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Monetary and Prudential Measures as responses

The outlook for output growth in India has improved in the recent months, particularly with the momentum gained in manufacturing sector. However, persistence of global imbalances and high oil prices with a significant permanent component do pose some risks. Furthermore, the credit growth has recently been extremely strong possibly impacting credit quality, while money-supply is over-shooting the anticipated trajectory and strong investment demand coupled with high oil-prices is turning the current account surplus into a deficit, though modest and manageable through normal capital flows.

These developments pose new challenges to maintaining price and financial stability while ensuring momentum in growth. Consequently, in the Mid-Term Review of Annual Policy Statement for the year 2005-06, released on October 25, 2005, several measures have been announced to contain and manage the downside risks.

First, the reverse-repo rate (overnight liquidity absorption by Reserve Bank) has been increased by 25 basis points to 5.25 per cent, keeping the spread between reverse repo and repo at 100 basis points. The Bank Rate, being the signalling rate for medium term, is retained at 6.00 per cent.

Second, rationalization of limits on banks' exposure to capital market has been announced, restricting it to 40 per cent of a bank's net worth while simplifying the exemptions and coverage.

Third, the general provisioning requirement for standard advances has been enhanced from the present level of 0.25 per cent to 0.40 per cent except in regard to Banks' exposures to laggards in credit-growth, namely, Agriculture and Small and Medium Industries. Fourth, a decision had been taken to treat the entire balance under Investment Fluctuation Reserve as Tier I capital, thus providing some head-room to banks to raise Tier II capital in future.

Fifth, revised guidelines are being issued on corporate restructuring mechanisms to be followed by banks in the light of experience gained.

Sixth, having regard to the recent trends in the credit markets, RBI is initiating a supervisory review process with select banks having significant exposure to some sectors, namely, real estate, highly leveraged non-banking financial companies, venture capital funds and capital markets. The purpose of such a review is to ensure that effective risk mitigants and sound internal controls are in place for managing such exposures.

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