Economic Survey 2016-17 Analysis : Financial Developments
The Government has amended the Reserve Bank of India Act, 1934 and the amended Act provides for inflation target to be set by the Government in consultation with the RBI, once in every five years and further provides a statutory basis for the constitution of an empowered Monetary Policy Committee (MPC).
Monetary Management and Financial Intermediation
Monetary Policy Committee
- The Monetary Policy Committee is empowered with the chore of fixing the benchmark policy interest rate i.e. repo rate, which controlling effect of inflation within the target level.
- The Central Government can convey its views regarding the inflation in writing and the RBI is mandated to the necessary information to the MPC so that they can make their decision precisely.
- The MPC has six members with one vote each out of which three will be nominated the government and other three will be from RBI itself. The MPC is headed by the present RBI governor.
- Earlier, a technical advisory constituted by the RBI consisted of the top ranked RBI officials, including the deputy Governors and the governor and the external advisors give their suggestions but the governor’s decision was final.
- As per the modified monetary policy framework, the Government has fixed the inflation target of 4 per cent with forbearance level of +/- 2 per cent for the period beginning on 5th August 2016 to March 31, 2021.
- The MPC, in its latest meeting held on December 7, 2016, while maintaining an accommodative policy stance did not change the policy rate while in its first meeting on October 4, 2016, the policy rate was reduced by 25 basis points to 6.25 per cent.
- At present, the reverse repo rate under the Liquidity Adjustment Facility (LAF) remains 5.75 per cent and the Marginal Standing Facility (MSF) rate is 6.75 per cent.
In April 2016, RBI refined its monetary policy framework with the objective of meeting short-term liquidity needs through regular facilities; frictional and seasonal mismatches through fine-tuning operations and more durable liquidity by modulating net foreign assets and net domestic assets in its balance sheet.
- The RBI has separate liquidity management framework for managing liquidity in the economy.
- In order to bring ex-ante liquidity conditions close to neutrality in the economy, RBI has pumped durable liquidity through open market operations (OMOs).
- Post demonetisation, the RBI has played an important role in mopping up the large surplus liquidity in the economy through its exceptional operations like variable reverse repo rate.
- To complement the RBI’s efforts of managing liquidity surplus, the Central Government also increased the limit on securities under market stabilisation scheme from Rs. 30,000 crore to Rs. 6 lakh crore.
Yield on Government bills/ securities
- There was a sharp decrease in the 91 days t-bill rate in April 2016 owing to 25 bps cut in repo rate.
- Ten years government security (G-sec) yield, however, continued to tread high in spite of the rate cut and in fact, increased marginally after the rate cut (see figure)but the yield on G-sec started softening since June 2016 which is as, on 30th December 2016, 10-year G-sec yield stood at 6.63 per cent.
- The transmission of the rate cuts by RBI, however, stayed far from perfect, but the base rate came down marginally from 9.30/9.70 in April 2016 to 9.30/9.65 as of 30th December 2016 and the term deposit rates for greater than one-year maturity period declined from 7.00/7.50 to 6.50/7.00 in this period.
- In the current financial year, the performance of the banking sector, public sector banks (PSBs) in particular, continued to be subdued and the asset quality of banks deteriorated further.
- The gross non-performing assets (GNPA) to total advances ratio of scheduled commercial banks (SCBs) increased by 9.1 per cent from 7.8 per cent between March and September2016.
- During the first half of 20165-17, the profit after tax (PAT) slandered on the year-on-year basis because of higher growth in risk provisions, loan write-off and a decline in net interest income.
- Non-food credit (NFC) outstanding grew at sub 10 per cent throughout all the months except for September 2016.
- The credit growth in the industrial sector remained unceasingly below 1 per cent during the current fiscal, with contraction in August, October and November.
- However, the major contributors to the overall NFC growth are the credit lendings to the sectors like agriculture and allied activities (A&A) and personal loans (PL) segments.
Measures to strengthen the corporate bond market
- The Reserve Bank of India (RBI) took several measures to make stronger the corporate bond market in India. It also accepted a number of the recommendations submitted by the khan Committee to boost investor participation and market liquidity in the corporate bond market.
- The new measures as announced by the RBI include:
- Commercial banks are allowed to issue rupee-denominated bonds overseas (masala bonds) for their capital needs and also for financing infrastructure and affordable housing;
- Banks allowed increasing the partial credit enhancement they provide for corporate bonds to 50 per cent from 20 per cent. This move will help lower-rated corporate to access the bond market;
- The brokers registered with the Securities and Exchange Board of India (SEBI) and certified as market makers in the corporate bond market permitted to carry out repo / reverse repo contracts in the corporate debt securities. This measure will make corporate bonds fungible and thus improve turnover in the secondary market;
- Permitting primary dealers to act as market makers for government bonds, to give further boost to government securities by making them more accessible to retail investors; and
- In order to make simplified access to the foreign exchange market for hedging in over the counter (OTC) and exchange-traded currency derivatives, the RBI has allowed entities uncovered to exchange rate risk to undertake hedge transactions with simplified procedures, up to a limit of US$30 million at any given time.
Indian markets performance
- As compared to losses registered in 2015, Indian markets registered modest growth of 1.95 – 3 per cent (the Sensex was up by 1.95 per cent, while Nifty was higher by 3.0 per cent) for the calendar year 2016.
- In the wake of foreign capital outflow from emerging markets, the visible upward momentum of September 2016 in the markets lost, but the global and domestic factors have a sizable impact on the performance of Indian markets.
- The major developments which closely affected the Indian markets are Brexit, the US Presidential elections as well as policy announcements by the US Federal Reserve and the RBI, while other factors weighed on market sentiment included the policy decisions taken by the OPEC regarding oil production and the appointment of the new governor of the RBI.
Foreign Portfolio Investments
- Net Foreign Portfolio Investments (FPI) have turned negative in 2016 for the first time since the meltdown of 2008 because of there an outflow from the Indian markets to the tune of Rs. 23079 crore.
- Such instances of FPI outflow was not a phenomenon associated with Indian markets only, but most of the FPIs pulled out of most EMEs in a big way due to higher returns in advanced economies.