indian monetary policy- challenges and unresolved...

Indira Gandhi Institute of Development Research, Mumbai, India

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INDIAN MONETARY POLICY INDIAN MONETARY POLICY --CHALLENGES AND UNRESOLVED CHALLENGES AND UNRESOLVED

ISSUESISSUES

Xth ANNUAL NEEMRANA CONFERENCE10 JAN 2009


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DILIP M. NACHANE, DIRECTOR, IGIDR, MUMBAI, INDIAMEMBER, TAC (MONETARY POLICY) RBIMEMBER, TAC (INFLATION

EXPECTATIONS MEASUREMENT) RBIHON. SR. RESEARCH FELLOW, NUS,

SINGAPORE


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STRUCTURE OF PRESENTATION

• 1. MONETARY POLICY IN INDIA: PRELIMINARY CONSIDERTAIONS

• 2. RBI APPROACH • 3. MONETARY POLICY

CHALLENGES & UNRESOLVED ISSUES

• 4. RBI RESPONSE TO CURRENT CRISIS


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• MAIN OBJECTIVE OF MONETARY POLICY

• INFLATION CONTROL

• POSSIBLE SUBSIDIARY OBJECTIVES IN EMEs

• GROWTH

• EXCHANGE RATE STABILITY

• STABILITY OF FINANCIAL MARKETS

AN EMERGING GLOBAL CONSENSUS ON THE OBJECTIVES OF MONETARY POLICY


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SPECIAL CONSIDERATIONS IN INDIA

• NEED TO HAVE AFFORDABLE HOUSING FOR THE MASSES

• CREDIT DELIVERY TO AGRICULTURE AND SMEs

• DIFFERENTIAL REGIONAL EFFECTS


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GLOBAL CONSENSUS ON RESOLUTION OF MONETARY

POLICY TRILEMMA (BERNANKE (2005)

• 1. FLEXIBLE EXCHANGE RATE• 2. AN INFLATION TARGET• 3. SOME VERSION OF MONETARY

POLICY RULE (TAYLOR 1995)• INDIA NOT FULLY A PART OF THIS

CONSENSUS


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MONETARY POLICY IN INDIA (OPERATING PROCEDURES)

1. RESERVE MONEY USED AS OPERATING TARGET

2. M3 USED AS INTERMEDIATE TARGET (FROM MID-1980s TO MID-1990s

A. EARLIER FRAMEWORK; (QUANTITY BASED MONETARY TARGETING )

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SINCE THE FINANCIAL LIBERALIZATION THAT BEGAN IN 1991, THE MONETARY POLICY OPERATING PROCEDURE HAS BEEN GRADUALLY CHANGING


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CURRENT FRAMEWORK

1. LESS RELIANCE ON DIRECT INSTRUMENTS & LIQUIDITY MANAGEMENT THROUGH OPEN –MARKET OPERATIONS (OMO) AND REPO AND REVERSE REPO OPERATIONS UNDER LIQUIDITY ADJUSTMENT FACILITY (LAF)

2. MULTIPLE INDICATOR APPROACH (SINCE APRIL 1998)


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A SHIFT IN ATTITUDE TOWARDS FINANCIAL MARKETS

• MONETARY POLICY SHOULD BE TRANSPARENT

• CENTRAL BANKS SHOULD COMMUNICATE ACTIVELY WITH FINANCIAL MARKETS


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THREE-PRONGED APPROACH OF THE RBI TO MONETARY

MANAGEMENT

• 1. SHORT-TERM LIQUIDITY MANAGEMENT (LAF)

• 2. LONG-TERM LIQUIDITY MANAGEMENT

• 3. STERILIZATION


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LIQUIDITY ADJUSTMENT FACILITY (LAF)

• INTENDED TO CORRECT SHORT-TERM LIQUIDITY MISMATCHES IN THE BANKING SYSTEM AND PROCEEDS BY DAILY AUCTION

• REPO RATE (RATE AT WHICH BANKS BORROW FROM RBI AGAINST GOVT. & OTHER APPROVED SECURITIES (REPURCHASE AGREEMENT) CURRENTLY AT 5.5%

• REVERSE REPO RATE (RATE AT WHICH BANKS CAN PLANT SURPLUS LIQUIDITY WITH RBI) CURRENTLY AT 4%

• CRR 5.0%


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STERILIZATION

• MARKET STABILIZATION SCHEME (MSS) INTRODUCED EFFECTIVE APRIL 2004 TO DEAL WITH SURGING CAPITAL INFLOWS

• UNDER MSS, RBI IS ALLOWED TO ISSUE ( BY AUCTIONS) TBs AND GoI SECURITIES

• THE TBs AND GoI SECURITIES ISSUED UNDER MSS WOULD HAVE ALL THE ATTRIBUTES OF EXISTING TBs & SECURITIES

• THE MSS INSTRUMENTS WILL NOT FIGURE IN THE GOVT. BUDGET EXCEPT FOR THE INTEREST COST

• ANNUAL CEILING ON MSS (REVISED IN OCT.2007 TO RS. 250,000 CRORES).


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MANAGING LONG-TERM LIQUIDITY

• 1. SIX-MONTHLY CALENDAR OF AUCTION OF GOVT. SECURITIES (MORE GEARED TO GoI BORROWING REQUIREMENTS)

• 2. EVERY WEDNESDAY THERE IS AN AUCTION OF 91-DAY TBs

• 3. LAST WEDNESDAY OF EVERY MONTH THERE IS AN AUCTION OF 364-DAY TBs


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MONETARY POLICY: CHALLENGES/UNRESOLVED

ISSUES -GENERAL

1.INFLATION TARGETING 2. MONETARY AND FINANCIAL

STABILITY-RELATIVE WEIGHTAGE3.RBI CREDIBILITY4. REGULATORY & SUPERVISORY

INDEPENDENCE5. FISCAL DOMINANCE


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MONETARY POLICY CHALLENGES/UNRESOLVED ISSUES –GENERAL (CONTD.)

4.LACK OF RELIABLE MEASURES OF INFLATIONARY EXPECTATIONS

5. SHOULD ASSET PRICES FIGURE IN INFLATIONARY MEASURE?

5. GREAT UNCERTAINTY (IGNORANCE?) ABOUT MONETARY POLICY LAGS AND MAGNITUDE OF EFFECTS


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MONETARY POLICY CHALLENGES/UNRESOLVED

ISSUES-SPECIFIC

• 1. APPROPRIATE RESPONSE TO STOCK MARKET VOLATILITY, ASSET BUBBLES (ESP. HOUSING BUBBLES )

• 2.SPECIAL CONSIDERATIONS RELATING TO SENSITIVE SECTORS SUCH AS SMEs, AGRICULTURE ETC.

• 3. ROLE OF PRUDENTIAL MEASURES (e.g. RISK WEIGHT ALTERATIONS)


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IS DECOUPLING THEORY STILL VALID ? MOST UNLIKELY

• CHANNELS OF CONTAGION TO INDIA

• 1. TRADE BALNCE• FALLING DEMAND IN TRADING

PARTNER COUNTRIES


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CHANNELS OF CONTAGION (CONTD.)

• 2. CURRENT A/C BALANCE• (i) IMPACT ON REMITTANCES• (ii) LIKELY DECLINE IN IT EXPORTS

AS MAJOR DEMAND FOR IT SERVICES IS FROM THE US (60%) AND ESPECIALLY ITS FINANACIAL SECTOR


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• 3. CAPITAL A/C• (i) FII OUTFLOWS (FLIGHT TO

SAFETY)• (ii) DRYING UP OF ECB LOANS


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• 4. FINANCIAL SYSTEM• (i) SOME EXPOSURE BY DOMESTIC PRIVATE,

AND FOREIGN SUBSIDIARIES TO SPVs• (ii) SOME NATIONALIZED BANKS ALSO

EXPOSED TO SPVs• (iii) EXTENT LIKELY TO BE LIMITED-$450 MN.

MARK-TO-MARKET ESTIMATED LOSSES • (iv) NBFIs & MFs AND CORPORATES

EXPERIENCED LOSSES AND LIQUIDITY PROBLEMS DUE TO THEIR EXPOSURE TO DOMESTIC STOCK & CURRENCY MARKETS, WHICH HAVE PLUNGED IN THE WAKE OF THE CRISIS


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INDIAN RESPONSE:MONETARY POLICY

• 1. MASSIVE INJECTION OF LIQUIDITY –RS. 385,000 CRORES SINCE SEPT. 08 (ABOUT $80 BILLION)

• 2. REPO RATE REDUCED FROM 9.0% TO 5.5%, CRR FROM 9.0% TO 5.0% AND SLR FROM 25% OF NDTL TO 24%


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INDIAN RESPONSE :FISCAL MEASURES

• 1. THE FIRST FISCAL STIMULUS (7 Dec. 08)PACKAGE WAS MAINLY COMPOSED OF AN ACROSS THE BOARD 4% TAX CUT IN EXCISE DUTY AND ESTIMATED TO COST THE EXCHEQUER RS. 31000 CRORES ($65 BILLION)


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INDIAN RESPONSE :FISCAL MEASURES (CONTD.)

• 2. THE SECOND PACKAGE ANNOUNCED ON 2 JAN. 09 COMPRISED RS.20,000 CRORES ($4 BILLION) OVER THE NEXT 2 YEARS TOWARDS BANK CAPITALIZATION

• 3. RAISING THE MARKET BORROWING LIMITS OF STATE GOVERNMENTS BY 0.5% OF THEIR SDP. ADDITIONAL ACCESS TO MARKET BORROWINGS FOR IIFCL (INDIA INFRASTRUCTURE FINANCING CO. LTD.)


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INDIAN RESPONSE :FISCAL MEASURES (CONTD.)

• THE TOTAL FINANCIAL IMPLICATIONS OF THE SECOND FISCAL STIMULUS ESTIMATED AT RS.70000 CRORES ($14 BILLION)

• FISCAL DEFICIT LIKELY TO CROSS 5.5% OF GDP.


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INDIAN RESPONSE -CONCERNS

• 1. IS INFLATION REALLY UNDER CONTROL?

• 2.IS THE BASIS BEING LAID FOR A FURTHER BOOM IN HOUSING PRICES ? ASYMMETRIC EFFECT ON HOMEOWNERS AND HOME OWNERSHIP ASPIRANTS.


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INDIAN RESPONSE –CONCERNS(CONTD.)

• 1. CAN LIQUIDITY INFUSION OF ITSELF SPUR PRIVATE INVESTMENT? ESPECIALLY IF LONG-TERM INTEREST RATES REMAIN HIGH. FEASIBILITY OF OPERATION TWIST?


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INDIAN RESPONSE –CONCERNS (CONTD.)

• FISCAL STIMULUS REVIVES DEMAND ONLY IF IT IS SPREAD ACROSS A WIDE SECTION OF THE POPULACE. INFRASTRUCTURE SPENDING ON CAPITAL-INTENSIVE PROJECTS (SUCH AS INTEGRATED TOWNSHIPS ETC.) IS NOT REALLY THE ANSWER


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INDIAN RESPONSE –CONCERNS(CONTD.)

• WILL THE FISCAL STIMULUS EXERT UPWARD PRESSURE ON INTEREST RATES AND ULTIMATELY CROWD OUT PRIVATE INVESTMENT?


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A FINAL COMMENT

1.MONETARY & FISCAL MEASURES BEING UNDERTAKEN IN ISOLATION WITHOUT ANY CORRESPONDING ACTION ON PRUDENTIAL MEASURES SUCH AS (I)DEPOSIT INSURANCE &

• (II) REGULATION OF RATING AGENCIES • 2.SLOW-PEDALLING ON THE 3 BASEL II

PILLARS


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•THANK YOU

indian monetary policy- challenges and unresolved...

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