer price ination was hurting people andthat the Reserve Bank was not able to subdue

inflation. Persisting inflation was eroding thecompetitive efciency of the economy and loweringthe financial savings of households with itsadverse consequences for the CAD, investmentand long-term growth. The Reserve Bank didcarefully weigh all information and options and,as the year progressed, it calibrated monetarypolicy in line with the evolving macroeconomicdynamics.

I.11 In assessing the developments of 2012-13it is important to understand (i) why growth slowedfurther in 2012-13, (ii) why ination, after a modestdecline towards the end of 2011-12, continued tolinger above its growth-neutral threshold, (iii) whythe scal decit widened in H1 of 2012-13 beforethe scal retrenchment in H2 and (iv) why the CADwidened and how external sector fragilitiesimpacted the economy.

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Causes for economic slowdown

I.12 Growth slowdowns are typically associatedwith cyclical or structural shocks that are often

called real business cycle shocks in economics.The former are transitory, while the latter are morepersistent because by nature they last until newer,lasting shocks take growth to a different level ofoutput in either direction. Cyclical shocks are in thenature of upswings and downswings in growth orin terms of booms and busts. Permanent shocksare generally associated with real business cycleproponents, such as productivity changes,demographic changes, wars, natural calamities,structural decits and other structural factors.

I.13 Over the past two years, although part ofthe slowdown has been driven by cyclical factors,structural constraints have played a major role inthe slowdown (see Box II.1). Mining activity wasimpacted adversely by governance factors. Theslack in manufacturing activity was largely due topoor investment on the back of structural issuesfacing the infrastructure sector. In addition, globalfactors played an important role in the currentgrowth slowdown. Global growth decelerated to 3.1per cent in 2012, the lowest since the 2009

contraction that followed the global nancial crisis.Likewise, global trade decelerated sharply to 2.5per cent from 6.0 per cent in the preceding yearand 12.5 per cent a year ago. Consequently,external demand fell and revival was difcult.

I.14 Growth slowdown to a substantial extenthas been the result of investment downturn.Investment climate for the private corporate sectorremained weak in 2012-13. The cost of new projectsplanned during 2012-13 which was sanctionednancial assistance by banks/FIs or funded throughECBs/FCCBs/capital market issuances in thedomestic market, aggregated to ` 2,634 billion asagainst that of ` 2,509 billion in 2011-12. In addition,many projects sanctioned in the past had beencancelled in the recent years. The investment planin 2012-13 was led by high value projects in powerand metal & metal products industries.

I.15 Based on the time phasing details ofexpenditure on such projects envisaged at theproposal stage, it is estimated that actual capitalexpenditure made during 2012-13 was lower thanthat in 2011-12 and available indication, so far,points that it would further decline in 2013-14.

I.16 Monetary policy encountered difculties insupporting revival in the face of the predominantrole of non-monetary factors in the slowdown andthe persistence of high ination. It is generallyrecognised that monetary policy can best impactgrowth by providing a reasonable degree of pricestability. Loose monetary policy can have a lastinginuence on ination and ination expectations and,

in turn, can cause actual as well as potential growthto fall. On the other hand, its direct impact on growthis limited in that it can inuence the level of outputin a counter-cyclical way. If there is a cyclical fall inoutput to below potential, monetary policy can tryto lift aggregate demand by easing monetary policy.If the economy gets overheated and operates at alevel above the potential output, it is important totighten monetary policy and bring it back to potentialto counter acceleration in inflation. Long-runchanges in growth are mainly driven by technology,productivity shocks and scal policies that affectthrift and investments. The greater focus ofmonetary policy on ination relative to growth isalso because inflation has distributionalconsequences and welfare costs that can hurt thepoor the most. These considerations affected theReserve Banks mix of growth-ination trade-offsin its policies, even as growth decelerated.

Persistence of Ination

I.17 The year 2012-13 was marked by headlineWPI ination ruling at a lower level than in theprevious two years. On an average basis, headlineination came down to 7.4 per cent from 8.9 percent in 2011-12 and 9.6 per cent a year ago.Headline ination, after receding in Q4 of 2011-12,exhibited persistence at that relatively lower level.This persistence mainly reected high food and fuel

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ination almost throughout the year. So, althoughnon-food manufacturing ination receded furtherduring H2 of 2012-13 due to softer global commodityprices and a fall in demand-side pressures, theoverall WPI ination exhibited a fair degree ofpersistence. The year saw the negative output gaphelping to moderate ination, but encounteringresistance amid supply-side constraints.

I.18 Food ination originated from an unusualspike in vegetable prices during FebruaryApril2012, a rise in cereal prices later in the year due tothe delayed monsoon and a signicant increase inminimum support prices (MSPs). Fuel inflationlargely reected the impact of administered price

changes during the year, with some of thesuppressed ination coming to the fore. A markedgrowth slowdown and past monetary tighteningalong with softer global commodity prices contributedto manufactured non-food products inflationdeclining sharply in H2 of 2012-13 and further inQ1 of 2013-14. Consequently, despite the pressuresof food and fuel ination, headline WPI inationremained range bound between 78 per cent forthe rst 11 months of 2012-13, before it declinedsharply in March 2013 to 5.7 and below 5 per centduring Q1 of 2013-14. Non-food manufacturedproducts ination has declined further in 2013-14and stood at 2.4 per cent in July 2013.

Fiscal imbalances and the reversal: a story oftwo halves

I.19 Fiscal developments during 2012-13 weresplit into two halves. The period H1 of 2012-13 wascharacterised by a scal slippage to a degree that itcould have undermined macro-stability. However, H2of 2012-13 was marked by an equally remarkablescal retrench, although in the face of a signicantovershooting of subsidies from the budget estimate,the burden of adjustment fell disproportionately onplan revenue expenditure and on plan and non-plancapital expenditure. At a time when private investmentin the economy was slack, the reduction in thegovernments capital expenditure had adverse

implications for aggregate investment and growth inthe economy. The importance of scal correctioncarried out during H2 has to be judged in the contextof the twin decit risks that the country faced.

I.20 The scal correction in the second half of theyear resulted in a signicant reduction in the grossscal decit (GFD) to 4.9 per cent of GDP in 2012-13from 5.7 per cent in 2011-12. In the process, theactual scal decit in 2012-13 turned out to be lowerthan that envisaged in the Union Budget.

I.21 The containment of the GFD in 2012-13 inthe face of a shortfall in tax and non-tax revenueswas largely brought about by scaling downexpenditure. Total expenditure was lower than the

budget estimates (BE) mainly on account of lowerplan expenditure (79.5 per cent of BE). The share ofcapital expenditure in total expenditure declined. Infact, the capital outlay to GDP ratio was lower in2012-13 than in 2011-12. While the compositionalshift might have been dictated by the expediency toreduce the headline decit, it does raise concernsabout the quality of scal consolidation. Over themedium term, efforts should be to contain revenueexpenditure, raise tax revenue buoyancy and containsubsidies to enable durable scal consolidation.

External sector vulnerabilities come to the forein 2012-13

I.22 External sector vulnerabilities came to thefore in 2012-13, as the CAD widened to a historicpeak of 4.8 per cent of GDP on top of an alreadyhigh level of 4.2 per cent in the previous year. Thewidening of the CAD was largely the result of highoil and gold imports and moderation in export growth.

I.23 In order to contain gold imports, importduties on gold were doubled from 2 per cent to 4per cent in March 2012, raised further to 6 per centin January 2013 and then hiked to 8 per cent inJune 2013. Further, in August 2013, custom dutieson gold, platinum, rened gold bars and silver barswere hiked by 2 percentage points each, taking theimport duty on gold to 10 per cent. Besides, theReserve Bank has been tightening gold imports

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through a series of regulatory steps. In March 2012,it issued directions to NBFCs to maintain a Loan-to-Value (LTV) ratio not exceeding 60 per cent forloans against collateral of gold jewellery. In May2012, it asked banks to reduce their regulatoryexposure ceiling on a single NBFC that had goldloans in excess of 50 per cent of their nancialassets. In November 2012, it asked banks to stopnancing NBFCs for purchase of gold in any form,except by way of working capital nance.

I.24 In 2013, the Reserve Bank restricted thefacility of advances against the security of goldcoins per customer to gold coins weighing up to amaximum of 50 gms. In June 2013, it extended the

restrictions to all nominated agencies/ premier/ startrading houses that were permitted to import gold.Further, it stipulated that all letters of credit (LCs)could be opened only on a 100 per cent cashmargin basis on imports of gold and would have tobe on a document against payment (DA) basis. InJuly 2013, it revised the scheme of gold imports inconsultation with the government, based on theprinciple that 20 per cent of the imported quantityby nominated banks/ agencies had to be retainedin customs bonded warehouses and fresh imports

could only be undertaken after at least 75 per centof the gold remaining in the customs bondedwarehouses were exported. With this, the ReserveBank withdrew extant instructions with regard togold on consignment basis, LC restrictions, etc.These instructions were further claried/modiedin August 2013 and import of gold in the form ofcoins and medallions was prohibited. Further,release of gold for domestic use was madecontingent on the full upfront payment.

I.25 Meanwhile, with a view to restraining scalsubsidies and to allow price responses to work tocurtail demand for oil and help bring about a CADcorrection, the government hiked the price of dieseland capped the supply of subsidised LPG cylindersin September 2012. Later in January 2013, it partiallyderegulated diesel prices by allowing a monthlyreset. These measures are expected to help contain

oil demand to some degree. However, oil and gasprices are yet to be fully market-determined and inthe absence of free pricing the reduction in demandmay not be enough to shrink the trade decit to thedesired extent.

I.26 With a view to moderate foreign currencyoutflows, the Reserve Bank undertook certainmeasures on August 14, 2013. These included (i)reduction in limit for overseas direct investment (ODI)under automatic route from 400 per cent to 100 percent (except for Navratna PSUs, ONGC VideshLimited and Oil India in overseas unincorporatedentities and incorporated entities, in the oil sector)(ii) reduction in remittances by resident individuals

under the Liberalised Remittance Scheme (LRS)from US$ 200,000 to US$ 75,000 per nancial year,and (iii) prohibition on use of LRS for acquisition ofimmovable property outside India directly orindirectly. However, the Reserve Bank wouldcontinue to consider genuine requirements abovethe revised limits under approval route. Also, with aview to augment NRI deposit ows, (i) incrementalFCNR(B) and NRE deposit were exempted fromCRR and SLR counting from the base date of July26, 2013; these deposits were also excluded fromadjusted net bank credit for computation of prioritysector lending targets; (ii) interest rates on NREdeposits were deregulated by removing the cap, thatthey cannot exceed interest rates on comparablerupee deposits.

I.27 With slowing growth over the past two years,external sector sustainability concerns came on thehorizon. During 2012-13, Indias external debt roseby about US$ 45 billion to US$ 390 billion. Its netinternational investment position worsened by US$57 billion to US$ (-) 307 billion. On a residualmaturity basis, the short-term external debtconstituted 44.2 per cent of total external debt and59 per cent of foreign exchange reserves at end-March 2013. Thus, maintaining external sectorsustainability poses an important challenge goingforward.

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PROSPECTS FOR 2013-14

I.28 The year 2013-14 has begun with tumultuouschanges. After early signs that growth was pickingup in the US and Japan, the indication by the Fedthat it would unwind part of the monetary stimulusearlier than anticipated, has led to tightening innancial conditions. Bond yields rmed up acrossthe curve and across geographies, and broughtfurther changes in other asset prices. Currenciesof the Emerging Markets and Developing Economies(EMDEs) depreciated speedily, not just of thecurrent account decit economies but also for somecurrent account surplus economies. This, in turn,led to a decline in equity prices as portfolio shiftsoccurred from EMDEs to US markets. Globalcommodity prices, which had exhibited a softer biasduring FebruaryApril 2013, rmed up temporarily.Political unrest in parts of the Middle East also putupward pressure on global oil prices.

I.29 These global spillovers affected India, likemany other EMDEs. After the Fed Chairmanscomments on May 22, until July 15, 2013 foreigninstitutional investors (FIIs) on a net basis disinvestedUS$ 8.3 billion of their bond portfolio and US$ 2.1billion of their equity portfolio in cash markets in

India. The resultant net outows brought the rupeeunder immense pressure. Considering theheightened exchange rate volatility, the ReserveBank announced measures to stabilise the rupeeon July 15, 2013 which were later modied in July23, 2013 (see paragraph I.5).

I.30 The emerging macroeconomic scenario forthe year 2013-14 is challenging amid the wide CAD,risks to scal targets, persistence of high consumerprice ination, risk of exchange rate depreciationfeeding into inflation, slowing growth and

deteriorating asset quality. As such, macroeconomicand monetary policies need to be carefullycalibrated to achieve the immediate objective ofmaintaining stability without compromising growth.

Growth Outlook for 2013-14

I.31 Recovery is possible and can take shapelater in 2013-14, but is predicated on better

governance, the removal of supply constraints andmaintenance of stability. Despite the new risks, asa baseline the real GDP growth outlook for 2013-14is better than that in 2012-13, following the growth-supportive measures taken by the Government ofIndia and the south-west monsoon that hasperformed well so far. The Annual Monetary PolicyStatement for 2013-14 of May 3, 2013 projectedthe baseline GDP growth for 2013-14 at 5.7 percent conditional upon a normal monsoon, revivalin domestic investment and global growth. Whilethe risks to the rst of these conditions have sincediminished, the risks to the latter have increased.Weakness in industrial activity has persisted andglobal growth has been tepid. Considering thesefactors, the First Quarter Review of Monetary Policyat end-July 2013 scaled down its growth projectionfrom 5.7 per cent to 5.5 per cent.

I.32 Normal and spatially well-distributed rainfallso far during the south-west monsoon augurs wellfor the agriculture sector and is expected to boostrural demand for industrial goods and services. UntilAugust 13, 2013, 85 per cent of the countrys areahad received excess or normal rainfall, with theremaining 15 per cent falling in Haryana and parts

of the East and North-East region receivingdecient rainfall. The Reserve Banks foodgrainproduction weighted index showed that rainfall was10 per cent above normal in the current monsoonseason till August 13, 2013. Ample rainfall hasresulted in an improvement in the water storagelevels in reservoirs.

I.33 Water storage in 85 major reservoirs tillAugust 8, 2013 was 66 per cent above the lastyears level and 55 per cent above the average oflast 10 years storage. This would benet the Kharif and the Rabi crops, as also hydropower generation.Crop prospects are also encouraging as the areasown under kharif crops till August 9, 2013 was 11per cent higher than last year and 7 per cent higherthan the normal area sown till date. Encouragingprospects for crop also augurs well for ruraldemand. The current slowdown in any case, has

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impacted economic activity in urban areas morethan in rural areas. As such, the rural economycould provide some buffer on the back of satisfactorymonsoon.

I.34 Industrial growth has been nearly stagnantfor two years now, with signs that the stagnationhas extended into 2013-14. Corporate performancecontinues to weaken as a result of slowing activitylevels in industry and services sectors. Results ofa sample of 1,149 listed non-government and non-nancial companies available till August 12, 2013for Q1 of 2013-14 indicated that sales haddecelerated further. The expenditure on consumptionof raw materials had contracted and at the

aggregate level prots recorded moderate growth.The operating prot margin (EBITDA to sales ratio)was maintained at the level observed in the previousquarter but the net prot margin declined due tohigher interest to sales ratio. However, thedownward spiral could get arrested with someuptick later in the year as improved rural demandand better project execution supports activity. Thelow inventory levels of nished goods may enableexpansion in output levels if rural consumptiondemand improves. If construction activity alsoimproves as public investment in road, urbanhousing projects and execution of mega projectspick up, it will generate more demand across theindustrial sector.

I.35 However, in attempting to revive demand,it is important to reduce the current high consumerprice inflation. This is necessary to arrest theagging growth rate of private nal consumptionexpenditure. The positive orientation of the UnionBudget 2013-14 and measures to arrestmacroeconomic deterioration and stabilise theeconomy are expected to have some favourableimpact on investment with a lag. The effects ofgovernment efforts to incrementally resolve keypolicy impediments to investment, such as landacquisition, environmental clearances and rawmaterial shortages, particularly coal, should

translate into ground-level execution. These includeactions taken by the Cabinet Committee onInvestments (CCI) since January 2013 that areaimed at fast-tracking the stalled mega investmentprojects. Evidently, it takes a mobilisation time ofaround six to eight months between projectapproval and actual investment, implying that theresults would be visible towards the end of 2013.Recent steps to increase in-bound FDI could alsoprovide a llip to domestic investments.

I.36 However, recovery has to be earned in thisdifcult economic environment through concertedaction. The economy is currently cruising in slow-speed mode along a rough road. Strategically, it is

necessary to rst patch the rough spots by puttingin place a set of complementary policies to addressthe structural constraints.

Ination Outlook for 2013-14

I.37 Although headline ination had moderatedin Q1 of 2013-14 to an average of 4.7 per cent,risks on the ination front are still signicant. First,this is evident in a rebound in ination to 5.8 percent in July 2013. Creeping ination pressures arevisible arising from rising food and fuel prices, the

latter in large part due to exchange rate depreciation.Second, while WPI ination has moderated, CPIinflation remains close to double digits. Third,although food ination came down from its high ofJanuary 2013, it has resurfaced since May 2013.While moderate MSP increases this year and agood monsoon give hope that inflation will becontained, if high food ination persists into H2 of2013-14, the risks of generalised ination couldbecome large. In this context, there is a need forclose attention to food management and for takingpolicy action to address structural factors thatconstrain agricultural supply response. Fourth, thepass-through of the depreciation of the rupeeexchange rate by about 11 per cent in the rst fourmonths of 2013-14 is incomplete and will putupward pressure as it continues to feed through todomestic prices. The exchange rate pass-through

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has declined in recent years. However, increase ininflation could occur, given the significantdepreciation of the rupee.

I.38 Overall, the ination outlook appears to bebetter than in the previous year. Non-foodmanufactured products ination at 2.4 per cent inJuly 2013 remained within comfortable limit. In itsAnnual Policy Statement of Monetary Policy on May3, 2013, the Reserve Bank projected WPI inationto be range-bound around 5.5 per cent during 2013-14, keeping in view the domestic demand-supplybalance, the outlook for global commodity pricesand the forecast of a normal monsoon. Theprojected path of inflation suggested some

moderation in the rst half of the year on accountof past policy actions, although there could be someincrease in ination during the second half thatlargely reects base effects. Headline ination sincethen has moved in line with the projected path. Ascommunicated at the time of the Annual Policy, theReserve Bank will endeavour to condition theevolution of ination to a level of 5.0 per cent byMarch 2014, using all instruments at its command.Its objective is to contain headline WPI ination ataround that level in the short term and 3.0 per centover the medium term.

I.39 On the demand-supply balance, the supplymay turn out to be slightly weaker than assessedearlier. Demand deceleration continues, but ruraldemand may stay robust in the wake of a likely goodcrop on the back of a normal monsoon. The outlookfor global commodity prices largely remains benign,but risks of price increase on-shore have increasedfollowing the rupee depreciation and rming up ofglobal crude prices during July 2013. Therefore,some price pressures may build up in the latter halfof 2013-14. The normal monsoon, however, hastaken a major risk off the horizon, although therenewed upsurge in food prices in the rst fourmonths of 2013-14 implies that a close vigil isnecessary so that the relative price change doesnot affect the general level of prices.

Need to stay focused on controlling twin decitrisks

I.40 The budget estimates for 2013-14 and the

rolling targets set for 2014-15 and 2015-16 indicatea continuation of the momentum of fiscalconsolidation, although slight deviations in revenueand scal decits from the path envisaged by theKelkar Committee could persist.

I.41 The planned reduction in the GFD to 4.8per cent of GDP in 2013-14 (BE) is expected to beachieved through higher mobilisation ofdis investment proceeds , tax revenues ,telecommunications receipts and reduction in

expenditure on subsidies. However, as the Budgetrelies largely on revenue-led scal consolidation,its success would depend on the revival ofinvestment climate and growth. The budgetestimates of gross tax revenue were based onestimated nominal GDP growth of 13.4 per cent.However, with growth likely to be lower, it may bedifcult to achieve the budgeted tax-GDP ratio of10.9 per cent even with the budgeted tax buoyancyof 1.4 per cent during 2013-14. Gross tax revenuegrowth during the rst quarter of 2013-14 was lowerthan a year ago due to deceleration/decline in majortax revenues. Among the other major items ofgovernment revenue, disinvestment receipts arebudgeted at ` 400 billion in 2013-14. An additionalamount of ` 140 billion is expected from disinvestmentof its residual shareholdings in non-governmentcompanies. Given the emerging conditions in thenancial markets, it would be challenging to raisethe budgeted disinvestment proceeds. Against thisbackdrop, strategic planning is necessary. The

possibility of larger dividends from cash-rich publicsector undertakings (PSUs) and further stake salesin PSUs, which are likely to get investor interestand consequently better price realisation, need tobe explored fully.

I.42 On the expenditure side, both capital andplan expenditure are budgeted for a sharp rise in

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2013-14. The re-prioritisation of expenditure infavour of capital expenditure indicates an increasein the capital outlay to GFD ratio to 38.5 per centin 2013-14 from 28.1 per cent in 2012-13 (RE).Although plan expenditure in 2013-14 is budgetedhigher, the budgetary support extended to centralplan outlay during the rst two years of the plan(i.e. , 2012-13 and 2013-14) works out to only 27.2per cent of the total budgetary support envisagedfor the entire ve-year period of the Twelfth Plan.

I.43 A posi tive feature on the non-p lanexpenditure front is the envisaged containment ofexpenditure on subsidies at 2 per cent of GDP in2013-14. However, while the phased deregulation

in diesel prices would help to keep the fuel subsidyunder control, the volatility in the exchange ratemay exert upward pressure on fuel and fertilisersubsidies in 2013-14. The under-recoveries of oilcompanies have risen sharply due to exchange ratedepreciation and a rise in global crude oil prices,combined with lagged adjustment of prices andvestiges of administered price mechanismsprevailing in the sector. While the impact of NationalFood Security Ordinance on the food subsidies ismanageable for 2013-14, in the years to come it

will add to the scal pressures. The key concern isthat it is difcult to contain food subsidies withinbudgeted amount even in 2013-14 when the Actwill just begin to get implemented. Over the nextfew years the growing subsidies could restrictinvestment opportunities, including those inagricultural sector.

I.44 Regard ing finan ces of the stategovernments, while several states have limited theirdecit and debt in recent years within the targetsset by the Thirteenth Finance Commission, nancesof the states participating in the FinancialRestructuring Plan (FRP) would be under pressuredue to additional debt and interest burden linked toissuance of bonds/special securities by state powerdistribution companies (discoms) under thescheme. It is imperative that the mandatoryconditions and recommended suggestions of the

FRP are implemented in the true spirit by thediscoms and state governments if these utilities areto become nancially viable. Going by the magnitudeof nancial implications on states nances, thestate governments have to ensure that debtrestructuring does not become a perpetual feature,considering its downside risks to the stability ofstate nances.

I.45 Even though CAD is expected to widenduring Q1 of 2013-14 on account of higher tradedecit, it is likely to moderate thereafter. After sharpincrease in rst two months of the current scalyear, trade decit has narrowed considerably in themonths of June and July 2013. Going forward, the

CAD is expected to see correction due to tradepolicy measures taken to curb gold imports andprice adjustments effected to moderate consumptionof fuel products. Besides, there may still be scopefor curbing non-essential imports as well to improvethe trade balance. CAD in 2013-14 is expected tobe lower than the historic high of 2012-13.

I.46 Nevertheless, CAD may continue to bemuch above the sustainable level, which isestimated at around 2.5 per cent of GDP,underscoring the importance of medium-termc o r r e c t i o n a i m e d a t i m p r o v i n g e x p o r tcompetitiveness, discouraging avoidable importsand to improve more stable capital inows.

Need to preserve financial stability withpossibilities that financial accelerator mayincrease asset quality risks

I.47 Over the current year and the next, utmostattention is needed to contain nancial stability risksthat are rising with the deteriorating asset qualityof banks. Although the average leverage ratio forthe corporate sector remains comfortable, stressis building up in some sectors, especiallyinfrastructure, where rms are nding it hard toraise fresh equity given an already high net debt toequity ratio. If infrastructure sector issues are notquickly resolved, it can have a domino effect on theasset quality of banks.

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end-March 2018. In this context, the need for Indiato adopt stringent capital requirements stems fromits growing involvement in the global bankingsystem, both as a market and as a service provider,and its vulnerability to global contagion. TheReserve Bank has prescribed a minimum capitalratio (CRAR) of 9 per cent, which

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