During the financial year 2007-08, Central government and Reserve Bank of India (RBI) took many measures to facilitate Indian financial growth amidst the clouds of recession, inflation, crude oil prices and other geo-political factors. The Reserve Bank continued to take measures to increase depth and liquidity in the money, Government securities and foreign exchange markets during the year in order to improve the price discovery mechanism. These efforts were intensified during the year in view of the Fiscal Responsibility and Budget Management provision, which prohibits the Reserve Bank from participating in the primary market for Central Government securities with effect from April 2006 onwards.
The implementation of FRBM Act necessitated a review of the Reserve Bank’s market operations, including introduction of new instruments and refining existing instruments in the context of the evolving scenario. Within the Reserve Bank, a clearer assignment of functional responsibilities has been sought to improve operational effectiveness by minimizing overlaps and conflict of interest. A Financial Markets Department (FMD) was set up in July 2005 with a view to strengthen monetary, debt and reserve management functions by moving towards functional separation in these objectives within the Reserve Bank. By January 2006, the Reserve Bank operations in financial markets were fully integrated with FMD, conducting all domestic market operations in money, Government securities and foreign exchange markets. A high level Committee on Fuller Capital Account Convertibility was constituted to set a road map for fuller convertibility on the capital account.
Institutional and policy measures to improve the legal system continued during the year. The Credit Information Companies (Regulation) Bill, 2005 has been enacted as the Credit Information Companies (Regulation) Act, 2005. In order to provide the Reserve Bank greater flexibility in the conduct of monetary policy, the Reserve Bank of India Act, 1934 has been amended by the Reserve Bank of India (Amendment) Act, 2006. The Amendment Act includes provisions for empowering the Reserve Bank to deal in derivatives, to lend or borrow securities and to undertake repo or reverse repo operation. It also defines the expressions ‘derivative’, ‘repo’ and ‘reverse repo’. It has an important function of removing ambiguity regarding the legal validity of derivatives. Apart from this, it will also be removing the floor and ceiling of cash reserve ratio (CRR) for scheduled banks, so as to provide flexibility to the Reserve Bank to specify CRR. It also empowers the Reserve Bank to lay down policy relating to interest rates or interest rate products and issue directions to any agency dealing in securities, money market instruments, derivatives, etc.
Demand for bank credit remained strong for the second successive year, in line with buoyant economic activity. In view of strong credit demand, banks reduced their investments in Government. Higher mobilization of funds through both deposit and non-deposit sources also helped banks to support the enhanced demand for commercial credit. Due to some tightness in the liquidity position during December 2005-March 2006, partly due to the redemption of the India Millennium Deposits (IMDs), the Reserve Bank injected liquidity in the system through Liquidity Adjustment Facility (LAF) operations, unwinding of the balances under the Market Stabilization Scheme (MSS) and some private placement of Central Government securities. Reflecting the liquidity injection operations, reserve money recorded a higher rate of expansion during 2005-06. Broad money growth also recorded acceleration in consonance with higher credit growth and acceleration in overall economic activity. Inflation was contained within the desired trajectory, despite continued pressures from record high international crude oil. These policies and measures helped the Finance Minister to put forward the socialist budget that came out, without much sacrificing the economic reforms. This also gives a boost to the idea that Indian growth story is here to stay!
Saurabh Sharma
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