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

PART TWO : THE WORKING AND OPERATIONS OF

THE RESERVE BANK OF INDIA

MONETARY AND CREDIT POLICY

III OPERATIONS

Monetary management during 2008-09 had to contend with the challenges of high inflation in the
first half and the high speed and magnitude of the external shock and its spill-over effects through the
real, financial and confidence channels in the second half. Policy initiatives by the Reserve Bank were
aimed at providing ample rupee liquidity, ensuring comfortable foreign exchange liquidity and
maintaining a market environment conducive for the continued flow of credit at viable rates to
productive sectors of the economy. The large government borrowings resulting from the fiscal stimulus,
and net capital outflows in the second half of the year warranted simultaneous offsetting operations by
the Reserve Bank in different markets, particularly the money market, the government securities market
and the foreign exchange market. The flexible use of multiple instruments enabled the Reserve Bank
to steer the liquidity and interest rate conditions amidst uncertain global macroeconomic environment.

III.1 The stance of monetary policy shifted in raised by 450 basis points, and risk weights and
phases in response to multiple challenges that general provisioning requirements for standard
emerged during the course of the year in the form advances were raised in the case of specific
of significant changes in both outcome and outlook sectors. In response to the knock-on effects of the
relating to inflation, growth and stability of financial global economic crisis on the Indian economy,
markets. Both the Government and the Reserve since October 11, 2008 the Reserve Bank has
Bank responded to the challenges decisively, reduced the CRR by a cumulative 400 basis points
swiftly and in close coordination and consultation. to 5.0 per cent of NDTL, the repo rate by 425 basis
The policy stance shifted from monetary tightening points to 4.75 per cent and the reverse repo rate
in response to the elevated inflationary pressures by 275 basis points to 3.25 per cent.
in the first half of 2008-09 to monetary easing in
the second half as significant moderation in III.2 The magnitude and the pace of the
inflationar y pressures created the scope for response have to be seen par ticularly in the
enhancing the magnitude and speed of response context of the fact that despite significant
to the weakening growth impulses as well as to moderation, India’s growth remained one of the
occasional disorderly pressures in financial highest in the world, at 6.7 per cent for the full
markets. The changing stance of policy must be year, and the minimum quarterly growth during the
seen in the context of the previous period of year was 5.8 per cent. Thus, the policy stance
gradual withdrawal of monetary accommodation clearly reflected the forward looking undertone,
from September 2004 till August 2008 during particularly the expectations of more prolonged
which the repo/reverse repo rates had been adverse external conditions in the face of no visible
increased by 300/150 basis points, the cash risks to inflation. Moreover, the gradual withdrawal
reserve ratio (CRR) for scheduled banks had been of monetary accommodation that had started from

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September 2004 was a signal of the Reserve The responsibility, accountability and time path of
Bank’s assessment of possible overheating, even the decision making remain entirely with the
though subsequent monetary tightening was in Reserve Bank. In addition to the quarterly pre-policy
response to building of inflationary pressures up to meeting where the TAC members contributed to
mid 2008-09. The need for monetary policy cycle enriching the inputs and processes of policy setting,
remaining ahead of the business cycle, which there were two special meetings held on June 23,
emerged as a lesson from the current global crisis, 2008 and December 17, 2008 in the context of the
was already evident in the Reserve Bank’s actual evolving global economic crisis and to advise the
conduct of policy even before the crisis. Similarly, Reserve Bank on the stance of monetary policy.
the current post-crisis suggestion for use of pro-
cyclical provisioning norms and counter-cyclical
Pre-policy Consultation Meetings
regulations as a bulwar k against financial
instability had already been implemented in India III.4 It has been the endeavour of the Reserve
prior to the crisis. Bank to make the policy making process more
consultative. As part of this outreach and the
Organisational Framework for Monetary Policy Reser ve Bank’s growing emphasis on
strengthening the consultative process of monetary
Technical Advisory Committee
policy for mulation, the Reser ve Bank has
III.3 The Reser ve Bank had constituted a constituted a process of consulting different entities/
Technical Advisory Committee (TAC) on Monetary experts before each policy Statement/Review.
Policy in July 2005 with four external experts in the Accordingly, with effect from October 2005, the
areas of monetary economics, central banking, Reser ve Bank has introduced pre-policy
financial markets and public finance with a view to consultation meetings with the Indian Banks’
strengthening the consultative process in the Association (IBA), market participants (Fixed
conduct of monetary policy. The TAC reviews Income Money Market and Derivatives Association
macroeconomic and monetary developments and of India, Foreign Exchange Dealers’ Association of
advises the Reser ve Bank on the stance of India, and Primary Dealers Association of India),
monetary policy and monetary measures. The leaders of trade and industry and other institutions
Committee was reconstituted in April 2007 and the (urban co-operative banks, non-banking financial
membership of the Committee was expanded by companies, rural co-operatives and regional rural
including two additional members of the Central banks). This consultative process has contributed
Board of the Reserve Bank and one more external to enriching the policy formulation process and
expert. The tenure of the reconstituted Committee enhanced the effectiveness of monetary policy
was extended up to June 30, 2009. The Reserve measures.
Bank has now reconstituted the TAC on Monetary
Policy with effect from July 1, 2009 with a view to III.5 The specific aspects of monetary policy
obtaining continued benefit of advice from external operations of the Reserve Bank during 2008-09 and
experts. The tenure of the Committee is for two 2009-10 so far and the context against which policy
years, i.e., up to June 30, 2011. The Committee is decisions were formulated and implemented have
headed by Governor, with the Deputy Governor in been outlined in this chapter.
charge of monetary policy as the vice-chairman.
The other Deputy Governors of the Bank are also MONETARY POLICY OPERATIONS: 2008-09
members of the Committee. The TAC normally
meets once in a quarter. However, the meeting of III.6 The conduct of monetary policy during
the TAC could be held at any other time also, if 2008-09 witnessed two distinctly different phases.
necessary. The role of the TAC is advisory in nature. The first phase up to mid-September 2008 was

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characterised by monetary tightening, reflecting the of the lagged and cumulative effects of monetary
need to contain high inflation and adverse inflation policy on aggregate demand and assuming that
expectations. The policy stance during the second supply management would be conducive, capital
phase starting from mid-September 2008 was guided flows had to be managed actively and in the
by the ramifications of the global financial crisis for absence of new adversities emanating in the
economic growth and financial markets in India. domestic or global economy, the Policy Statement
indicated that the monetary policy endeavour
Annual Policy Statement for 2008-09 would be to bring down inflation from the prevailing
high level of above 7.0 per cent to around 5.5 per
III.7 The Annual Policy Statement (APS) for cent in 2008-09, with a preference for bringing it
2008-09 (April 29, 2008) had noted that there were close to 5.0 per cent as soon as possible,
significant shifts in both global and domestic recognising the evolving complexities in globally-
developments in relation to initial assessments transmitted inflation. The Statement also added
presented for 2007-08. In the backdrop of the that going forward, the Reserve Bank would
deteriorating outlook for the global economy, the continue to condition policy and perceptions for
APS highlighted that the dangers of global inflation in the range of 4.0-4.5 per cent so that
recession had increased at the time of an inflation rate of around 3.0 per cent became a
announcement of the Third Quarter Review of medium-term objective consistent with India’s
January 2008. It also added that since January broader integration into the global economy and
2008, the upside pressures from international food with the goal of maintaining self-accelerating
and energy prices appeared to have imparted a growth over the medium-term.
degree of persistent upward pressure to inflation
globally. On the domestic front, the outlook III.9 The Statement also noted that money
remained positive up to January 2008, with some supply remained above indicative projections
indications of moderation in industrial production, persistently through 2005-07 on the back of
services sector activity, business confidence and sizeable accretions to the Reserve Bank’s foreign
non-food credit thereafter. exchange assets and a cyclical acceleration in
credit and deposit growth. In view of the resulting
III.8 The initial forecast predicted a near-normal monetary overhang, the Statement mentioned that
rainfall in the 2008 South-West monsoon season, there was a need to moderate monetary expansion
suggesting sustenance of the trend growth in in the range of 16.5-17.0 per cent in 2008-09 in
agriculture. The Statement noted that the expected consonance with the outlook on growth and inflation
decline in world GDP growth in 2008 in relation to so as to ensure macroeconomic and financial
the preceding year could temper the prospects of stability. Consistent with the projections of money
growth in the industrial and services sectors at supply, the growth in aggregate deposits for 2008-
the margin, although the underlying momentum 09 was placed at around 17.0 per cent or around
of expansion in these sectors was likely to be Rs.5,50,000 crore. Based on the overall
maintained. In view of this overall macroeconomic assessment of the sources of funding and the
scenario, the APS placed real GDP growth during overall credit requirements of various productive
2008-09 in the range of 8.0 to 8.5 per cent for sectors of the economy, the growth of non-food
policy purposes, assuming that (a) global financial credit, including investments in bonds/debentures/
and commodity markets and real economy would shares of public sector undertakings and private
be broadly aligned with the central scenario as corporate sector and commercial paper (CP), was
assessed at that stage; and (b) domestically, placed at around 20.0 per cent for 2008-09
normal monsoon conditions may prevail. In view consistent with the monetary projections.

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III.10 Given the unprecedented complexities increased the repo rate under the LAF from 8.00
involved and the heightened uncer tainties, a per cent to 8.50 per cent effective from June 25,
number of factors influenced the stance of 2008. The CRR was also raised by 50 basis points
monetary policy for 2008-09. First, there was the to 8.75 per cent in two stages, 25 basis points each,
immediate challenge of escalated and volatile food effective from the fortnights beginning July 5 and
and energy prices, which possibly contained some July 19, 2008 respectively (Table 3.1).
str uctural components apar t from cyclical
components. Second, while demand pressures First Quarter Review 2008-09
persisted, there was some improvement in the
domestic supply response. Third, previous III.13 The First Quarter Review of the Annual
initiatives in regard to supply-management by the Statement on Monetary Policy for 2008-09 (July 29,
Government of India and monetary measures by 2008) noted that after the announcement of the
the Reserve Bank were in the process of impacting Annual Policy Statement in April 2008, global as
the economy. Fourth, policy responses emphasised well as domestic developments on both supply and
managing expectations in an environment of the demand sides pointed to accentuation of
evolving global and domestic uncertainties. Fifth, inflationary pressures, especially in terms of
monetary policy had demonstrated a resolve to act inflation expectations. In an environment of surging
decisively on a continuing basis to curb any signs global inflation, and with domestic inflation also
of adverse developments with regard to inflation rising to a 13-year high, the Reserve Bank noted
expectations. with concern that inflation had emerged as the
biggest risk to the global outlook, having risen to
III.11 In view of the macroeconomic conditions and very high levels across the world, not generally
then prevailing inflationary condition, the Reserve seen for a couple of decades.
Bank continued with its pre-emptive and calibrated
approach to contain inflation expectations, and raised III.14 The First Quar ter Review stated that
CRR by 25 basis points to 8.25 per cent with effect inflation was expected to moderate from the then
from the fortnight beginning May 24, 2008. This high levels in the months to come and a noticeable
followed the hike in the CRR by 25 basis points each decline in inflation was expected towards the last
effective from the fortnights beginning April 26 and quarter of 2008-09. Accordingly, it emphasised that
May 10, 2008 respectively. The Reserve Bank while the policy actions would aim to bring down
announced on June 11, 2008 an increase in the repo the prevailing intolerable level of inflation to a
rate under the Liquidity Adjustment Facility (LAF) by tolerable level of below 5.0 per cent as soon as
25 basis points to 8.00 per cent from 7.75 per cent possible and around 3.0 per cent over the medium-
with immediate effect. term, at that juncture a realistic policy endeavour
would be to bring down inflation from the then
III.12 Inflation, based on var iations in the prevailing level of about 11.0-12.0 per cent to a level
wholesale price index (WPI) on a year-on-year close to 7.0 per cent by end-March 2009. It stated
basis, increased to 11.05 per cent as on June 7, that taking into account aggregate demand
2008 from 7.75 per cent at end-March 2008 and management and supply prospects, the projection
4.28 per cent a year ago. At that juncture, the of real GDP growth of the Indian economy in 2008-
overriding priority for monetary policy was to 09, in the range of 8.0 to 8.5 per cent as set out in
eschew any further intensification of inflationary the Annual Policy Statement of April 2008, might
pressures and to fir mly anchor inflation prove to be optimistic and hence, for policy
expectations and to urgently address aggregate purposes, a projection of around 8.0 per cent
demand pressures which appeared to be strongly appeared to be a more realistic scenario, barring
in evidence. Accordingly, the Reser ve Bank domestic or external shocks.

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Table 3.1: Movement in Key Policy Rates and Reserve Requirements

(Per cent)

Effective since Bank Rate Reverse Repo Rate Repo Rate Cash Reserve Ratio Statutory Liquidity Ratio
1 2 3 4 5 6

March 31, 2004 6.00 4.50 6.00 4.50 25

September 18, 2004 6.00 4.50 6.00 4.75 (+0.25) 25
October 2, 2004 6.00 4.50 6.00 5.00 (+0.25) 25
October 27, 2004 6.00 4.75 (+0.25) 6.00 5.00 25
April 29, 2005 6.00 5.00 (+0.25) 6.00 5.00 25
October 26, 2005 6.00 5.25 (+0.25) 6.25 (+0.25) 5.00 25
January 24, 2006 6.00 5.50 (+0.25) 6.50 (+0.25) 5.00 25
June 9, 2006 6.00 5.75 (+0.25) 6.75 (+0.25) 5.00 25
July 25, 2006 6.00 6.00 (+0.25) 7.00 (+0.25) 5.00 25
October 31, 2006 6.00 6.00 7.25 (+0.25) 5.00 25
December 23, 2006 6.00 6.00 7.25 5.25 (+0.25) 25
January 6, 2007 6.00 6.00 7.25 5.50 (+0.25) 25
January 31, 2007 6.00 6.00 7.50 (+0.25) 5.50 25
February 17, 2007 6.00 6.00 7.50 5.75 (+0.25) 25
March 3, 2007 6.00 6.00 7.50 6.00 (+0.25) 25
March 30, 2007 6.00 6.00 7.75 (+0.25) 6.00 25
April 14, 2007 6.00 6.00 7.75 6.25 (+0.25) 25
April 28, 2007 6.00 6.00 7.75 6.50 (+0.25) 25
August 4, 2007 6.00 6.00 7.75 7.00 (+0.50) 25
November 10, 2007 6.00 6.00 7.75 7.50 (+0.50) 25
April 26, 2008 6.00 6.00 7.75 7.75 (+0.25) 25
May 10, 2008 6.00 6.00 7.75 8.00 (+0.25) 25
May 24, 2008 6.00 6.00 7.75 8.25 (+0.25) 25
June 11, 2008 6.00 6.00 8.00 (+0.25) 8.25 25
June 25, 2008 6.00 6.00 8.50 (+0.50) 8.25 25
July 5, 2008 6.00 6.00 8.50 8.50 (+0.25) 25
July 19, 2008 6.00 6.00 8.50 8.75 (+0.25) 25
July 30, 2008 6.00 6.00 9.00 (+0.50) 8.75 25
August 30, 2008 6.00 6.00 9.00 9.00 (+0.25) 25
October 11, 2008 6.00 6.00 9.00 6.50 (-2.50) 25
October 20, 2008 6.00 6.00 8.00 (-1.00) 6.50 25
October 25, 2008 6.00 6.00 8.00 6.00 (-0.50) 25
November 03, 2008 6.00 6.00 7.50 (-0.50) 6.00 25
November 08, 2008 6.00 6.00 7.50 5.50 (-0.50) 24 (-1.00)
December 08, 2008 6.00 5.00 (-1.00) 6.50 (-1.00) 5.50 24
January 05,2009 6.00 4.00 (-1.00) 5.50 (-1.00) 5.50 24
January 17,2009 6.00 4.00 5.50 5.00 (-0.50) 24
March 05,2009 6.00 3.50 (-0.50) 5.00 (-0.50) 5.00 24
April 21,2009 6.00 3.25 (-0.25) 4.75 (-0.25) 5.00 24

Note: 1. With effect from October 29, 2004, the nomenclature of repo and reverse repo was changed keeping with international usage. Now,
reverse repo indicates absorption of liquidity and repo signifies injection of liquidity. Prior to October 29, 2004, repo indicated absorption
of liquidity while reverse repo meant injection of liquidity. The nomenclature in this Report is based on the new usage of terms even for
the period prior to October 29, 2004.
2. Figures in parentheses indicate changes in policy rates/ratios.

III.15 The First Quarter Review emphasised the 2008-09 in consonance with the outlook on
necessity of moderating monetary expansion and gr ow t h a n d i n f l a t i o n s o a s t o e n s u r e
revised the projection for indicative money supply macroeconomic and financial stability in the
growth in the range of around 17.0 per cent in period ahead.

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III.16 The First Quarter Review noted that in view the interest rate ceilings on FCNR (B) deposits of
of the criticality of anchoring inflation expectations, all maturities and on deposits under the NR(E)RA
a continuous heightened vigil over ensuing for one to three years maturity by 50 basis points
monetary and macroeconomic developments was each and other measures to enhance availability
to be maintained to enable swift responses with of liquidity in the financial system (for details see
appropriate measures as necessary, consistent Chapter II.5, Box II.27). On October 20, 2008 in
with the monetary policy stance. Furthermore, in order to alleviate the pressures on domestic credit
view of the then macroeconomic and overall markets brought on by the indirect impact of the
monetary conditions, the First Quarter Review global liquidity constraint and, in particular, to
announced an increase in fixed repo rate under the maintain financial stability, the Reserve Bank
LAF by 50 basis points from 8.5 per cent to 9.0 per decided to reduce the repo rate under the LAF by
cent with effect from July 30, 2008 and an increase 100 basis points to 8.0 per cent with immediate effect.
of CRR by 25 basis points to 9.0 per cent with effect
from August 30, 2008. Mid-Term Review 2008-09
III.17 As the global liquidity crisis deepened in III.19 The Mid-Term Review of the Annual Policy
September 2008, capital inflows dried up and the Statement 2008-09 (October 24, 2008) was set in
demand for credit from the domestic banking the context of several complex and compelling
system increased, thereby aggravating the liquidity policy challenges as the global financial crisis
pressures. In the wake of the emerging stress on witnessed unprecedented dimensions.
India’s financial markets as a result of the contagion Gover nments, central banks and financial
from the global financial crisis, the immediate regulators around the world responded to the crisis
challenge for the Reserve Bank was to infuse with aggressive, radical and unconventional
confidence by augmenting both domestic and measures to restore calm and confidence to the
foreign exchange liquidity. Accordingly, the Reserve markets and bring them back to normalcy and stability.
Bank announced the first phase of measures on
September 16, 2008, including increase in the III.20 The Mid-Term Review highlighted that
interest rate ceilings on FCNR (B) deposits of all India’s financial sector continued to remain stable
maturities and on deposits under the NR(E)RA for and healthy. All indicators of financial strength and
one to three years maturity by 50 basis points and soundness such as capital adequacy, ratios of non-
other measures to augment liquidity (for details see performing assets (NPA) and return on assets
Chapter II.5, Box II.27). (RoA) for commercial banks were robust. The
Review also noted that the global developments,
III.18 Liquidity conditions tightened even further however, had some indirect, knock-on effects on
after October 7, 2008 as contagion from the US domestic financial markets.
financial crisis spread to Europe and Asia. Globally,
money markets froze and the stock markets turned III.21 The Mid-Ter m Review noted that the
highly volatile. Even coordinated policy actions by measures taken since mid-September 2008
monetary authorities in America, Europe, Asia and substantially assuaged liquidity stress in domestic
Australia failed to inspire the confidence of financial financial markets arising from the contagion of
markets. In view of the persisting uncertainty in the adverse external developments. The total liquidity
global financial situation and its impact on India, suppor t through reductions in the CRR, the
and continuing demand for domestic market temporary accommodation under the SLR and the
liquidity, the Reserve Bank took further measures first instalment of the agricultural debt waiver and
in October 2008 including a cumulative reduction debt relief scheme was of the order of Rs.1,85,000
of 250 basis points in the CRR effective from the crore. The Review further noted that the cut in the
fortnight beginning October 11, further increase in repo rate effected on October 20, 2008 was

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expected to ease the conditions in the money and III.26 Early signs of a global recession became
credit markets, restore their orderly functioning and evident by late October 2008 as global financial
sustain financial stability. conditions continued to remain uncertain and
unsettled. Globally, commodity prices, including
III.22 The First Quarter Review of July 2008 had crude oil prices, began to abate which reduced
placed the projection of real GDP growth in 2008- domestic inflationar y pressures. It was also
09 at around 8.0 per cent for policy purposes. The important to ensure that credit requirements for
Mid-Term Review noted that since then there had productive purposes were adequately met so as to
been significant global and domestic developments, support the growth momentum of the economy.
which rendered the outlook uncertain, suggesting Accordingly, the Reserve Bank announced a series
increased downside risks associated with this of measures on November 1, 2008 including
projection. Taking these developments and reduction in the repo rate under the LAF by 50 basis
prospects into account, the Mid-Term Review
points to 7.5 per cent with effect from November 3,
revised the projection of overall real GDP growth
2008, reduction in the CRR by 100 basis points to
for 2008-09 to the range of 7.5-8.0 per cent.
5.5 per cent of NDTL and the relaxation of the SLR,
III.23 The Mid-Term Review assessed that inflation on a temporary basis earlier, was made permanent
would remain a concern and emphasised that the and reduced to 24 per cent of NDTL effective from
Reserve Bank would keep a strong vigil on inflation. November 8, 2008. By mid-November 2008, there
Keeping in view the supply management measures were indications that the global slowdown was
taken by the Central Government and the lagged deepening with a larger than expected impact on
demand response to the monetary policy measures the domestic economy, particularly for the medium
taken by the Reserve Bank over the last one year, and small industry sector and export-oriented units.
the Review maintained the earlier projection of inflation In the context of these developments, for
of 7.0 per cent by end-March 2009 for policy purposes. augmenting r upee and forex liquidity, and
strengthening and improving credit deliver y
III.24 The Mid-Term Review noted that India’s mechanisms, the Reser ve Bank announced
balance of payments till then reflected strength and measures on November 15, 2008 including
resilience in a highly unsettled international increase in interest rate ceilings on FCNR(B) and
environment. Assessing the various factors NR(E)RA deposits by 75 basis points each to Libor/
affecting balance of payments, the Review expected swap rates plus 100 basis points and Libor/swap
somewhat higher current account deficit in 2008- rates plus 175 basis points, respectively. On a
09 than in the preceding year, but it also expected further review of the then prevailing liquidity
enough capital inflows to meet the exter nal conditions, the Reserve Bank again announced
financing requirement in 2008-09. measures for liquidity management and improving
credit flows on November 28, 2008.
III.25 The Review expressed the Reserve Bank’s
concerns about the depth of global financial crisis III.27 The global outlook deteriorated further
and its endeavour to remain proactive, and take dur ing December 2008 indicating that the
measures to manage the unfolding developments recession would be deeper and the recovery
by easing pressures stemming from the global longer than anticipated earlier. With indications of
crisis. Against the backdrop of the ensuing global slowing down of the domestic economic activity
and domestic developments and in the light of while inflationary pressures abated significantly,
measures taken by the Reser ve Bank over the Reserve Bank initiated a series of measures
September-October 2008, the Bank Rate, the repo on December 6 and 11, 2008 which included
rate and the reverse repo rate and the cash reserve reduction in the repo rate under the LAF by 100
ratio (CRR) were kept unchanged. basis points to 6.5 per cent, reduction in the

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reverse repo rate by 100 basis points from 6.0 per experienced a cyclical moderation in growth
cent to 5.0 per cent, effective from December 8, accompanied by high inflation in the first half of
2008 and measures relating to refinance facilities 2008-09 and there was a distinct evidence of further
(for details see Chapter II.5, Box II.27). These slowdown as a consequence of the global
measures were aimed at improving the credit flow downturn. The knock-on effects of the global crisis,
to productive sectors to sustain the growth and falling commodity prices affected the Indian
momentum. economy in several ways. Access to international
credit continued to be constrained; capital market
III.28 While domestic financial markets continued
valuations remained low; industrial production
to function in an orderly manner, India’s growth
growth slackened; export growth turned negative,
trajectory was impacted by the global recession.
and overall business sentiment deteriorated. On the
The Reserve Bank’s monetar y policy stance
positive side, the Review noted that the headline
recognised the concerns over rising credit risk
inflation decelerated, though consumer price
together with the slowing of economic activity which
inflation did not show any moderation. Also, the
appeared to affect credit growth. Accordingly, in
domestic financial markets continued to function
order to stimulate growth, the Reserve Bank took
in an orderly manner and in sharp contrast to their
the following measures on January 2, 2009: (i) the
international counterparts, the financial system in
repo rate under the LAF was reduced by 100 basis
India remained resilient and stable. The Review
points to 5.5 per cent with effect from January 5,
further observed that although bank credit growth
2009; (ii) the reverse repo rate under the LAF was
was higher in 2008-09 (up to mid- January 2009)
reduced by 100 basis points to 4.0 per cent with
than in the previous year, the flow of overall financial
effect from January 5, 2009; and (iii) the CRR
resources to the commercial sector during April
was reduced from 5.5 per cent to 5.0 per cent of
2008-Januar y 2009 declined marginally as
NDTL effective from the for tnight beginning
compared with the previous year. This was on
January 17, 2009.
account of decline in other sources of funding such
as resource mobilisation from the capital market and
Third Quarter Review 2008-09 external commercial borrowings (ECBs).
III.29 The Third Quarter Review of Monetary III.31 The Third Quarter Review noted that the
Policy 2008-09 (January 27, 2009) was set in the downside risks to growth had amplified since Mid-
context of a deepening global crisis with persistent Ter m Review of October 2008 because of
uncertainty in the global financial system. There
slowdown in industrial activity and weakening of
was a rapid and marked deterioration in the global
external demand, as reflected in decline in exports.
economic outlook after the release of the Reserve Services sector activities were likely to further
Bank’s Mid-term Review in October 2008. The decelerate in the second half of 2008-09. Keeping
continued bad news from large international in view the slowdown in industry and services and
financial institutions on a regular basis renewed with the assumption of nor mal agr icultural
concerns about the time when the global financial production, the Third Quarter Review revised the
sector would attain a semblance of stability. There projection of overall real GDP growth for 2008-09
was an emerging consensus that there might be downwards to 7.0 per cent with a downward bias.
no recovery till late 2009; indeed, some outlook
The Review emphasised that the fundamental
suggested that the recovery might be delayed strengths continued to be in place and once the
beyond 2009. global economy star ted to recover, India’s
III.30 The Third Quarter Review, prepared in the turnaround would be sharper and swifter, backed
backdrop of rising effects of contagion from the by India’s strong fundamentals and the untapped
global crisis, observed that the Indian economy growth potential.

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III.32 Since the time of presentation of the Mid- III.35 In view of the continuing uncertain credit
Term Review in October 2008, pressures on conditions globally and domestically, the Reserve
commodity prices had abated markedly around the Bank, on February 5, 2009 extended the forex swap
world, reflecting slump in global demand. In the facility and restructuring of advances by banks and
domestic market, WPI inflation was already below raised ceiling rate on export credit in foreign
7.0 per cent, which was projected earlier for end- currency.
March 2009. Based on the then available
III.36 Subsequent to the release of the Third
information, the Review assessed the inflation rate
Quarter Review in January 2009, there was evidence
to moderate further in the last quarter of 2008-09.
of further slowing down of economic activity as
The Review recognised that the headline WPI
manifested by the decline in exports and IIP and
inflation might fall well below 3.0 per cent in the
moderation in GDP growth (across all the sectors).
short-run partly because of the statistical reason
The total flow of resources to the commercial sector
of high base, and the global trends caused by sharp
from banks and non-banks during April-February
corrections from exceptionally high oil and
2008-09 was also lower than in the corresponding
commodity prices prevailing in early 2008.
period of the last year. Against the backdrop of the
III.33 The Review recognised that with the decline then prevailing macroeconomic conditions, the
in upside risks to inflation, monetary policy was Reserve Bank on March 4, 2009 decided to reduce
responding to slackening economic growth in the both repo and reverse repo rate under the LAF by
context of significant global stress. Accordingly, in 50 basis points to 5.0 per cent and 3.5 per cent,
the Third Quarter Review, for policy purposes, the respectively, effective from March 5, 2009.
projection of money supply (M3) growth for 2008-
09 was raised to 19.0 per cent from 16.5-17.0 per MONETARY POLICY OPERATIONS: 2009-10
cent projected earlier.
Annual Policy Statement 2009-10
III.34 Based on the assessment of the global III.37 The Annual Policy Statement (APS) 2009-
scenario and the domestic economy, particularly 10 (April 21, 2009) was presented in the midst of
the outlook for growth and inflation, the Reserve exceptionally challenging circumstances in the
Bank in the Third Quarter Review maintained its global economy. It noted that the global economic
monetary policy stance of provision of comfortable crisis had called into question several fundamental
liquidity to meet the required credit growth assumptions and beliefs governing economic
consistent with the overall projection of economic resilience and financial stability. What started off
growth. Furthermore, the Reserve Bank announced as turmoil in the financial sector of the advanced
that monetary policy actions would be aimed at economies had snowballed into the deepest and
ensuring a monetary and interest rate environment most widespread financial and economic crisis of
consistent with price stability, well-anchored the last 60 years. The Statement noted that
inflation expectations and orderly conditions in although the governments and central banks
financial markets. In light of the measures already around the world responded to the crisis through
taken by the Reserve Bank over November 2008- both conventional and unconventional fiscal and
January 2009, the Review kept the Bank Rate, the monetary measures, the global financial situation
repo rate and the reverse repo rate under the LAF remained uncer tain and the global economy
and the CRR unchanged. On a review of the then continued to cause anxiety for several reasons.
prevailing liquidity conditions, the Reserve Bank There was no clear estimate of the quantum of
announced the extension of the special term repo tainted assets, and doubts persisted on whether
facility under the LAF and special refinance facility the initiatives underway were sufficient to restore
for banks up to September 30, 2009. the stability of the financial system. There was a

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continued debate on the adequacy of the fiscal the global trend in commodity prices and domestic
stimulus packages across countries, and their demand-supply balance, the Statement projected
effectiveness in arresting the downturn, reversing WPI inflation at around 4.0 per cent by end-March
job losses and reviving consumer confidence. 2010. The Statement emphasised that monetary
policy in India would continue to condition and
III.38 The Statement mentioned that both the
contain perceptions of inflation in the range of 4.0-
Government and the Reserve Bank responded to
4.5 per cent so that an inflation rate of around 3.0
the challenge of minimising the impact of the crisis
per cent becomes the medium-term objective.
on India in co-ordination and consultation. The
policy responses in India beginning September III.41 Monetary and credit aggregates had
2008 were designed largely to mitigate the adverse exhibited deceleration from their peak levels in
impact of the global financial crisis on the Indian October 2008. The liquidity overhang emanating
economy. The conduct of monetary policy had to from the earlier surge in capital inflows had
contend with the high speed and magnitude of the substantially moderated in 2008-09. The Reserve
external shock and its spill-over effects through the Bank was committed to provide ample liquidity for
real, financial and confidence channels. The all productive activities on a continuous basis. As
evolving stance of policy had been increasingly the upside risks to inflation declined, monetary
conditioned by the need to preserve financial policy started responding to slackening economic
stability while arresting the moderation in the growth growth in the context of significant global stress.
momentum. The Policy Statement also mentioned Accordingly, for policy purposes, the Statement
that taking a cue from the Reserve Bank’s monetary projected money supply (M3) growth at 17.0 per cent
easing; most banks started to reduce their deposit for 2009-10.
and lending rates.
III.42 The Annual Policy Statement recognised
III.39 It was viewed that the fiscal and monetary that while continuing to support adequate liquidity
stimulus measures initiated during 2008-09 coupled in the economy, the Reserve Bank would have to
with lower commodity prices could cushion the ensure that as economic growth gathers
downturn in the growth momentum during 2009-10 momentum, the excess liquidity is rolled back in
by stabilising domestic economic activity to some an order ly manner. Based on the overall
extent. While based on the available information it assessment of the macroeconomic situation, the
was found that domestic financing conditions had Policy Statement emphasised the need to ensure
improved, external financing conditions were a policy regime that would enable credit expansion
expected to remain tight. Private investment at viable rates while preserving credit quality so as
demand was, therefore, expected to remain to support the return of the economy to a high
subdued. On balance, with the assumption of growth path. It indicated that the Reserve Bank
normal monsoon, the Statement, for policy purpose, would continuously monitor the global and domestic
projected real GDP growth for 2009-10 at around conditions and respond swiftly and effectively
6.0 per cent. through policy adjustments as warranted so as to
minimise the impact of adverse developments and
III.40 On account of a slump in global demand, reinforce the impact of positive developments. The
pressures on global commodity prices abated stance further emphasised to maintain a monetary
markedly around the world by the end of the fiscal and interest rate regime supportive of price stability
year 2008-09. The sharp decline in prices of crude and financial stability taking into account the
oil, metals, foodgrains, cotton and cement had emerging lessons of the global financial crisis.
influenced inflation expectations in most parts of Against the backdrop of global and domestic
the world. This was also reflected in the domestic developments, the Reserve Bank reduced the repo
WPI inflation reaching close to zero. Keeping in view rate under the LAF by 25 basis points from 5.0 per

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 ANNUAL REPORT

cent to 4.75 per cent with effect from April 21, 2009. banking sector and well-functioning financial
The reverse repo rate under the LAF was also markets helped to cushion the economy from the
reduced by 25 basis points from 3.5 per cent to worst impact of the crisis.
3.25 per cent with effect from April 21, 2009.
III.45 The First Quar ter Review noted the
progressive signs of recovery in India: (i) increase
First Quarter Review 2009-10 in food stocks; (ii) positive industrial production
growth; (iii) improved corporate performance;
III.43 The First Quarter Review of Monetary
(iv) optimism in business confidence surveys;
Policy 2009-10 (July 28, 2009) noted that the global
(v) upturn in leading indicators; (vi) easing of lending
economy was showing incipient signs of
rates; (vii) pick-up in credit off-take after May 2009;
stabilisation, albeit not recovery. The pace of decline
(viii) rebound in stock prices; (ix) activity in the
in economic activity in several major advanced
primary capital market; and (x) improved external
economies had slowed, frozen credit markets had
financing conditions. On the other hand, the
thawed and equity markets had begun to recover.
negative signs included: (i) delayed and deficient
Recent months also witnessed industrial activity
monsoon; (ii) food price inflation; (iii) rebound in
reviving in a number of emerging mar ket
global commodity prices; (iv) continuing weak
economies. Notwithstanding some positive signs,
external demand; and (v) high fiscal deficit.
the path and the time horizon for global recovery
remained uncer tain in the light of subdued III.46 It was noted that due to various policy
consumption demand, increased unemployment initiatives by the Reserve Bank, the liquidity
levels and in anticipation of further contraction in situation remained comfor table since mid-
global trade and private capital flows. While November 2008 as evidenced by the LAF window
business and consumer confidence were yet to where the Reserve Bank was absorbing more than
show definitive signs of revival and the financial Rs.1,20,000 crore on a daily average basis. The
sector appeared to be stabilising in response to liquidity expansion was consistent with the Reserve
concerted actions taken by governments and Bank’s stance of ensuring a policy regime that
central banks across the world, economic recession would enable credit expansion at viable rates while
in the real sector persisted. preserving credit quality. With ample liquidity, the
competitive pressure on banks to reduce lending
III.44 The Indian economy exper ienced a
rates increased and the transmission of policy rate
significant slowdown in 2008-09 in comparison with
changes to bank lending rates improved since the
the robust growth performance in the preceding five
last Annual Policy Statement in April 2009. It further
years, largely due to the knock-on effect of the
noted that as the short-term deposits contracted
global financial crisis. India’s exports contracted for
earlier at high rates mature and get repriced, it
eight straight months which, in turn, impacted the
opens up room for banks to further reduce their
industrial sector and the services sector. The
lending rates.
financial sector, however, remained relatively
unaffected despite the severe stress created by the III.47 The First Quar ter Review revised the
global deleveraging process, which triggered capital indicative policy projection for GDP growth in 2009-
outflows in the second half of 2008-09. Quick and 10 to 6.0 per cent with an upward bias which
aggressive policy responses both by the marked a slight improvement over the growth
Government and the Reserve Bank mitigated the expectation of around 6.0 per cent indicated in the
impact of the global financial crisis. The large Annual Policy Statement. It was recognised that an
domestic demand bolstered by the government uptrend in the growth momentum was unlikely
consumption, provision of forex and rupee liquidity before the middle of 2009-10. On inflation
coupled with sharp cuts in policy rates, a sound prospects, WPI inflation for end-March 2010 was

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 MONETARY AND CREDIT POLICY OPERATIONS

projected higher at around 5.0 per cent from 4.0 III.49 Consistent with the assessment of
per cent given in the Annual Policy Statement of macroeconomic and monetary conditions, the repo
April 2009. It was noted that the WPI inflation turned rate, the reverse repo rate and the CRR were kept
negative in June 2009 due to the statistical base unchanged. The Reserve Bank reiterated that it
effect as anticipated, and not because of any would maintain an accommodative monetar y
contraction in demand. However, the sharp decline stance until there are definite and robust signs of
in WPI inflation had not been commensurately recovery. This accommodative monetary stance is,
matched by a similar decline in inflation however, not the steady state. On the way forward,
expectations. Also, inflation of WPI primary articles, the Reserve Bank would have to reverse the
particularly food articles, remained significantly expansionar y measures to anchor inflation
positive and consumer price indices (CPIs) also expectations and subdue inflationary pressures
were elevated, indeed also hardened in recent while preserving the growth momentum. The exit
months. The Review further noted that global strategy will be modulated in accordance with the
commodity prices had rebounded ahead of global evolving macroeconomic developments.
recovery and the uncertain monsoon outlook could
further accentuate food price inflation. On balance, III.50 The stance of monetary policy changed
the risks to the revised projections of real GDP swiftly during 2008-09 in response to the changing
growth and inflation for 2009-10 were on the upside. domestic and international environment. In the first
The comfortable levels of food grains stocks should half of 2008-09, the Reserve Bank continued with
help mitigate the risks in the event of price the tight monetary stance to contain inflationary
pressures from the supply side. It was emphasised expectations in view of the elevated inflationary
that the Reserve Bank will also closely monitor the pressures emanating from the substantial increase
level of liquidity so as to contain inflationary in commodity prices. All the policy rates and the
expectations if supply side price pressures were to CRR were accordingly increased on a continuous
rise. Further, in order to ensure that the increased basis up to August 2008. However, the Reserve
Government market borrowing programme does Bank reversed the stance of monetary policy swiftly
not crowd out credit flow to the private sector, the after mid-September 2008 and moved towards
projection of money supply (M3) growth for 2009- monetary easing anticipating the impact of the
10 was raised to 18.0 per cent from 17.0 per cent inter national financial tur moil on the Indian
indicated in the Annual Policy Statement. Consistent economy, in the backdrop of declining inflation.
with this, aggregate deposits and adjusted non-food Accordingly, the Reserve Bank reduced the CRR,
credit of commercial banks were projected to grow cut policy rates and injected liquidity in the system
by 19.0 per cent and 20.0 per cent, respectively. to support the growth momentum of the economy
and make credit available for productive purposes.
III.48 On the basis of the overall assessment, the During the course of last one year, thus, the stance
stance of monetary policy for the remaining period of monetary policy had to change significantly to
of 2009-10 was stated to be as: (i) managing meet the various challenges in relation to the
liquidity actively so that the credit demand of the objectives of the monetary policy (Box III.1).
Government is met while ensuring the flow of credit
to the private sector at viable rates (ii) keeping a Cash Reserve Ratio
vigil on the trends and signals of inflation, and be
prepared to respond quickly and effectively through III.51 Between April-August 2008, the CRR for
policy adjustments; (iii) maintaining a monetary and scheduled banks was raised by 150 basis points in
interest rate regime consistent with price stability six stages of 25 basis points each to 9.0 per cent
and financial stability supportive of returning the of the banks’ net demand and time liabilities (NDTL)
economy to the high growth path. (Chart III.1). Subsequently, the CRR was reduced

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Box III.1
Changing Stance of Monetary Policy in India
2008-09 • Emphasise credit quality and credit delivery, in particular,
Annual Policy Statement (April 2008) for employment-intensive sectors, while pursuing
financial inclusion.
• To ensure a monetary and interest rate environment that
accords high priority to price stability, well-anchored Third Quarter Review (January 2009)
inflation expectations and orderly conditions in financial
• Provision of comfortable liquidity to meet the required
markets while being conducive to continuation of the
credit growth consistent with the overall projection of
growth momentum.
economic growth.
• To respond swiftly on a continuing basis to the evolving
• Respond swiftly and effectively with all possible measures
constellation of adverse international developments and
as warranted by the evolving global and domestic situation
to the domestic situation impinging on inflation
impinging on growth and financial stability.
expectations, financial stability and growth momentum,
with both conventional and unconventional measures, • Ensure a monetary and interest rate environment
as appropriate. consistent with price stability, well-anchored inflation
expectations and orderly conditions in financial markets.
• To emphasise credit quality as well as credit delivery, in
particular, for employment-intensive sectors, while 2009-10
pursuing financial inclusion.
Annual Policy Statement (April 2009)
First Quarter Review (July 2008) • Ensure a policy regime that will enable credit expansion
• To ensure a monetary and interest rate environment that at viable rates while preserving credit quality so as to
accords high priority to price stability, well-anchored support the return of the economy to a high growth path.
inflation expectations and orderly conditions in financial
• Continuously monitor the global and domestic conditions
markets while being conducive to continuation of the
and respond swiftly and effectively through policy
growth momentum.
adjustments as warranted so as to minimise the impact
• To respond swiftly on a continuing basis to the evolving of adverse developments and reinforce the impact of
constellation of adverse international developments and positive developments.
to the domestic situation impinging on inflation
• Maintain a monetary and interest rate regime supportive
expectations, financial stability and growth momentum,
of price stability and financial stability taking into account
with both conventional and unconventional measures,
the emerging lessons of the global financial crisis.
as appropriate.
• To emphasise credit quality as well as credit delivery, in First Quarter Review (July 2009)
particular, for employment-intensive sectors, while • Manage liquidity actively so that the credit demand of
pursuing financial inclusion. the Government is met while ensuring the flow of credit
to the private sector at viable rates.
Mid-Term Review (October 2008)
• Keep a vigil on the trends and signals of inflation, and
• Ensure a monetary and interest rate environment that be prepared to respond quickly and effectively through
optimally balances the objectives of financial stability, policy adjustments.
price stability and well-anchored inflation expectations,
and growth; • Maintain a monetary and interest rate regime consistent
with price stability and financial stability supportive of
• Continue with the policy of active demand management returning the economy to the high growth path.
of liquidity through appropriate use of all instruments
including the CRR, open market operations (OMO), the Since September 2008, along with the usual emphasis on
MSS and the LAF to maintain orderly conditions in containment of inflation and inflation expectations,
financial markets; supporting growth momentum and financial stability, the
balance of focus in the policy stance has changed in
• In the context of the uncertain and unsettled global response to the evolving conditions with greater policy
situation and its indirect impact on the domestic economy accent on adequate and swift response, using conventional
in general and the financial markets in particular, closely and unconventional measures, to maintain orderly market
and continuously monitor the situation and respond conditions, and provision of adequate liquidity to support
swiftly and effectively to developments, employing both credit growth and aggregate demand without diluting the
conventional and unconventional measures; emphasis on credit quality.

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 MONETARY AND CREDIT POLICY OPERATIONS

the notice of the central banks that liquidity

injected by the central banks to the commercial
banks may not reach the non-banks in the face of
heightened risk aversion and uncertainties about
the soundness of even the most reputed global
financial institutions. The global financial crisis not
only tested the limits of conventional liquidity
management operations of central banks, but also
necessitated extensive resor t to a range of
unconventional measures as it became
increasingly evident that to avoid a systemic
financial crisis, not only the liquidity needs of “too
big to fail” banks have to be met, but even the
liquidity needs of “too interconnected to fail”
financial institutions (such as Bear Stearns & AIG)
must also be met.

III.54 Despite no direct exposure of the Indian

banks and financial institutions to the failing
by 400 basis points to 5.0 per cent in four stages
inter national institutions or troubled assets,
between October 11, 2008 and April 21, 2009.
liquidity management operations of the Reserve
Bank assumed greater urgency in the face of the
Statutory Liquidity Ratio knock-on effects of the global financial crisis,
III.52 The statutory liquidity ratio (SLR) was which manifested not only as reversals in capital
reduced by 100 basis points to 24.0 per cent of inflows but also adverse market expectations
banks’ NDTL effective from November 8, 2008. causing sharp correction in asset prices, and
Commercial banks’ actual holdings of SLR pressures on the exchange rate. The Reserve
securities as at end-March 2009 stood at 28.1 per Bank had to swiftly respond to the rapidly evolving
cent of their NDTL as compared with 27.8 per cent macroeconomic conditions. In the initial few
at end-March 2008. months of 2008-09, inflation expectations driven
by surge in global commodity prices dictated a
contractionary stance; during the following few
LIQUIDITY MANAGEMENT
months, the autonomous pressures on liquidity
III.53 Central banks around the world faced arising from capital outflows, and drying up of
complex challenges in the conduct of their liquidity sources of overseas funding necessitated
management operations, as the pressure on discretionary expansion; in the last few months,
funding liquidity became unprecedented in the the surge in Government’s market borrowings to
face of significant erosion in market liquidity. Sharp deal with the slow-down of the economy elicited
corrections in asset pr ices affected mar ket fur ther accommodating response from the
liquidity, which had the potential to create Reserve Bank (Table 3.2). Thus, by synchronising
insolvency problem for several leading global the liquidity management operations with those
financial institutions. Moreover, as the liquidity of exchange rate management and non-disruptive
needs of non-banks, ranging from investment inter nal debt management operations, the
banks, insurance companies, housing finance Reserve Bank ensured that appropriate liquidity
companies, hedge funds to even money market was maintained in the system so that all legitimate
mutual funds increased exponentially, it came to requirements of credit were met, particularly for

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Table 3.2: Reserve Bank’s Liquidity Management Operations

(Rupees crore)
Item 2007-08 2008-09 2008-09
Q1 Q2 Q3 Q4
1 2 3 4 5 6 7
A. Drivers of Liquidity (1+2+3+4+5) 2,03,010 -1,67,708 6,061 -18,851 -1,01,278 -53,640
1. RBI’s net purchases from Authorised Dealers 3,12,054 -1,78,592 -8,555 -40,249 -1,12,168 -17,620
2. Currency with the Public -85,587 -97,921 -30,063 12,360 -40,070 -40,147
3. Surplus cash balances of the Centre
with the Reserve Bank -26,594 60,367 40,073 -3,845 36,554 -12,415
4. WMA and OD 0 0 0 0 0 0
5. Others (residual) 3,137 48,438 4,606 12,884 14,406 16,542
B. Management of Liquidity (6+7+8+9) -1,17,743 2,35,209 -37,659 7,217 1,33,325 1,32,326
6. Liquidity impact of LAF Repos 21,165 -51,835 -18,260 24,390 -71,110 13,145
7. Liquidity impact of OMO (Net) * 13,510 1,04,480 14,642 11,949 10,681 67,208
8. Liquidity impact of MSS -1,05,418 80,314 -6,041 628 53,754 31,973
9. First round liquidity impact due to CRR change -47,000 1,02,250 -28,000 -29,750 1,40,000 20,000
C. Bank Reserves (A+B) # 85,267 67,501 -31,598 -11,634 32,047 78,686

(+) : Indicates injection of liquidity into the banking system.

(-) : Indicates absorption of liquidity from the banking system.
# : Includes vault cash with banks and adjusted for first round liquidity impact due to CRR change.
* : Includes oil bonds but excludes purchases of government securities on behalf of State Governments.
Note : Data pertain to March 31 and last Friday for all other months.

productive purposes, consistent with the objective stipulations and open market operations (OMO),
of price and financial stability. The management including MSS and LAF and a slew of special
of liquidity was through appropriate use of CRR facilities (Table 3.3).

Table 3.3: Monthly Primary Liquidity Flows and Open Market Operations
(Rupees crore)

Month RBI’s Net Foreign Net Repos under the LAF Net Open Market Market Stabilisation
Currency Assets # Operations Scheme
2007-08 2008-09 2009-10 2007-08 2008-09 2009-10 2007-08 2008-09 2009-10 2007-08 2008-09 2009-10
1 2 3 4 5 6 7 9 10 11 12 13 14

Apr 11,935 15,059 -1,971 -19,189 -83,115 -1,06,945 -313 -111 18,591 -12,951 -4,052 17,861
May 8,138 9,447 -7,519 -5,306 3,155 -26,410 -680 -54 16,959 -11,395 -2,918 30,326
Jun 27,655 -8,971 3,245 -7,687 34,610 555 -252 8,860 6,451 4,702 929 17,000
Jul 25,219 -33,674 23,592 -3 29,325 -5,405 -664 9,488 5,243 -2,410 2,993 1,827
Aug 38,817 15,580 -13,855 -26,725 -498 1,883 -21,407 -2,218
Sep 54,039 -13,547 22,925 48,880 -398 -836 -25,039 -146
Oct 52,372 -42,465 -24,205 -67,285 -531 -1 -42,804 8,617
Nov 29,994 -47,375 9,425 6,785 -146 -7 -1,103 22,821
Dec 18,521 -2,262 31,080 -1,670 4,597 7,677 12,716 22,316
Jan 45,251 10,557 -34,305 -48,915 680 6,621 1,607 11,286
Feb 38,428 6,022 3,850 -5,215 2,321 5,801 -14,031 6,773
Mar 20,181 -8,679 58,435 58,335 1,809 55,227 6,697 13,914
Total 3,70,550 -1,00,308 17,347 21,165 -51,835 -1,38,205 5,925 94,548 47,244 -1,05,418 80,315 67,014
# : Adjusted for revaluation.
+ : Indicates injection of liquidity into the banking system.
- : Indicates absorption of liquidity from the banking system.
Note : 1. Data based on March 31 for March and last reporting Friday for all other months.
2. From April 2006 onwards, the Reserve Bank has stopped participating in the primary market for Government securities in line with the stipula-
tions of the Fiscal Responsibility and Budget Management (FRBM) Act. 2003.

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 MONETARY AND CREDIT POLICY OPERATIONS

First Half of the Fiscal Year 2008-09 term foreign funding requirements. The Reserve
Bank also continued with the Special Market
III.55 The initial impact of the sub-prime crisis on
Operations (SMO) which were instituted in June 2008
the Indian economy was rather muted. During most for meeting the foreign exchange requirements of
part of the first half of fiscal 2008-09, liquidity public sector oil marketing companies, taking into
management operations were essentially geared account the then prevailing extraordinary situation
towards mopping up of excess domestic liquidity, in the money and foreign exchange markets. Finally,
mainly through CRR hikes (in April, May, July and measures to ease foreign exchange liquidity also
August cumulatively by 150 basis points to 9.0 per included those aimed at encouraging capital
cent) with a view to containing inflationar y inflows, such as an upward adjustment of the
pressures. Signalling the contractionary stance, the interest rate ceiling on the foreign currency deposits
Bank also raised the repo rate cumulatively by 125 by non-resident Indians, substantially relaxing the
basis points (in June and July 2008) to 9.0 per cent external commercial borrowings (ECB) regime for
effective July 30, 2008. Meanwhile, by end May, corporates, and allowing non-banking financial
2008, capital flows had been adversely affected as companies and housing finance companies access
a consequence of the worsening global financial to foreign borrowing.
conditions leading to foreign exchange market
operations by the Reser ve Bank to contain III.58 The cumulative effect of Reserve Bank’s
excessive volatility in the exchange rate, which in operations in the foreign exchange market as well
turn contributed to some absorption of domestic as transient local factors such as build up in
liquidity. Concomitantly, with the reversal in the government balances following quarterly advance
nature of foreign exchange market operations, tax payments, however, adversely impacted the
auction of dated securities under the MSS was domestic liquidity conditions. Consequently, with
suspended. Reflecting the impact of these receding inflationary pressures and rising possibility
developments, the LAF turned from absorption mode of global crisis affecting India’s growth prospects
to injection mode after the first week of June 2008. the Reserve Bank switched to an expansionary
regime in mid-October, 2008 in contrast to its
Second Half of the Fiscal Year 2008-09 contractionary regime earlier.

III.56 Though the direct impact of the sub-prime III.59 As a fallout of the global financial crisis,
crisis on Indian banks/financial sector was almost foreign funding dwindled and the domestic capital
negligible because of limited exposure to the market slumped, which, in turn, put pressures on
troubled assets, prudential policies put in place by some segments of the Indian financial system, such
the Reserve Bank and relatively lower presence of as mutual funds and NBFCs. Facing large
foreign banks in the Indian banking sector, there redemption pressures, the mutual funds started
was a sudden change in the external environment conserving their liquidity which, in turn, affected
following the Lehman Brothers’ failure in mid- other sections of the market, particularly NBFCs,
September, 2008. that had been dependent on mutual funds for their
funding needs. To address such liquidity shortages,
III.57 With a view to maintaining order ly the Reserve Bank introduced a term repo facility
conditions in the foreign exchange market which for an amount up to Rs.60,000 crore under which
had turned volatile, the Reserve Bank scaled up banks could avail central bank funds to address
its intervention operations, particularly in October, the liquidity stress faced by mutual funds, NBFCs
2008. The other important measures taken by the and housing finance companies (HFCs) with
Reserve Bank to contain foreign exchange volatility associated SLR exemption of up to 1.5 per cent of
included a rupee-dollar swap facility for Indian NDTL. This facility has been extended up to March
banks to give them comfort in managing their short- 31, 2010. A SPV was also set up to address the

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 ANNUAL REPORT

temporary liquidity constraints of systemically

important non-deposit taking NBFCs. Thus, the
Reserve Bank addressed the financial stress faced
by non-banks indirectly through the banking
channel and a SPV and without compromising
either on the eligible counterparties or on the asset
quality of its balance sheet, which was in contrast
to the approach adopted by the Central Banks of
some of the advanced countries (See Box III.2).

III.60 In addition, a special refinance facility was

introduced by the Reserve Bank, under which all
scheduled commercial banks (SCBs) (excluding
Regional Rural Banks) were provided refinance,
against the collateral of promissor y notes,
equivalent to up to 1.0 per cent of their NDTL as
on October 24, 2008 at the LAF repo rate up to a
maximum period of 90 days. Banks were also
encouraged to use this facility for the purpose of
extending finance to micro and small enterprises. Rs.54,737 crore offsetting issuances of Rs 43,500
crore ) to Rs.1,21,353 crore at end December 2008
III.61 The other measures that aimed at keeping (Table 3.4 and Chart III.3).
the domestic money and credit markets functioning
normally, since solvency was not an issue in India Table 3.4: Indicators of Liquidity
at all, included (a) reduction in statutory liquidity (Rupees crore)

ratio (SLR) by one percentage point, (b) extension Outstanding as LAF MSS Centre’s Surplus Total
on last Friday with the RBI@ (2 to 4)
of the period of entitlement of pre-shipment and
1 2 3 4 5
post-shipment rupee export credit, (c) increase in 2008
the eligible limit of the ECR facility and (d) amounts January 985 1,66,739 70,657 2,38,381
February 8,085 1,75,089 68,538 2,51,712
to be allotted from SCBs for contribution to the March* -50,350 1,68,392 76,586 1,94,628
SIDBI and the NHB. April 32,765 1,72,444 36,549 2,41,758
May -9,600 1,75,362 17,102 1,82,864
June -32,090 1,74,433 36,513 1,78,856
III.62 Following the reversal in capital flows and July -43,260 1,71,327 15,043 1,43,110
significant increase in the liquidity needs of the August -7,600 1,73,658 17,393 1,83,451
September -56,480 1,73,804 40,358 1,57,682
economy, the Reserve Bank also started unwinding October -73,590 1,65,187 14,383 1,05,980
of the outstanding MSS balances. After September, November -9,880 1,32,531 7,981 1,30,632
December 14,630 1,20,050 3,804 1,38,484
2008, the issue of Treasury Bills under the MSS
2009
was suspended, resulting in a steady release of January 54,605 1,08,764 -9,166 1,54,203
liquidity. With effect from November 2008, the February 59,820 1,01,991 -9,603 1,52,208
March* 1,485 88,077 16,219 1,05,781
Reserve Bank also started buy back of dated April 1,08,430 70,216 -40,412 1,38,234
securities issued earlier under the MSS to augment May 1,10,685 39,890 -6,114 1,44,461
June 1,31,505 22,890 12,837 1,67,232
liquidity. The buyback was conducted through July 1,39,690 21,063 26,440 1,87,193
auctions and largely dovetailed with normal market @ : Excludes minimum cash balances with the Reserve Bank in case of surplus.
borrowing programme of the Central Government * : Data pertain to March 31.
Note: 1. Negative sign in column 2 indicates injection of liquidity through
(Chart III.2). Outstanding balances under the MSS LAF.
had declined by around Rs.50,000 crore (comprising 2. Negative sign in column 4 indicates injection of liquidity through
WMA/overdraft.
buyback of Rs.37,964 crore and redemptions of

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Box III.2
Central Banks’ Unconventional Policy Measures - International Experience on
Liquidity Support to Non-banking Financial Entities
Some Central Banks provided liquidity support to non-bank examples of direct credit easing include: (i) the outright
financial institutions (NBFIs) as part of their ‘unconventional’ purchases of Commercial Paper and Asset-backed Commercial
policy response to deal with the intense liquidity scare that was Paper as well as corporate bonds by the Bank of Japan to
experienced during the global financial crisis. Despite adequate facilitate corporate financing; (ii) the Bank of England’s Asset
access to central bank liquidity at falling costs for the banking Purchase Facility; and (iii) the Fed’s Commercial Paper Funding
system, the non-banking financial entities had to contend with Facility (CPFF); Term Asset-Backed Securities Loan Facility
a severe liquidity crisis, as the monetary policy transmission (TALF); and purchases by the Fed, in cooperation with the US
turned increasingly ineffective in allocating the liquidity injected Treasury Department, of mortgage securities backed by
into the banking system among non-banks. Moreover, the government-sponsored enterprises (GSEs). Even though it is
uncertain environment and the associated concerns about difficult to distill the impact of all these measures, it has been
counterparties, falling asset (collateral) values, and rising risk observed that the spreads of eligible commercial paper in the
premium also contributed to the liquidity problems for the non- US have declined after the introduction of the CPFF; the spread
banks. The central banks, in response, had to introduce a range between mortgage rates and Treasuries have also declined.
of non-conventional policy measures to provide the non-banks
Unlike direct easing, indirect (endogenous) easing options have
direct access to liquidity.
been resorted to by the ECB. In the case of direct easing, the
There are impor tant strategic issues relating to use of central bank acquires assets, in exchange for central bank
unconventional monetary policy measures, as highlighted by money, which leads to the central bank holding the assets until
Smaghi (2009), which include: (a) why and when should central maturity or resale, and taking thereby the associated risks on
banks resort to unconventional measures?, (b) what are the its balance sheet. In the indirect (endogenous) approach,
main characteristics of unconventional measures?, (c) how are however, “the size of the balance sheet expands by lending to
unconventional measures implemented, if and when they are banks at longer maturities, against collateral which includes
needed, and (d) how and when do central banks need to unwind assets whose markets are temporarily impaired. The increase
the extra monetary stimulus? On the first issue, central banks in the monetary base is determined endogenously by the
use unconventional measures because either they exhaust the banking system, based on banks’ preference for liquidity and
conventional option when the policy rates drop to zero, or, even thus on the state of stress of the banking system” Smaghi (2009).
when the policy rates are above zero, the monetary policy This option could widen the pool of collaterals that may be
transmission may get significantly impaired during an intense accepted by the central bank for the refinancing operations.
financial crisis. As regards the second issue, while the The primary reason as to why the ECB’s approach was different
conventional measures may primarily target to anchor the from that of the Fed is the importance of the banking channel
market rates around the policy rates, the unconventional in providing credit in the euro-area as against a more market-
measures could focus on “directly targeting liquidity shortages based financial system in other advanced countries.
and credit spreads in certain market segments”. One possible
In India, on the conventional side, the Reserve Bank reduced
implication of unconventional measures, though, is the impact
the policy interest rates aggressively and rapidly, lowered the
on the soundness of the balance sheets of central banks. On
quantum of bank reserves impounded by the central bank and
the third question of implementation of unconventional
expanded/ liberalised the refinance facilities for export credit.
measures, there could be “direct quantitative easing”, or “direct
The important among the many unconventional measures taken
credit easing” or “indirect/endogenous easing”.
by the Reserve Bank of India were introduction of a rupee-
In the case of direct quantitative easing, the central bank could dollar swap facility for Indian banks to give them comfort in
expand the balance sheet by buying all sorts of assets from the managing their short-term foreign funding requirements, an
commercial banks (as opposed to only gilts and highly rated exclusive refinance window as also a special purpose vehicle
papers). Banks then get enough liquidity to expand new loans. for supporting non-banking financial companies, and expanding
If the banks, however, decide to hoard liquidity rather than lend, the lendable resources available to apex finance institutions
then this option may not work. The next option then could be for refinancing credit extended to small industries, housing and
“direct credit easing”, under which, instead of providing liquidity exports. Unlike other central banks, however, the Reserve Bank
through banks, the central bank could extend liquidity support deliberately avoided exposing its balance sheet to risks arising
to all non-banks directly, particularly to certain wholesale from counter par ties and collaterals in the process of
markets “through the purchase of commercial papers, corporate implementing the unconventional measures.
bonds and asset-backed securities”. When banks face crisis
Reference
and tighten credit norms contrary to the expectations of the
monetary policy stance, direct easing could become more 1. Berananke, B. S. and Reinhart V. R. (2004), “Conducting
effective, and a better policy alternative for the central banks. Monetary Policy at Very Low Short-Term Interest Rates”,
American Economic Review, 94(2), pp.85-90.
Central Banks such as the Federal Reserve, the Bank of England
and the Bank of Japan adopted a range of direct credit easing 2. Smaghi, Lorenzo Bini (2009), “Conventional and
measures to address liquidity shortages and spreads in certain Unconventional Monetary Policy”, Keynote lecture at the
wholesale market segments via the purchase of commercial International Centre for Monetary and Banking Studies,
paper, corporate bonds and asset-backed securities. Notable Geneva, April 28, 2009.

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quar ter of 2008-09 to finance the additional

expenditure approved by the Parliament by way of
two supplementary demands for grant to support
various stimulus packages. For more effective
liquidity management and to ensure that the market
borrowing programme of the Central Government
was conducted in a non-disruptive manner, the
scope of the OMO was widened with effect from
February 19, 2009 by including purchases of
government securities through an auction-based
mechanism in addition to purchases through the
Negotiated Dealing System – Order Matching
(NDS-OM) segment. The cut-off yields in the OMO
purchase auctions were based on the
attractiveness of offers for securities relative to their
secondary market yields. The total amount of OMO
auction-based purchases was Rs.46,640 crore
during 2008-09.
III.63 Reflecting the impact of these measures,
III.65 With the change in the flows in the external
the average daily net outstanding liquidity injection
accounts and the attendant draining of primary
under LAF which had increased to around
liquidity reflecting the impact of the Reserve Bank’s
Rs.43,000-46,000 crore during September and
operations in the foreign exchange market, the
October 2008, declined sharply thereafter and has
Memorandum of Understanding (MoU) on the MSS
turned into net absorption since early December
was amended on February 26, 2009 to permit the
2008 (Chart III.4).
transfer of the sequestered liquidity from the MSS
III.64 Mar ket borrowings of the Central cash account to the normal cash account of the
Government increased sharply during the last Government. An amount of Rs.12,000 crore was
de-sequestered on March 4, 2009.

III.66 The cumulative impact of the various

liquidity augmenting measures put in place since
mid-September 2008 could be gauged from the
fact that notwithstanding quarterly advance tax
outflows, net injection of liquidity through LAF did
not occur even on a single day of March 2009,
including the last day of the month, in sharp
contrast to the experience in the previous few
years (Table 3.5).

III.67 Dur ing 2008-09, under the LAF, the

Reserve Bank injected liquidity through repo
operations on 158 days (86 days in 2007-08), while
it absorbed liquidity through reverse repo
operations on 169 days (225 days in 2007-08). On
a net basis, there was net injection of liquidity on
106 days and net absorption on 130 days (75

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Table 3.5: Reserve Bank’s Holdings of Central Government Dated Securities

(Rupees crore)

Year Devolvement Private OMO Conversion Total Addition Open Net Addition Outstanding Memo:
on Reserve Placement Purchases of Special to Stock of Market to Stock Holding by Net Repo
Bank taken by by Reserve Securities Reserve Sales by (6-7) Reserve (+)/Reverse
Reserve Bank into Dated Bank’s Reserve Bank Repos (-)
Bank Securities Investments Bank (end Out-
(2+3+4+5) period)* standing #
1 2 3 4 5 6 7 8 9 10
1996-97 3,698 – 623 – 4,321 11,206 -6,885 6,666 -2,300
1997-98 7,028 6,000 467 20,000 33,495 8,081 25,414 31,977 -4,202
1998-99 8,205 30,000 – – 38,205 26,348 11,857 42,212 -400
1999-00 – 27,000 1,244 – 28,244 36,614 -8,370 35,190 -
2000-01 13,151 18,000 4,471 – 35,622 23,795 11,827 41,732 -1,355
2001-02 679 28,213 5,084 – 33,976 35,419 -1,443 40,927 -4,355
2002-03 5,175 31,000 – 40,000 76,175 53,780 22,395 55,438 -2,415
2003-04 – 21,500 – 61,818 83,318 41,849 41,469 77,397 -34,645
2004-05 847 350 - - 1,197 2,899 -1,702 80,770 -19,330
2005-06 - 10,000 740 - 10,740 4,653 6,087 83,205 -7,250
2006-07 - - 720 - 720 5,845 -5,125 75,537 29,185
2007-08 - - 13,510 - 13,510 7,587 5,293 68,965 50,350
2008-09 10,773 - 1,04,480 - 1,15,253 9,932 1,05,321 1,65,836 -1,485

*: Inclusive of securities sold under the LAF. # : Data pertain to end-March.

days and 171 days), respectively, during 2008-09 market borrowings. Auction-based OMO purchases
(Table 3.6). during April 2009 aggregated around Rs.12,000
crore. Consistent with the assessment of
Fiscal Year 2009-10, so far
macroeconomic and monetary conditions, the
III.68 Carrying forward its stance of maintaining Reserve Bank in its Annual Policy Statement 2009-
ample liquidity in the system and ensuring a smooth 10 (April 2009) reduced the repo and reverse repo
passage to the Central Government’s market rates further by 25 bps each to 4.75 per cent and
borrowings, an indicative OMO programme for the 3.25 per cent, respectively. On a review of the cash
first half of 2009-10 was announced on March 26, position of the Government of India, it was also
2009, in terms of which, the RBI expressed its decided to de-sequester MSS balances to the
intention to purchase Government securities extent of Rs.28,000 crore as on May 2, 2009.It was
amounting to Rs.80,000 crore, excluding the also announced that, except on reporting Fridays,
expected unwinding of MSS securities of Rs.42,000 only one LAF would be conducted from May 6,
crore through redemptions. It was also indicated 2009. Liquidity conditions remained easy during
that OMO purchase auctions would normally be June and July 2009. The daily net outstanding
conducted every alternate week on Thursdays, with liquidity absorption under LAF mostly remained
the Reserve Bank reserving the right to alter the above Rs.1,00,000 crore throughout this period. In
amount, frequency and day of the auction, while fact, the amount accepted under the reverse repo
maintaining ample liquidity in the system. window of LAF peaked at Rs.1,56, 655 crore on
July 3, 2009. Outstanding MSS balances were at
III.69 Liquidity conditions eased significantly Rs.21,063 crore on July 31, 2009. The aggregate
during April 2009, mainly reflecting the steep notified amount of OMO purchases in current fiscal
decline (by around Rs.56,000 crore) in cash year so far (up to August 14, 2009) was Rs.55,500
balances of the Central Government with the crore and the total purchases amounted to
Reserve Bank, notwithstanding relatively higher Rs.36,397 crore.

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Table 3.6 : Reverse Repo/Repo Bids under LAF

Year/Month Reverse Repo Repo

No. of days No. of days No. of days No. of days No. of days No. of days No. of days No. of days No. of days No. of days
bids all bids of full with less of partial bids all bids of full with less of partial
received rejected acceptance than full acceptance received rejected acceptance than full acceptance
of bids acceptance of bids of bids acceptance of bids
of bids of bids
1 2 3 4 5 6 7 8 9 10 11

2005-06 244 0 244 0 0 78 0 76 @ 2 0

2006-07 244 0 234 0 10 64 0 63 @ 1 0
2007-08 225 0 165 0 60 86 0 86 0 0
2008-09 169 0 169 0 0 158 0 158 0 0
April 18 0 18 0 0 1 0 1 0 0
May 19 0 19 0 0 7 0 7 0 0
June 6 0 6 0 0 16 0 16 0 0
July 5 0 5 0 0 21 0 21 0 0
August 4 0 4 0 0 18 0 18 0 0
September 6 0 6 0 0 20 0 20 0 0
October 13 0 13 0 0 18 0 18 0 0
November 19 0 19 0 0 19 0 19 0 0
December 21 0 21 0 0 16 0 16 0 0
January 20 0 20 0 0 8 0 8 0 0
February 19 0 19 0 0 5 0 5 0 0
March 19 0 19 0 0 9 0 9 0 0
2009-10 80 0 76 0 4 5 0 4 0 0
April 16 0 16 0 0 1 0 1 0 0
May 20 0 16 0 4 0 0 0 0 0
June 22 0 22 0 0 2 0 2 0 0
July 22 0 22 0 0 2 0 2 0 0

@ : Number of days of full acceptance of bids was less than the number of days bids were received on account of non-acceptance of one bid each on
technical grounds on January 24, 2006, March 23, 2006 and April 4, 2006.
Note: 1. With effect from October 29, 2004, the nomenclature of repo and reverse repo was changed in keeping with international usage. Now, reverse
repo indicates absorption of liquidity and repo signifies injection of liquidity. Prior to October 29, 2004, repo indicated absorption of liquidity while
reverse repo meant injection.
2. Between March 5 and August 5, 2007, daily reverse repo absorptions were restricted to a maximum of Rs.3000 crore comprising Rs.2000 crore
in the First LAF and Rs.1000 crore in the Second LAF.
3. Bids for fixed rate term repo facility have also been included.

III.70 In sum, the monetar y and liquidity mar kets through adequate injection of both
management operations of the Reserve Bank domestic and foreign exchange liquidity assumed
dur ing 2008-09 had to respond swiftly and prominence. The overall emphasis in the second
judiciously to the fast changing global and domestic half, however, was to support aggregate demand
developments that necessitated timely rebalancing to contain growth slowdown, and in the face of
of the policy emphasis on containment of inflation almost no r isk on the inflation front, the
and inflation expectations, preserving orderly expansionary policy stance of the Reserve Bank
conditions in the financial markets, and supporting was manifested in the form of cumulative reduction
the growth momentum. The anti-inflationary focus in CRR and the repo rate by 400 basis points and
of the monetary policy stance in the first half of the 425 basis points, respectively. The intricacies of the
year 2008-09 was evident in the 125 basis point actual conduct of policies were particularly reflected
increase in repo rate and 150 basis points increase in the liquidity management operations and the
in the CRR to 9.0 per cent. In the first phase of the management of the Reserve Bank’s balance sheet.
second half, restoring orderly conditions in the The contraction to the Reserve Bank’s balance

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sheet resulting from the decline in its foreign assets of even non-bank financial entities were met
necessitated strategic response aimed at indirectly by extending liquidity support to the
expanding domestic assets on the Reserve Bank’s designated counter par ties like scheduled
balance sheet, which was ensured through open commercial banks and primary dealers. Liquidity
market operations, unwinding of MSS, introduction expansion achieved through unwinding of MSS and
of refinance facilities, regular operations under the reduction in reserve requirement ensured that the
LAF and purchase of oil bonds under special Reserve Bank’s balance sheet did not expand,
mar ket operations. These measures, taken unlike in several other central banks. The
together, have released actual/potential liquidity movement in the BPLRs does not fully and
amounting to over Rs.5,61,700 crore since mid- accurately reflect the changes in effective lending
September 2008. The MSS, which had emerged rates as nearly two-thirds of banks’ lending takes
as a key intervention instrument during the period place at sub-BPLR rates. The ample liquidity in the
of surges in capital flows, had also ensured system and the subdued demand for bank credit
hoarding of adequate liquidity by the Government, have increased competitive pressure on banks to
and when the liquidity conditions changed lend at Sub-BPLR rates. The effective average
significantly in the second half of 2008-09, the lending rate of SCBs declined during 2008-09 and
unwinding of MSS balances clearly became a key the effective lending rate was expected to have
channel for expanding liquidity in the system. It declined further in Q1 of 2009-10. In effect, the
needs to be noted that the liquidity injection efforts BPLRs of banks have turned out to be the maximum
of the Reserve Bank, despite being large, could be lending rates in most cases, distor ting their
achieved without compromising either on the information content. Currently a Working Group
eligible counterparties or on the asset quality in the (Chairman: Deepak Mohanty) is examining the
Reserve Bank’s balance sheet. The liquidity needs BPLR system.

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