MONETARY MANAGEMENT

With reference to
INDIAN OVERSEAS BANK

A Project report submitted in partial fulfilment of the requirements for the

award of the degree of

MASTER OF BUSINESS ADMINISTRATION

By
MAMIDI SAI NAVYA PRIYA
(REGD. NO:120232802081)

Under the guidance

Of
Mrs. R. DEEPTHI
B.Tech, MBA
Assistant professor

DEPARTMENT OF MANAGEMENT STUDIES

SAMATA COLLEGE
(AFFILIATED BY ANDHRA UNIVERSITY AND APPROVED BY AICTE)
Visakhapatnam 2020-2022
 DECLARATION

I hereby declare that the Project report titled “MONETARY

MANAGEMENT” WITH reference to INDIAN OVERSEAS BANK submitted
by me on partial fulfilment for the requirement of the MASTER OF BUSINESS
ADMINISTRATION degree in SAMATA COLLEGE FOR DEGREE AND
PG, Affiliated to ANDHRA UNIVERSITY VISAKHAPATNAM is an
original work and it is not submitted to this institution, any other institutions or
published anywhere for the award of any degree or diploma.

Place: VISAKHAPATNAM SAI NAVYA PRIYA

Date: (REGD. NO. 120232802081)
 SAMATA COLLEGE

CERTIFICATE

This is to certify that MAMIDI SAI NAVYA PRIYA, Student of MBA in the
Department of Management Studies of SAMATA COLLEGE during the
academic year 2020-2022 has undergone the Project Work on MONETARY
MANAGEMENT with reference to INDIAN OVERSEAS BANK under my
guidance and supervision and had fulfilled the requirements concerning the
project work.

Place: Visakhapatnam Mrs. R. DEEPTHI

Date: B. Tech, MBA

Assistant Professor
Project guide
 ACKNOWLEDGEMENT

I express my sincere thanks to Dr. S. VIJAYA RAVINDRA, Principal and

Prof. G. SRINIVASA RAO, Director of SAMATA COLLEGE, Visakhapatnam for
giving me permission to carry out this project work.
I also express my sincere thanks to Mr. G. RAMESH, assistant Professor and
Head of the Department of SAMATA COLLEGE, Visakhapatnam, for his

encouragement in doing my project work.

I do record my everlasting thanks and feeling of gratitude to my Project
Guide Mrs. R. DEEPTHI, for her constant moral support and valuable guidance
in successful completion of the Project work

SAI NAVYA PRIYA

(REGD. NO:120232802081)
 CONTENTS

CHAPTER-1

1.1 INTRODUCTION
1.2 NEED FOR STUDY
1.3 OBJECTIVE OF THE STUDY
1.4 METHODOLOGY
1.5 LIMITATIONS
1.6 CHAPTERIZATION

CHAPTER-2

2.1 INDUSTRY PROFILE

2.2 COMPANY PROFILE

CHAPTER-3

3.1 THEORETICAL FRAMEWORK

CHAPTER-4

4.1 DATA ANALYSIS & INTERPRETATION

CHAPTER-5

5.1 SUMMARY
5.2 FINDINGS
5.3 SUGGESTIONS
5.4 CONCLUSION

ANNUXURE

BIBILOGRAPHY
CHAPTER-1

1.1 INTRODUCTION

1.2 NEED FOR STUDY

1.3 OBJECTIVE OF THE STUDY

1.4 METHODOLOGY

1.5 LIMITATIONS
 CHAPTER -I

INTRODUCTION

1.1 INTRODUCTION TO THE STUDY

What Is Monetary Management?

Monetary policy is a set of tools that a nation's central bank has available to promote sustainable
economic growth by controlling the overall supply of money that is available to the nation's
banks, its consumers, and its businesses.
The goal is to keep the economy humming along at a rate that is neither too hot nor too cold.
The central bank may force up interest rates on borrowing in order to discourage spending or
force down interest rates to inspire more borrowing and spending.
The main weapon at its disposal is the nation's money. The central bank sets the rates it charges
to loan money to the nation's banks. When it raises or lowers its rates, all financial institutions
tweak the rates they charge all their customers, from big businesses borrowing for major
projects to home buyers applying for mortgages.
All of those customers are rate- sensitive. They're more likely to borrow when rates are low
and put off borrowing when rates are high.
By managing the money supply, a central bank aims to influence macroeconomic factors
including inflation, the rate of consumption, economic growth, and overall liquidity.
In addition to modifying the interest rate, a central bank may buy or sell government bonds,
regulate foreign exchange (forex) rates, and revise the amount of cash that the banks are
required to maintain as reserves.
Economists, analysts, and investors eagerly await monetary policy decisions and even the
minutes of meetings in which they are discussed. This is news that has a long-lasting impact
on the overall economy as well as on specific industry sectors and markets.
Monetary policy is the policy adopted by the monetary authority of a nation to control either
the interest rate payable for very short-term borrowing (borrowing by banks from each other
to meet their short-term needs) or the money supply, often as an attempt to reduce inflation or
the interest rate, to ensure price stability and general trust of the value and stability of the
nation's currency.
Monetary policy is a modification of the supply of money, i.e. "printing" more money, or
decreasing the money supply by changing interest rates or removing excess reserves. This is in
contrast to fiscal policy, which relies on taxation, government spending, and government
borrowing as methods for a government to manage business cycle phenomena such as
recessions.

Further purposes of a monetary policy are usually to contribute to the stability of gross domestic
product, to achieve and maintain low unemployment, and to maintain predictable exchange
rates with other currencies.

Monetary economics can provide insight into crafting optimal monetary policy. In developed
countries, monetary policy is generally formed separately from fiscal policy.
Monetary Management is referred to as being either expansionary or contractionary.
Expansionary policy occurs when a monetary authority uses its procedures to stimulate the
economy. An expansionary policy maintains short-term interest rates at a lower than usual rate
or increases the total supply of money in the economy more rapidly than usual.

It is traditionally used to try to reduce unemployment during a recession by decreasing interest

rates in the hope that less expensive credit will entice businesses into borrowing more money
and thereby expanding. This would increase aggregate demand (the overall demand for all
goods and services in an economy), which would increase short-term growth as measured by
increase of gross domestic product (GDP).

Expansionary monetary policy, by increasing the amount of currency in circulation, usually

diminishes the value of the currency relative to other currencies (the exchange rate), in which
case foreign purchasers will be able to purchase more with their currency in the country with
the devalued currency.

Contractionary policy maintains short-term interest rates greater than usual, slows the rate of
growth of the money supply, or even decreases it to slow short-term economic growth and
lessen inflation. Contractionary policy can result in increased unemployment and depressed
borrowing and spending by consumers and businesses, which can eventually result in an
economic recession if implemented too vigorously.
For the most part of the 1980s, credit policy and monetary management by the Reserve Bank
had to contend with the task of neutralising the inflationary impact of persistently rising deficit
in the Government’s budgetary operations.
A significant part of the widening fiscal deficit following expansionary fiscal policy,
especially in the later part of the decade had perforce to be monetised automatically by the
Reserve Bank through issuance of ad hoc Treasury Bills. This resulted in high inflation rates
and culminated in the acute balance of payments (BoP) crisis of 1991.

In such a milieu, the two main objectives of credit and monetary policy of the Reserve Bank
were to maintain a reasonable degree of price stability by moderating money supply (M3 )
growth and to ensure adequate credit flow to the productive sectors of the economy by using
essentially direct instruments such as the cash reserve ratio

(CRR), administered interest rates and directed credit with stringent use of refinance facilities.
A defining event that had a far-reaching impact on the conduct of monetary policy for years to
come was the implementation of wideranging recommendations of the committee to review
the working of the monetary system (Chairman: Prof Sukhamoy Chakravarty).
The later part of the 1980s was also marked by early measures for liberalisation of the money
market and the introduction of new instruments.

The Reserve Bank experimented with interest rate deregulation in April 1985 by giving banks
freedom to fix short-term deposit rates, but the move had to be reversed quickly since it failed
to evoke the expected competitive response from the banking system. These developments
have been chronicled at length in chapter titled: Monetary and Credit Policy.
The early economic liberalisation measures pursued in the 1980s were carried forward more
vigorously as a cohesive and detailed framework of economic reforms from about the middle
of 1991–92. The trigger, as discussed elsewhere in this volume, came from the critical BoP
crisis of 1991.
The liberalisation measures were comprehensive and meant to bring about stabilisation and
structural changes in the economy. Initially, the focus was on real, external and fiscal sector
reforms, with monetary and financial sector reforms following in relatively quick succession.
The focus of monetary policy as a result was transformed in the 1990s, with emphasis accorded
to progressive and prudential regulation in the banking operations. The main objectives of the
monetary policy of the Reserve Bank during this eventful period (beginning in 1992) continued
to be multidimensional, with emphasis being placed as much on growth as on price stability.
Towards this end, the perception within the Reserve Bank was that monetary growth had to be
consistent with the expected growth in output and a tolerable rate of inflation.

In pursuit of the given objectives, monetary policy was rendered flexible enough to make
strategic adjustments to any market disequilibria as also the surge in foreign capital inflows.
Consequently, monetary management was also vested with the additional responsibility of
maintaining orderly conditions in the money, credit, securities and foreign exchange markets.
Growth with moderate or tolerable level of inflation continued to be the primary goal of
monetary policy in India. Broad money (M3 ), also referred to as the aggregate monetary
resources (AMR), was adopted as an intermediate target, with the level of bank reserves serving
as the operating target.
What was more important was the progressive rationalisation and deregulation of the interest
rate structure as an integral part of financial liberalisation.
1.2 NEED FOR THE STUDY

The monetary policy is a policy formulated by the central bank, i.e., RBI (Reserve Bank of
India) and relates to the monetary matters of the country. The policy involves measures taken
to regulate the supply of money, availability, and cost of credit in the economy.

The policy also oversees distribution of credit among users as well as the borrowing and
lending rates of interest. In a developing country like India, the monetary policy is significant
in the promotion of economic growth.
Appropriate Adjustment between Demand and Supply of Money Economic development can
be measured by analysing the rising demand for money.
To carry out day-to-day transactions the demand for money increases if there is increase in
population of country and rise in per capita income. And if monetary authority is supplying
more money to the industries than its requirements this will hinder the growth of the country
and will cause an inflation.
The monetary authority should keep balance between demand and supply of money in order to
prevent economic fluctuations and pave the ground for rapid development.

Traditionally, the monetary policy in India was focused on controlling inflation. This was done
through the contraction of money supply and credit. However, this resulted in poor growth of
the economy.

Therefore, RBI adopted a new policy of growth with stability. In simple terms, this means that
the RBI will provide sufficient credit for the increasing needs of the different sectors of the
economy. Also, it will control inflation within a certain limit.

Regulation, Supervision, and Development of Financial Stability

Financial stability is the ability of an economy to absorb shocks and ensure that people retain
confidence in the financial system of the country. Internal and External shocks can threaten the
financial stability of a country and destabilize its financial system.
Therefore, the RBI gives a lot of importance to maintaining confidence in the country’s
financial system through adequate regulation and controls. It also ensures that the objective of
growth is not sacrificed. Therefore, we can say that the RBI focuses on the regulation,
supervision, and development of financial stability.

Promoting Priority Sector

In India, the priority sector includes agriculture, export, small-scale enterprises, and the weaker
section of the population. RBI consistently ensures that the banking system provides timely
and adequate credit to these sections at affordable costs.

• Price Stability Price stability plays a vital role in economic growth of a country. It is very
important to maintain the stability in exchanges rates and the domestic level of prices. If it is
not done by the monetary authority it will lead to inflationary pressures in under developed
countries
• Credit Control Short term credits are provided to the businessmen and traders mainly and
long-term credits are provided to industries and manufacturing sectors for meeting their
financial needs. Selective credit systems shall be adopted to inspire the design of investment
and production by distinguishing between the costs and availability of credit in different sectors
and industries.
• Creation and Expansion of Financial Institutions Special attention needs to be paid by the
Central Bank for the problem of rural credit. A system of cooperative credit societies can go a
long way in providing the credit requirements of the ruralites. Central Bank along with other
financial corporations shall provide finance to business and industry. This will help to upsurge
the rate of economic development of the country.

• Suitable Interest Rate Structure Interest rate serve as an anti-inflationary measure by limiting
borrowing from the banks for suppositious purposes and undesirable investments. It will arouse
savings and thus increase the supply of investible source

• Debt Management The government has to derive on a large scale to implement the
programmes of economic development and hence the responsibility of managing public
liability effectively and efficiently so as to assist the requirements of economic growth. The
main objective of debt management “is to create circumstances in which public borrowing can
increase on a big scale without giving any surprise to the system. And this must be on lower
rates to keep the burden of the liability low.” It is clear that a sensible monetary policy can go
a long way in motivating economic development.
1.3 OBJECTIVES OF THE STUDY

1. Objective of this project is to get exposure and to understand monetary system and
fiscal system in Indian financial system.

2. To know the impact on monetary management i.e (Inflation, unemployment, and

deposit lending rates) after covid

3. To identify the maintenance of the currency exchange rates and to promote maximum
employment.

4. What are the Changes in existing cash reserve ratio and repo rates

5. To know the growth and developments in India

1.4 METHODOLOGY

Research methodology is a systematic approach in management research to achieve pre-

defined objectives. A Research design is the arrangement of conditions for collection and
analysis of data in a manner that aims to combine relevance to the research purpose with
economy in procedure.

Sources of data collection:

Generally, we can collect data from two sources, primary sources and secondary
sources. Data collected from primary sources are known as primary data and data collected
from secondary sources are called secondary data.

Primary data:

Primary data are also known as raw data. Data are collected from the original source in
a controlled or an uncontrolled environment. Example of a controlled environment is
experimental research where certain variables are being controlled by the researcher. On the
other hand, data collected through observation or questionnaire survey in a natural setting are
examples data obtained in an uncontrolled environment.

Secondary data:

The secondary data are those which have already collected and stored. It can be easily got from
records, journals, annual reports of the company etc. It will save the time, money and efforts
to collect the data. Secondary data also made available through trade magazines, annual reports,
books etc. This project is based on secondary data collected through annual reports of the
organization. Secondary data used in this project are Annual reports of GCC from 2012 to
2015.
1.5 LIMITATIONS

1. Case of Deflation
Compared to inflation, deflation is usually hard to control. During deflationary periods, central
banks reduce their policy rates to as low as zero. The economy, therefore, cannot be stimulated
beyond this point. We’ve recently seen cases in which central banks have even opted for
negative rates.
2. Case of Banks Decreasing the Money They Lend
Sometimes when the money supply rises, banks can have excess reserves, making the short-
term rates decrease. This is mostly a result of the business environment.
3. Uncertainty About How the Economy Reacts to Expansionary and Contractionary Policy
Uncertainty about the effect of a policy puts the economy and prices on a complicated path.
Some economies might over or underreact to central bank policies. It is imperative to note that
economists often disagree on the policies central banks should use.
Every attempt of central banks to manipulate the supply of money within an economy does not
always work. This is due to their lack of capacity to control the deposits households and
corporations make in commercial banks.
4. Liquidity Trap
A liquidity trap is when interest rates are close to zero and savings rates are high, rendering
monetary policy ineffective. In a liquidity trap, consumers choose to avoid purchasing treasury
securities and keep their funds in savings because of the prevailing belief that interest rates will
soon rise. A rise in interest rates will cause a decrement in bond prices.
5. Case of the Government Reducing the Money Supply
If a government decreases the money supply, for example, with higher taxes, individuals expect
low future inflation. This could render an expansionary monetary policy ineffective.
6. Bond Market Vigilantes
Vigilantes are individuals who participate in the bond market, which can reduce their demand
for long-term bonds, thus raising their yields.
Chapter 2

2.1 INDUSTRY PROFILE

2.2 COMPANY PROFILE

INDUSTRY PROFILE

The banking sector is the lifeline of any modern economy. It is one of the important financial
pillars of the financial sector, which plays a vital role in the functioning of an economy.
It is very important for economic development of a country that its financing requirements of
trade, industry and agriculture are met with higher degree of commitment and responsibility.
Thus, the development of a country is integrally linked with the development of banking. In a
modern economy, banks are to be considered not as dealers in money but as the leaders of
development. They play an important role in the mobilization of deposits and disbursement of
credit to various sectors of the economy.

The banking system reflects the economic health of the country. The strength of an economy
depends on the strength and efficiency of the financial system, which in turn depends on a
sound and solvent banking system. A sound banking system efficiently mobilized savings in
productive sectors and a solvent banking system ensures that the bank is capable of meeting its
obligation to the depositors.
In India, banks are playing a crucial role in socio-economic progress of the country after
independence. The banking sector is dominant in India as it accounts for more than half the
assets of the financial sector.

Indian banks have been going through a fascinating phase through rapid changes brought about
by financial sector reforms, which are being implemented in a phased manner.
The current process of transformation should be viewed as an opportunity to convert Indian
banking into a sound, strong and vibrant system capable of playing its role efficiently and
effectively on their own without imposing any burden on government.

After the liberalization of the Indian economy, the Government has announced a number of
reform measures on the basis of the recommendation of the Narasimhan Committee to make
the banking sector economically viable and competitively strong.
The current global crisis that hit every country raised various issue regarding efficiency and
solvency of banking system in front of policy makers.

Now, crisis has been almost over, Government of India (GOI) and Reserve Bank of India
(RBI) are trying to draw some lessons. RBI is making necessary changes in his policy to ensure
price stability in the economy.
The main objective of these changes is to increase the efficiency of banking system as a whole
as well as of individual institutions. So, it is necessary to measure the efficiency of Indian
Banks so that corrective steps can be taken to improve the health of banking system.
The period of last six decades has viewed many macro economic development of India. The
monitory, external and banking policies have undergone several changes.

The structural changes in the Indian financial system specially in banking system has influence
the evaluation of Indian Banking in different ways. After the independence and implementation
of banking reforms, we can see the changes in the functioning of commercial banks.

In order to understand the changing role of commercial banks and the problems and
challenges, it would be appropriate to review the major development in the Indian banking
sector.
Evaluation of Indian banking may be traced through four distinct phases
1. Evolutionary phase (Prior to 1947)
2. Foundation phase (1947-1969)
3. Expansion phase (1969-1990)
4. Consolidation and Liberalization phase (1990 to till)
The present chapter analyses the above phases and structure of the banking sector in India. The
main objective of this chapter is to setup the ground and logic for the next chapter.
BANKING STRUCTURE IN INDIA

Indian banking system consists of “non scheduled banks” and “scheduled banks”. Non
scheduled banks refer to those that are not included in the second schedule of the Banking
Regulation Act of 1965 and thus do not satisfy the conditions laid down by that schedule.
Schedule banks refer to those that are included in the Second Schedule of Banking Regulation
Act of 1965 and thus satisfy the following conditions: a bank must

(1) have paid up capital and reserve of not less than Rs. 5 lakh and
(2) satisfy the Reserve Bank of India (RBI) that its affairs are not conducted in a manner
detrimental to the interest of its deposits. Scheduled banks consists of “scheduled commercial
banks” and scheduled cooperative banks.
The former are further divided into four categories:
(1) public sector banks (that are further classified as “Nationalized Banks and the “State Bank
of India (SBI) banks”);
(2) private sector banks (that are further classified as “Old Private Sector Banks” and “New
Private Sector Banks” that emerged after 1991);
(3) foreign banks in India, and
(4) regional rural banks (that operate exclusively in rural areas to provide credit and other
facilities to small and marginal farmers, agricultural workers and small entrepreneurs).
These scheduled commercial banks except foreign banks are registered in India under the
Companies Act.

The SBI banks consist of SBI and five independently capitalized banking subsidiaries. The SBI
is the largest commercial bank in India in terms of profits, assets, deposits, branches and
employees and has 13 head offices governed each by a board of directors under the supervision
of a central board.
It was originally established in 1806 when the bank of Calcutta (latter called the Bank of
Bengal) was established, and then amalgamated as the Imperial Bank of India after the merger
with the bank of Madras and the Bank of Bombay.
The Imperial Bank of India was Nationalized and named SBI in 1955. Nationalized banks refer
to private sector banks that were nationalized (14 banks in 1969 and 6 in 1980) by the central
government compared with the SBI banks, nationalized banks are centrally governed by their
respective head offices. In 1993, Punjab National Bank merged another nationalized bank, New
Bank of India, leading to a decline in total number of nationalized banks from 20 to 19.
Regional rural banks account for only 4% of total assets of scheduled commercial banks.

As at the end of March 2001, the number of scheduled banks is a follows: 19 nationalized
banks, 8 SBI banks, 23 old private sector banks, 8 new private sector banks, 42 foreign banks,
196 regional rural banks and 67 cooperative banks. But number of scheduled commercial banks
in India as on 31 October, 2012 as follows: 26 public sector banks 20 private sector banks.

A financial system, which is inherently strong, functionally diverse and displays efficiency and
flexibility, is critical to our national objectives of creating a market-driven, productive and
competitive economy.
A mature system supports higher levels of investment and promotes growth in the economy
with its depth and coverage. The financial system in India comprises of financial institutions,
financial markets, financial instruments and services.
The Indian financial system is characterised by its two major segments - an organised sector
and a traditional sector that is also known as informal credit market.

Financial intermediation in the organised sector is conducted by a large number of financial

institutions which are business organisations providing financial services to the community.
Financial institutions whose activities may be either specialised or may overlap are further
classified as banking and non-banking entities. The Reserve Bank of India (RBI) as the main
regulator of credit is the apex institution in the financial system.
 Other important financial institutions are the commercial banks (in the public and private
sector), cooperative banks, regional rural banks and development banks. Non-bank financial
institutions include finance and leasing companies and other institutions like LIC, GIC, UTI,
Mutual funds, Provident Funds, Post Office Banks etc.

The banking system is, by far, the most dominant segment of the financial sector, accounting
as it does, for over 80 per cent of the funds flowing through the financial sector. The aggregate
deposits of the scheduled commercial banks (SCBs) rose from Rs.5,05,599 crore in March
1997 to Rs.11,03,360 crore in March 2002 representing a rise of 17 per cent.
During the same period, the credit portfolio (food and non-food) of SCBs grew from
Rs.2,78,401 crore to Rs. 5,89,723 crore, i.e. by 16 per cent.

The net profits of SCBs witnessed a noticeable upturn from Rs.6,403 crore in 2000-01 to Rs.11,
572 crore in 2001- 02.
The extent and coverage of the banking system can be gauged from the fact that the number of
branches of SCBs grew from 8045 in 1969 to 66,186 in June 2002

While rural branches constituted 49 per cent of the total in 2002, semi-urban branches
accounted for 22 per cent, urban branches accounted for 16 per cent and metropolitan branches
accounted for 13 per cent.

As regards the capital market, the resource mobilization from the primary market by non-
government public limited companies has declined in the recent past from the high levels
witnessed between 1992-93 and 1996-97.
Resource mobilization of these companies in the public issues market stood at Rs. 5,692 crore
in 2001-02 registering an increase of 16.4 per cent over the amount mobilized during the
previous year. The public issues market has been dominated by debt issues both in the private
and public sectors in the recent past.

In recent years, private placement has emerged as an important vehicle for raising resources
by banks, financial institutions and public and private sector companies. Such placements
continued to dominate the primary market although the pace of growth of the private placement
market has slackened during the last two years

Resource mobilization by mutual funds is an important activity in the capital markets.

Although there has been a decline in the net resource mobilization by mutual funds to the extent
of 28 per cent during 2001-02, according to SEBI, outstanding net assets of all mutual funds
stood at Rs.1,00,594 crore as at end-March 2002. The strong potential of the capital market as
an area of resource mobilization needs no emphasis and this segment of the financial sector
would continue to play a significant role in the future.

Reforms The quantum of resources required to be mobilised, as the economy grows in

complexity and generates new demands, places the financial sector in a vital position for
promoting efficiency and momentum. It intermediates in the flow of funds from those who
want to save a part of their income to those who want to invest in productive assets.

The efficiency of intermediation depends on the width, depth and diversity of the financial
system. Till about two decades ago, a large part of household savings was either invested
directly in physical assets or put in bank deposits and small savings schemes of the
Government.
Since the late eighties however, equity markets started playing an important role. Other
markets such as the medium to long-term debt market and short-term money market remained
relatively segmented and underdeveloped.
In the past decades, the Government and its subsidiary institutions and agencies had an
overwhelming and all-encompassing role with extensive system of controls, rules, regulations
and procedures, which directly or indirectly affected the development of these markets.

The financial system comprising of a network of institutions, instruments and markets suffered
from lack of flexibility in intermediary behaviour and segmentation of various markets and sets
of financial intermediaries. Well developed markets should be inter-connected to facilitate the
demand-supply imbalances in one market overflowing into related markets thereby dampening
shocks and disturbances.
The inter connection also ensures that interest rates and returns in any market reflect the broad
demand-supply conditions in the overall market of savings.

But such adjustment of interest rates is delayed when the intermediaries lack flexibility. On
account of the historical role of the Government in controlling and directing a large part of the
financial activity, such adjustments were slow and the problem needed to be addressed urgently
if the financial sector had to keep pace with the reforms in the real sector.

Worldwide experience confirms that the countries with well-developed and market-oriented
financial systems have grown faster and more steadily than those with weaker and closely
regulated systems.
The financial sector in general and banking system in particular in many of the developing
countries have been plagued by various systemic problems which necessitated drastic structural
changes as also a re-orientation of approach in order to develop a more efficient and well-
functioning financial system. The Indian financial system has been no exception in this respect
and the problems encountered in the way of efficient functioning necessitated the financial
sector reforms.
Recognising the critical nature of the financial sector prompted the Government to set up two
Committees on the Financial System (Narasimham Committees) in 1991 and 1998 to examine
all aspects relating to the structure, organisation, functions and procedures of the financial
system.

The deliberations of the Committees were guided by the demands that would be placed on the
financial system by the economic reforms talking place in the real sectors of the economy and
by the need to introduce greater competition through autonomy and private sector participation
in the financial sector. Despite the fact that the bulk of the banks were and are likely to remain
in the public sector, and therefore with virtually zero risk of failure, the health and financial
credibility of the banking sector was an issue of paramount importance to the Committees.

The Committees proposed reforms in the financial sector to bring about operational flexibility
and functional autonomy, for overall efficiency, productivity and profitability. In the banking
sector, in particular, the measures have been taken aimed at restoring viability of the banking
system, bringing about an internationally accepted level of accounting and disclosure standards
and introducing capital adequacy norms in a phased manner. Most of the measures suggested
by the Committees have been accepted by the Government.
A Board for Financial Supervision has been set up within the Reserve Bank of India and it has
introduced a new system of offsite surveillance even while revamping the system of on-site
surveillance.
The financial sector reforms have been pursued vigorously and the results of the first set of
reforms have brought about improved efficiency and transparency in the financial sector. It is
well recognized that reforms in the financial sector are an ongoing process to meet the
challenges thrown up on account of the integration of financial markets, both within the country
and worldwide.
Future direction of reforms If the financial sector reforms are viewed in a broad perspective,
it would be evident that the first phase of reforms focussed on modification of the policy
framework, improvement in financial health of the entities and creation of a competitive
environment. The second phase of reforms target the three interrelated issues viz.
(i)strengthening the foundations of the banking system;
(ii) streamlining procedures, upgrading technology and human resource development;
(iii) structural changes in the system.

These would cover aspects of banking policy, and focus on institutional, supervisory
and legislative dimensions. Although significant steps have been taken in reforming
the financial sector, some areas require greater focus.

One area of concern relates to the ability of the financial sector in its present structure
to make available investible resources to the potential investors in the forms and tenors
that will be required by them in the coming years, that is, as equity.

In 6 such a situation the segment facing the highest level of excess demand would
prove to the binding constraint to investment activity and effectively determine the
actual level of investment in the economy.

Such problems could be resolved through movement of funds between various types
of financial institutions and instruments and also by portfolio reallocation by the savers
in response to differential movements in the returns in the alternative financial
instruments. In this context, it is very important to identify the emerging structure of
investment demand, particularly from the private sector, in order to reorient the
functioning of the financial sector accordingly, so that investment in areas of national
importance flows smoothly.
 A growing economy needs supporting infrastructure at all levels, be it adequate and
reasonably priced power, efficient communication and transportation facilities or a
thriving energy sector. Such infrastructure development has a multiplier effect on
economic growth, which cannot be overlooked.

Infrastructure services have generally been provided by the public sector all over the
world for a large part of the twentieth century as most of these services have an element
of public good in them.

It was only in the closing years of the century that private financing of infrastructure
made substantial progress. It may be relevant to point out that infrastructure was largely
privately financed in the nineteenth century. The twenty-first century would, therefore,
be more like the nineteenth than the twentieth century

This has been so because infrastructure services are difficult to price so as to fully cover
all costs thereby making it unattractive for private sector participation.

Also the provisions of infrastructure usually involve high upfront costs and long
payback periods and the private investor is often unable to provide the large initial
capital required and is not capable of obtaining matching long-term finance.

Finally cross subsidization, which forms an important part of infrastructure provision,

is easier done by public sector than the private. However, there has been a paradigm
shift in funding of infrastructure from the Government to the private sector mainly due
to budgetary constraints in making available funds to meet the huge requirements of
the infrastructure sector.

The other contributing factors for the diminishing role of the Government have been
the dissatisfaction with the performance of state provided infrastructure, more efficient
utilization of resources by the private sector and greater Government emphasis on
allocation of budgetary resources to social service sectors such as health and education.

The Government’s role is perceived as the ability to provide a stable and conducive
macro economic environment and carry out necessary regulatory reforms, which in
turn would facilitate private sector investments in the infrastructure sector.
The Government continues to play the role of a facilitator and the development of
infrastructure really becomes an exercise in public-private partnership.

The fact that funding for infrastructure has increasingly to come from the private sector
has now been widely recognized and the focus of the debate has been on best practices
in reform strategies, regulatory frameworks and risk mitigation techniques.

The Government has the challenging task of providing fair, predictable and sustainable
framework for private sector participation in infrastructure that will deliver better
services with greater efficiency.

It has been observed globally that project finance to developing countries flows in
where there is a relatively stable macro-economic environment. However, there are
certain other conditions, which must be present. These include regulatory reforms and
opening markets to competition and private investment

Liberalized financial markets, promoting the deepening and widening of local

markets, wider use of risk management and other financial products, improved legal
frameworks and accounting standards and privatization programmes are some of the
other aspects which favourably impact on infrastructure project finance.

Infrastructure projects are characterised by large capital costs and long gestation
periods. The assets of these projects are not easily transferable and the services
provided are non-tradable in nature.

These projects are typically vulnerable to regulatory and political changes and are also
dependent on supportive infrastructure. There are also politically sensitive issues like
tariffs and relocation and rehabilitation of people.

For these reasons, the infrastructure projects carry a relatively higher risk profile and,
therefore, this funding is different from the traditional balance sheet financing. The
characteristics and complex nature of infrastructure projects call for proper risks
assessment and mitigation mechanisms.

The financing of infrastructure projects is largely cash flow based and not asset based.
In fact, in some sectors like telecom, roads, bridges etc. the tangible assets may not
even provide adequate cover for the loans.

These projects are financed through Special Purpose Vehicles by way of non-
recourse/limited recourse financing structures.
 The approach to such projects is to properly identify and allocate various elements of
project risks to the entities participating in the project.

The role of sponsors is normally limited to bringing in the contracted equity/contingent

equity contribution The non-recourse financing of infrastructure projects necessitates
exhaustive due-diligence process on the part of the funding agencies to ascertain that
the project cash flows are adequate to cover the debt service obligations.

Risk analysis and risk mitigation mechanisms, therefore, constitute a critical part 9 of
the due-diligence exercise. These risks can broadly be classified into various types viz.
Construction risk, Operation risk, Political risk, Force Majeure risk, Market risk and
Payment risk. The success of project financing depends in a large measure on good
risk management.

There are various mechanisms for mitigating these risks such as execution of
appropriate contracts, performance guarantees, liquidated damages, purchase/sale
contracts, cash support agreements, insurance coverage etc.

Financial structuring has to be such that it would help a project withstand a wide variety
of risks, both expected and unexpected. The complexity of the transactions and large
funding requirements demand an innovative approach towards financial structuring
and the use of a variety of financial instruments.

The involvement of project finance lenders in some projects is quite intense, who often
take a blend of debt and equity positions in these ventures. Such a blended role includes
broad representation and tiered returns and levels of security for various tranches of
participation. In India such financing is usually undertaken by the specialized term
lending agencies like IL&FS, IDFC, ICICI and IDBI.

Commercial banks rarely take equity positions in projects. Infrastructure financing

necessarily requires the commitment of long-term funds, both as equity and long-term
debt. In the past, since the infrastructure sector was predominantly catered to by public
investment, the need to develop appropriate financing mechanisms was not felt.

2.1 COMPANY PROFILE

IOB Bank is India’s first rural bank with total assets of R
s . 219648.17 billion on March 31, 2012 and profit after tax Rs. 10.8 Billion for the year
ended March 31, 2012. The Bank has a network of 2010 branches a n d a b o u t 1 0 0 0
ATMs in India and presence in 18 counties.

Indian Overseas Bank provides customer and commercial Banking services extending their
aims to obtain a radical change that can cause reinforcement in economy.

It inculcates in everyone to buy or sell or transfer money conferring to diverse facts and figures.
The overseas Bank ensures a good way of tackling the intensification evolving currency.
Imagining the world without paper notes adds more simplicity in conduct adhered to it that
makes it lucid for people round the corner with good user interface and other amenities such
that it can outfit them in a first-rate craze.
This paper deals with the key financial factor, the growth rate of IOB, comparison of total
deposits and advances with All Scheduled Commercial Banks and the corresponding
profitability ratios.

INDIAN BANKING SYSTEM :-

The Banking sector in India has always been one of the most preferred avenues of employment. In the
current decade, this has emerged as a resurgent sector in the Indian economy.
As per the McKinsey report „India Banking 2010‟, the banking sector index has grown at a compounded
annual rate of over 51 per cent since the year 2001, as compared to a 27 per cent growth in the market
index during the same period.

It is projected that the sector has the potential to account for over 7.7 per cent of GDP with over Rs.7,
500 billion in market cap, and to provide over 1.5 million jobs.

Today, banks have diversified their activities and are getting into new products and services that include
opportunities in credit cards, customer finance, wealth management, life and general insurance,
investment banking, mutual funds, pension fund regulation, stock broking.
FUND GENERATION :-
There are two main categories of sources that generate funds for a commercial bank
1.Non -Deposit Sources of Funds these include Service fees, Cash handling charges, Penalties
and Interests etc.
2. Deposit Sources of Funds these include Current accounts, saving accounts and Term deposits
etc.
LONG-TERM SOURCES
1. Tier one and Tier two Capitals in the form of equity/subordinate
debts/debentures/preference shares.
2. Internal accrual generated out of profits.
3. Long-term fixed deposits generated from public and corporate clients, financial institutions,
and mutual funds, etc.
4. Long-term borrowings from financial institutions like NABARD/SIDBI.
SHORT-TERM SOURCES
1. Call money market, i.e., funds generated among inter banking transactions where there is
online trading of money between bankers.
2. Fixed deposits generated from public and corporate clients, FIs, and MFs, etc.
3. Market-linked borrowings from RBI.
4. Sale of liquid certificate deposits in the open market.
5. Borrowing from RBI under Repo (Repurchase option).
6. Short and medium-term fixed deposits generated from public and corporate clients, mutual
funds, and financial institutions, etc.
7. Floating in current and saving accounts.
8. Short-term borrowings from FIs by way of rated papers placed, etc.

CONTEMPORARY BANKING SYSTEM SCENARIO

It is true that banks in India are facing difficulty in getting deposits. There are many reasons
behind this problem.
People were looking for more alternatives like mutual funds, different insurance schemes, stock
market, etc. People were moving to these products with higher return expectations.
These instruments also have higher risk and increased income level people who deposit high
amounts of money into banks were ready to take these high-risk alternatives.

But now the situation will be slightly better for banking system in India because investors are
losing a lot of wealth in stock markets and mutual funds.
People will realize the importance of safer investment vehicle and will start diversifying their
portfolio with increased exposure to safer instruments like bank deposits.

HISTORY OF IOB
1937:- Shri.M. Ct. M. Chidambaram Chettyar establishes the Indian Overseas Bank (IOB) to encourage
overseas banking and foreign exchange operations.

IOB started up simultaneously at three branches, one each in Karaikudi, Madras (Chennai) and
Rangoon (Yangon). It then quickly opened a branch in Penang and another in Singapore.

➢ 1960 The banking sector in India was consolidating by the merger of weak private
sector banks.

➢ with the stronger ones; IOB absorbed five banks, including Kulitali Bank (est. 1933).

➢ 1969 The Government of India nationalized IOB. At one point, probably before
nationalization, IOB had twenty of its eighty branches located overseas. After
nationalization it,

➢ like all the nationalized banks, turned inward, emphasizing the opening of branches in
rural India in 1988 IOB acquired Bank of Tamil Nadu in a rescue.

➢ 2000 IOB engaged in an initial public offering (IPO) that brought the government's
share in the bank's equity down to 75%.

➢ 2009 IOB took over Shree Suvarna Sahakari Bank, which was founded in 1969 and had
its head office in Pune. In 2001 it had acquired the Mumbai-based Adarsha Janata
Sahakari Bank,

➢ which gave it a branch in Mumbai. Shree Suvarna Sahakari Bank has been in
administration since 2006.
 ➢ It has nine branches in Pune, two in Mumbai and one in Shirpur. The total employee
strength is estimated to be little over 100.

➢ 2010 Malaysia awarded a commercial banking license to a locally incorporated bank to

be jointly owned by Bank of Baroda, Indian Overseas Bank and Andhra Bank. The new
bank, India
International Bank (Malaysia), will reside in Kuala Lumpur, which has a large population of
Indians. Andhra Bank will hold a 25% stake in the joint venture; Bank of Baroda will own 40%
and IOB the remaining 35%.
➢ IOB launched retail finance–car loans and loans for
c o n s u m e r durables.

➢ IOB becomes the first Indian Company to list on the NYSE through an issue of
American Depositary Shares

➢ IOB Bank’s pioneer in many fields banking, Insurance and Industry with the twin
objectives of specializing in foreign exchange business and overseas banking.

➢ IOB Bank enters first three branch in Karaikudi and Chennai in India and Rangoon
in Burma (presently Myanmar) followed by a branch in Penang.

➢ IOB Bank was one among the first to join Reserve Bank of India’s negotiated
dealing system for security dialling online.

➢ In Pre-nationalization era (1947- 69), IOB expanded its domestic activities

and enlarged its international banking operations.

➢ This led to creation of United Asian Bank Berthed in which IOB had16.67% of the paid
up capital.

➢ The Bank sponsored 3 Regional Rural Banks viz. Puri Gramya Bank, Pandyan Grama
Bank and Dhenkanal Gramya Bank.

➢ The Bank had setup a separate Computer Policy and Planni

n g Department (CPPD) to implement the programme of computerizations,
develop s o f t w a r e p a c k a g e s o n i t s o w n a n d t o i m p a r t t r a i n i n g
t o s t a f f members in this field. bills.

➢ Mobile banking under SMS technology was implement in

A h m e d a b a d and Baroda.
➢ During May of the year 2007, Indian rating agency ICRA
assigneda n ' A 1 + ' r a t i n g t o t h e p r o p o s e d 2 0 b l n r u p e e

➢ c e r t i f i c a t e s o f d e p o s i t programme of Indian Overseas Bank, citing the b

ank's consistent andm e a s u r e d g r o w t h , t h e i m p r o v e m e n t i n i t s a s s e t
q u a l i t y t h r o u g h e f f e c t i v e monitoring and collection systems, and improving
core profitability.

➢ During June of the year 2008, IOB launched two new

p r o d u c t s namely IOB Gold' and IOB Silver' in savings account and IOB Classic'
and IOB Super' under current account.

➢ IOB have a network of more than one thousand eight hundr

e d branches all over India located in various metropolitan cities, urban,

➢ IOB plans to set up banking operations in Malaysia in a joint venture with two other
India-based banks Bank of Baroda and Andhra Bank with a minimum capital
investment of RM320 million (US$100 million).In year 2000, it came out with a
public issue of 11,12,00,000 shares of Rs 10 each for cash at per aggregating Rs
111.20 crores. It also raised Rs125 corers through bonds issue in year 2001.

➢ it gained the rating of AA for the issue. Being ranked as the best public
sector.

➢ In 2006 total business of the bank crossed Rs. 1,00,000 crores whereas the total net
profit exceeded the same figure in 2007. as of September 2008, there were
1425 branches under Core Banking Solution, 525 branches u n d e r T o t a l B r a n c h
Automation and a number of br anches linked under ser vices like
N E F T a n d R T G S . I O B h a s b e e n u p g r a d e d t o “ B B B ” ( l o n g term) rating
by Standard and Poor’s third bank in India after SBI and ICICI.

➢ As per the Reserve bank of India ‘s banking sector is sufficiently capitalized as well
regulated. The financial and economic conditions in the country are far superior to any
other countries in the worlds, credit market and liquidity risk studies suggests that
Indian banks are generally resilient and have withstood the global downtown well

➢ Indian Overseas Bank (IOB) is a major Indian nationalized bank. It is under the
ownership of Ministry of Finance, Government of India based in Tamilnadu, India, with
about 3,400 domestic branches, about 6 foreign branches and representative office.
Founded in February 1937 by M. Ct. M. Chidambaram Chettyar with twin objectives
of specializing in foreign exchange business and overseas banking, it has created
various milestones in Indian Banking Sector. During the nationalization, IOB was one
of the 14 major banks taken over by the government of India.
 ➢ It is one of the two banks recommended for privatization by NITI ayog as per various
news reports. Indian Overseas Bank (IOB) is one of oldest major Public Sector banks
in India with its Head Office located at Chennai.

➢ As on June 2015, the bank has 3392 branches (with overseas branches in Hongkong,
Singapore, Seoul, Bangkok as well as Colombo with a Joint Venture Bank (India
International Bank) in Malaysia. As on 31 March 2021, IOB's total business stands at
₹379,885 crore (US$50 billion).

➢ Indian Overseas Bank is the only bank of Indian origin providing banking services in
the Royal Kingdom of Thailand since 23rd December 1947.
The Bangkok branch of IOB is as old as Independent India and has completed 6 glorious
decades of banking services in Thailand.
Objectives
1) Making Profit: Commercial banks are established with the fundamental objective of
making profit.
2) Medium of Exchange: Commercial banks introduce cheques, bills of exchange etc. as
mediums of exchange.
3) Capital Formation: Collecting surplus money from the people and formation of capital is
one of the main objectives of commercial banks.
4) Welfare of People: Public welfare is an indirect objective of commercial banks.
5) Assisting in Regulation of Loans: Participating and assisting the central bank in formation
of loan policy and loan regulation is one of the objectives of commercial banks.
6) Assisting in Planning and Implementation: Another purpose of commercial banks is to
assist the central bank in

Services provided by Indian overseas bank

1. Retail Banking
Savings, Current and Term Deposit
2. Loans / Overdrafts - against Thai & Repartriable Indian deposit
3. Car loan, Mortgage loan, Housing loan
4. SME loans, Corporate loans
5. Trade Finance
6. Remittance Services
7. Safe Deposit Lockers
8. NRI Services / Help Desk
Deposit schemes
Saving Deposit
Current deposit
Fixed deposit
Remittances
Bahtnet Facility Within Thailand
Swift transfer to any country
Rupee remittances facility to India
Demand draft in various currencies
Lending
Loans to Smes
Corporate finance
Mortgage Loan
Car loan
Loan/Overdraft against Thai Deposit
Letter of guarantee

Trade finance
Import Finance
Letter of credit
Trust Receipt
Packing credit
Export finance
Bills finance
Invoice finance
Collection of bills
Buyer’s credit
Forward contracts
Other Services
CHAPTER 3

3.1 THEORETICAL FRAMEWOR

3.1 THEORETICAL FRAMEWORK

MACROECONOMIC OUTLOOK
The rebound from the COVID-19 induced slump has been sharper than anticipated and
economic activity is expected to rebound strongly in 2021-22. Headline consumer price index
(CPI) inflation receded into the tolerance band beginning December 2020. Core inflation
pressures remain elevated, reflecting pass-through from higher crude oil and non-oil
commodity prices, high fuel and other taxes post-COVID and increased operating costs.
The evolving COVID-19 trajectory and progress on vaccination remain the key drivers of
economic activity and inflation, globally and in India
Section 45-ZA of the RBI Act, 1934 requires that the Central Government shall, in
consultation with the Reserve Bank of India (RBI), determine the inflation target in terms of
consumer price index (CPI), once in every five years. Accordingly, in a notification on March
31, 2021,

The Central Government, in consultation with the RBI, retained the inflation target at 4 per
cent (with the upper tolerance level of 6 per cent and the lower tolerance level of 2 per cent)
for the 5-year period April 1, 2021 to March 31, 2026.

The experience with successfully maintaining price stability and the gains in credibility for
monetary policy since the institution of the inflation targeting framework in 2016 would be
reinforced by the retention of the target and the tolerance band.1 The experience during the
COVID-19 period has testified to the flexibility of the framework to respond to sharp growth-
inflation trade-offs and extreme supply-side shocks
HOW COVID EFFECTED THE BANKI NG SECTOR

While the banking sector will be negatively affected by the pandemic,

it is also critical for economic recovery. But the crisis will strengthen
competitive pressures on banks by accelerating trends towards
digitalisation and new financial service providers.

The lockdown to prevent the spread of the Covid-19 has stopped economic activity
across many sectors, with important repercussions for firms and households. Firms
relying on direct customer contact – such as hospitality and transport – are losing
revenue sources; and households working in these sectors are losing employment
income.

The banking sector is also affected, although mostly indirectly. While banking services
can be provided remotely and do not rely on direct customer contact, the linkage of the
sector with the real sector as provider of payment, savings, credit and risk management
services extends the negative effect of the Covid-19 crisis to banks and other financial
institutions.

At the same time, the banking sector has the role of supporting firms and households
during this period of lower revenues and incomes, which has triggered important policy
actions by financial supervisors and governments.

How does the crisis affect banks?

First, firms that have stopped working miss out on revenues, and therefore might not be
able to repay loans. Similarly, households with members who have lost their jobs or are
furloughed have less income, and therefore might not be able to repay their loans.

This will result not only in lost revenue but also in losses (if repayment capacity is
permanently impaired), negatively affecting profits and bank capital. And as a swift
recovery becomes less likely, banks can expect further losses, resulting in the need for
additional provisions, further undermining their profitability and capital position.

Second, banks are negatively affected as bonds and other traded financial instruments
have lost value, resulting in further losses for banks. There might also be losses from
open derivative positions that have moved in unexpected directions due to the crisis.

Third, banks face increasing demand for credit, as especially firms require additional
cash flow to meet their costs even in times of no or reduced revenues. In some cases,
this higher demand has presented itself in the drawdown of credit lines by borrowers.

Fourth, banks face lower non-interest revenues, as there is lower demand for their
different services.

For example, there are fewer payments and transactions to be done with lower
economic activity, and fewer security issues by corporates reduce fee income for
investment banks.

Losses and lower capital buffers in banks can have negative spillover effects, which
might make banks’ solvency position even worse and might also undermine the broader
economy.

Banks might sell bonds and other traded financial instruments to improve their
liquidity position or to make up for losses, with prices of these instruments falling as a
consequence and negatively affecting other banks that hold them.

Banks might reduce credit provision to the economy, thus negatively affecting firms
relying on such buffers, undermining their survival. We saw similar spillover effects
during the 2008/09 global financial crisis. This could make the economic shock even
worse.
Key Developments since the October 2020 MPR

Since the release of the Monetary Policy Report (MPR) in October 2020, domestic economic
activity has turned out to be better than anticipated on the back of a turnaround in gross fixed
capital formation and a much shallower contraction in private consumption than in the
preceding quarters of the financial year.

➢ The global economy is pulling out of the loss of momentum in Q4:2020, driven by
multiple vaccine approvals, the launch of inoculation drives in many countries and the
extension of monetary and fiscal stimuli.

➢ On the other hand, new mutants of the COVID-19 virus, second/third waves of
infections, renewed lockdowns in many countries and uneven access to vaccines
across countries continue to weigh on the outlook.

➢ The resurgence of commodity price inflation, supported by abundant global liquidity,

has fuelled reflation trade in global financial markets.

➢ Despite the promise of continued accommodative monetary policies by central banks,

bond yields have firmed up from very low levels, spurred by inflation concerns and
expectations of stronger growth. Amidst stretched valuations, equity prices have
become sensitive to the hardening of yields. In turn, exchange rates have become
volatile, with capital outflows from emerging economies in early March interrupting
their earlier ebullience on risk-on sentiments.
➢ Crude oil prices jumped sharply on production cuts by the Organization of the
Petroleum Exporting Countries (OPEC) plus and on anticipation of stronger demand.

➢ Non-oil commodity prices have risen substantially across the board, putting upward
pressures on inflation in commodity importing countries. Gold prices eased from the
highs reached in August 2020 on a stronger US dollar and expectations of economic
recovery. While inflation is expected to remain

➢ subdued in advanced economies (AEs) and most of the emerging market economies
(EMEs) on account of negative output gaps,

➢ the large fiscal and monetary stimuli and elevated commodity prices have raised
inflation concerns over longer horizons in advanced economies and in the nearer-term
in the case of EMEs. Turning to the domestic economy, the gross domestic product
(GDP) shrugged off the contractions of preceding quarters and moved into expansion
zone in 2020-21 (+ 0.4 per cent, year-on-year).
 ➢ High frequency indicators point to the growth momentum gaining strength in Q4
although the surge in COVID-19 infections in a few states in March 2021 imparts
uncertainty to the assessment. The outlook for the agriculture sector remains bright,
with higher rabi sowing, above normal north-east monsoon and adequate reservoir
levels.

➢ Inflation receded into the tolerance band beginning December 2020 after breaching
the upper threshold of 6 per cent for six consecutive months (June-November 2020).
The late winter easing of vegetable prices that caused this softening has dissipated,
however.

➢ In its February 2021 print, headline inflation firmed up again, with upside pressures
getting generalised across constituents of core inflation. Monetary Policy Committee:
October 2020-March 2021 During October 2020-March 2021, the Monetary Policy
Committee (MPC) met thrice. In the October 2020 meeting, the MPC noted that the
revival of the economy from the unprecedented COVID-19 pandemic assumed the
highest priority in the conduct of monetary policy. High inflation was seen as easing
with the unlocking of the economy, restoration of supply chains and normalisation of
activity.

Hence, the MPC decided to look through the inflation spike and unanimously voted to keep
the policy repo rate unchanged. It also voted to continue with the accommodative stance as
long as necessary – at least during the current financial year and into the next financial year –
to revive growth on a durable basis and mitigate the impact of COVID-19

on the economy, while ensuring that inflation remained within the target going forward. In
the run up to the December 2020 meeting, CPI inflation had increased to 7.6 per cent in
October 2020 with food inflation surging to double digits across protein-rich items.
Edible oils, vegetables and spices on multiple supply shocks. Core inflation had remained
sticky and was seen to firm up as economic activity normalised and demand picked up. At the
same time, with the signs of economic recovery being far from broad-based and still
dependent on sustained policy support, the MPC decided to maintain status quo on the policy
rate and continue with the accommodative stance set out in the October resolution.
By the time the MPC met in February 2021, CPI inflation had declined to 4.6 per cent in
December 2020 on the back of a larger than anticipated deflation in vegetable prices.

The MPC noted the sharp correction in food prices but was concerned that some pressures
persisted, and core inflation remained elevated. As the recovery was still to gather firm
traction and continued policy support remained crucial.
The MPC unanimously decided to keep the policy repo rate unchanged and maintain its
accommodative stance.
The MPC’s voting pattern reflects the individual members’ assessments, expectations and
policy preferences (Table I.1). The MPC’s unanimous vote on the policy rate in all the three
meetings during October 2020-March 2021 was a reflection of the unprecedented pandemic
and an unambiguous consensus on continued policy support.
The instruments of monetary policy are of two types:
1. Quantitative, general or indirect (CRR, SLR, Open Market Operations, Bank Rate, Repo
Rate, Reverse Repo Rate)
2. Qualitative, selective or direct (change in the margin money, direct action, moral suasion)
These both methods affect the level of aggregate demand through the supply of money, cost of
money and availability of credit. Of the two types of instruments, the first category includes
bank rate variations, open market operations and changing reserve requirements (cash reserve
ratio, statutory reserve ratio).
Policy instruments are meant to regulate the overall level of credit in the economy through
commercial banks. The selective credit controls aim at controlling specific types of credit. They
include changing margin requirements and regulation of consumer credit.
We discuss them as under:

Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it rediscounts first class
bills of exchange and government securities held by the commercial banks. When the central
bank finds that inflation has been increasing continuously, it raises the bank rate so borrowing
from the central bank becomes costly and commercial banks borrow less money from it (RBI).
The commercial banks, in reaction, raise their lending rates to the business community and
borrowers who further borrow less from the commercial banks.

There is contraction of credit and prices are checked from rising further. On the contrary, when
prices are depressed, the central bank lowers the bank rate. It is cheap to borrow from the
central bank on the part of commercial banks.
The latter also lower their lending rates. Businessmen are encouraged to borrow more.
Investment is encouraged and followed by rise in Output, employment, income and demand
and the downward movement of prices is checked. List of Public Sector Banks in India and
their Headquarters

Open Market Operations:

Open market operations refer to sale and purchase of securities in the money market by the
central bank of the country.
When prices start rising and there is need to control them, the central bank sells securities.
The reserves of commercial banks are reduced, and they are not in a position to lend more to
the business community or general public. Further investment is discouraged and the rise in
prices is checked. Contrariwise, when recessionary forces start in the economy, the central bank
buys securities.

The reserves of commercial banks are raised so they lend more to business community and
general public. It further raises Investment, output, employment, income and demand in the
economy hence the fall in price is checked

Changes in Reserve Ratios:

Under this method, CRR and SLR are two main deposit ratios, which reduce or increases the
idle cash balance of the commercial banks. Every bank is required by law to keep a certain
percentage of its total deposits in the form of a reserve fund in its vaults and also a certain
percentage with the central bank.
When prices are rising, the central bank raises the reserve ratio. Banks are required to keep
more with the central bank.
Their reserves are reduced, and they lend less. The volume of investment, output and
employment are adversely affected. In the opposite case, when the reserve ratio is lowered, the
reserves of commercial banks are raised. They lend more and the economic activity is
favourably affected.
Selective Credit Controls: Selective credit controls are used to influence specific types of
credit for particular purposes.
They usually take the form of changing margin requirements to control speculative activities
within the economy.

When there is brisk speculative activity in the economy or in particular sectors in certain
commodities and prices start rising, the central bank raises the margin requirement on them.
Structure of Banking Sector in India

a. Change in Margin Money: The result is that the borrowers are given less money in
loans against specified securities. For instance, raising the margin requirement to 70% means
that the pledger of securities of the value of Rs 10,000 will be given 30% of their value,
i.e., Rs 3,000 as loan. In case of recession in a particular sector, the central bank encourages
borrowing by lowering margin requirements.

b. Moral Suasion: Under this method RBI urges to commercial banks to help in controlling
the supply of money in the economy.
Repo rate and CRR reduction

Finance Minister Nirmala Sitharaman released a Rs 1.7 trillion package to curb the impact of
the 21-day coronavirus lockdown, the Reserve Bank of India (RBI) on Friday cut benchmark
interest rate by 75 basis points to 4.4 per cent to deal with the hardship caused due to the
outbreak of Covid-19.

➢ CRR: Cash reserve ratio reduced for all banks by 100 basis points to 3 per cent for
one year
➢ Minimum daily CRR balance requirement reduced from 90 per cent to 80 per cent...
one-time dispensation up to June 2020
➢ Marginal standing facility reduced to 2 per cent of SLR. Policy rate corridor widened
from 50 basis points to 65 bps
➢ As a consequence of the lockdown, consumption has decreased significantly, resulting in
surplus liquidity in the financial sector.

➢ To alleviate this challenge, the RBI announced on March 27, 2020, that the current policy
rate corridor will be increased from 50 to 65 basis points.

➢ The reverse repo rate, which is the price at which the federal bank borrows money from
domestic commercial banks, was reduced by 90 basis points from 4.90 per cent to 4.00
per cent under LAF. On April 17th, 2020, a memo has released the RBI decided to limit
the interest rate from 4.00 per cent to 3.75 rates on fixed reverse repo rates.

➢ It was said that banks in the reverse repo market have lent up to 8 lakh crores, resulting in
an improvement in machine liquidity. As a result, at a meeting with the governor of RBI,
some economists proposed abolishing the reverse repo rate and combining it with the
“Standing Deposit Facility”.

➢ A remunerated facility, SDF, allows banks to lend as much money at a rate lower than the
reverse repo rate with RBI. Additionally, the provision of collateral for liquidity
absorption is not required by the same.

The central bank also reduced the cash reserve ratio (CRR) of all banks by 100 basis points to
3 per cent with effect from March 28 for 1 year. RBI will maintain accommodative stance,
Governor Shaktikanta Das said while announcing decisions of Monetary Policy Committee
(MPC).
 Monetary policy and liquidity operations during 2020-21 were geared towards mitigating the
adverse impact of the unprecedented economic devastation brought by the COVID-19
pandemic on the Indian economy.
Supply disruptions imposed persistent upside price pressures, with inflation ruling above the
upper tolerance band for six consecutive months during June-November 2020.
The monetary policy committee (MPC) maintained status quo on the policy repo rate during
June 2020 to February 2021 after a sizeable cut of 115 basis points (bps) during March-May
2020. Given the growth-inflation dynamics,

the MPC decided to continue with the accommodative stance as long as necessary to revive
growth on a durable basis and mitigate the impact of COVID-19 on the economy, while
ensuring that inflation remains within the target going forward.
These decisions were in consonance with the objective of achieving the medium-term target
for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while
supporting growth.

➢ During 2020-21, the Reserve Bank undertook several conventional and

unconventional measures to address liquidity constraints in the face of COVID-19
related dislocations.
This unprecedented response eased financial stress, unclogged monetary transmission and
credit flows while ensuring financial stability. With fears of liquidity drying up being
dispelled, financial market sentiments were bolstered while ensuring orderly market
conditions.
Interest rates and bond yields declined across market segments and spreads narrowed to pre-
COVID levels.
Corporate bond issuances benefitted from surplus liquidity conditions which enabled record
number of issuances at reasonably low costs
Despite a significant jump in market borrowings, the government could raise funds at the
lowest weighted average cost in 17 years along with the highest weighted average maturity of
the stock of public debt on record.
➢ Surplus liquidity conditions, coupled with the external benchmark-based pricing of
floating rate loans, led to a considerable improvement in monetary transmission
during 2020-21. Interest rates on outstanding loans declined for a majority of the
sectors.
The external benchmark-linked framework incentivised banks to adjust their term as well as
saving deposit rates to protect their net interest margins, thereby improving monetary
transmission.
 ➢ Against the above backdrop, Section 2 presents the implementation status of the
agenda set for 2020-21 along with major developments, while Section 3 sets out the
agenda for 2021-22. Concluding observations are in the last section.

In last year’s Annual Report, the Department had set out the following
goals

• Strengthening nowcasting of inflation with wider information systems, including

commodity price monitoring (Utkarsh)

• Augmenting the external sector block of the quarterly projection model (QPM) by
incorporating capital inflows dynamics for an improved analysis of external spill overs and
feedback mechanisms, and recalibration of the QPM based on recent empirical estimates
(Utkarsh)

• Analysis of MPC voting patterns (Utkarsh)

• Assessing the efficacy of the conventional [open market operation (OMO)] and
unconventional [long-term repo operation (LTRO) and targeted LTRO (TLTRO)] monetary
policy instruments and

• Understanding the dynamics of banks’ holdings of government securities and credit growth
to assess the relative roles of crowding out and portfolio re-balancing

Implementation Status of Goals

A number of studies were undertaken during 2020-21 to strengthen the analytical inputs for
the conduct of monetary policy and liquidity management.
They included: strengthening nowcasting of inflation with wider information system,
including commodity price monitoring; augmenting the external sector block of QPM by
incorporating capital inflows dynamics and recalibration of the QPM based on recent
empirical estimates; analysis of MPC voting pattern; the impact of LTRO and TLTRO on
bond markets; dynamics of banks’ holdings of government securities and credit growth to
assess the relative roles of crowding out and portfolio rebalancing; analysing and forecasting
currency demand in India;
evaluating the impact of asset quality of banks on credit channel of monetary policy;
constructing an economic activity index for India; revisiting the determinants of term
premium in India.
examining the pass-through of global food prices to domestic prices in emerging market
economies (EMEs); and assessing volatility spill over from US monetary policy on select
EMEs, including India. Major Developments Monetary Policy.

The COVID-19 pandemic triggered extreme risk aversion and elevated volatility in financial
markets, necessitating an advancement in the MPC’s first two meetings scheduled for March
31, April 1 and 3, 2020 and June 3-5, 2020 to March 24, 26 and 27, 2020 and May 20-
22,2020, respectively.
In the March 2020 meeting, the MPC noted that macroeconomic risks brought on by the
pandemic, both on the demand and supply sides, could be severe and there was a need to do
whatever necessary to shield the domestic economy from the pandemic.

The MPC, therefore, voted unanimously for a sizeable reduction in the policy repo rate. With
a 4 to 2 majority, the repo rate was cut by 75 bps to 4.40 per cent, while 2 members voted for
a reduction of 50 bps.
All members voted unanimously to continue with the accommodative stance as long as
necessary to revive growth and mitigate the impact of COVID-19 on the economy, while
ensuring that inflation remained within the target. In the May 2020 meeting, with the growth
outlook remaining sombre, the MPC decided to reduce the policy repo rate by another 40 bps
to 4.0 per cent to emotively use available space to ease financial conditions further to mitigate
the adverse impact of the pandemic on the economy.
Five members voted for a reduction in policy repo rate by 40 bps and one member voted for a
reduction of 25 bps. The MPC also voted unanimously to continue with the accommodative
stance set out in its March meeting.

➢ By the time of the August 2020 bi-monthly review, there was greater clarity on the
likely recovery of economic activity in Qled by the rural economy.
GDP GROWTH

However, for the year 2020-21, real GDP growth was expected to be negative. On inflation,
though the release of June CPI was still not normalised in terms of data coverage, headline
inflation ruled above the upper tolerance threshold of 6 per cent.
Issues in data reliability, coupled with high retail mark-ups amidst the pandemic added
uncertainty to the inflation outlook. Accordingly, the MPC decided to pause and remain
watchful for a durable reduction in inflation to use the available space to support the revival
of the economy.
➢ The October 2020 policy2 was held in a setting in which high frequency indicators
suggested recovery of economic activity in Q2:2020-21, after a record contraction in
real GDP in 2020-21. Headline CPI inflation continued to remain above the upper
tolerance threshold as price pressures accentuated across food, fuel, and core sub-
groups due to supply disruptions, high retail margins, high indirect taxes on
petroleum products and higher cost of doing business in the post-lockdown period.

The rural economy was expected to strengthen further while the recovery in urban demand
was seen as lagging due to social distancing norms.
Moreover, private investment and exports were likely to remain subdued. Real GDP was
projected to contract by 9.5 per cent during 2020-21, with GDP growth moving into the
positive zone by 2020-21 and placed at 20.6 per cent in 2021-22.

CPI headline inflation was projected to moderate to 5.4-4.5 per cent in H2:2020-21 and
further to 4.3 per cent in 2021-22, with risks broadly balanced.
The MPC noted that the revival of the economy from the unprecedented COVID-19
pandemic assumed the highest priority in the conduct of monetary policy.
On the elevated inflation, the MPC judged that the underlying factors were essentially supply
shocks which were likely to dissipate over the ensuing months as the economy unlocked,
supply chains were restored, and activity normalised and as such these could be looked
through in setting the monetary policy stance.

Accordingly, the MPC voted unanimously to keep the policy repo rate unchanged. With a
vote of 5 to 1, the MPC also decided to continue with the accommodative monetary policy
stance if necessary –
at least during the current financial year and into the next financial year – to revive growth on
a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that
inflation remains within the target going forward.
 By the time of the December 2020 meeting, the economic recovery had progressed further,
but alongside the intensification of inflationary pressures
The contraction in real GDP in 2020-21 was shallower than anticipated, and high frequency
indicators suggested that recovery was gaining traction in Q3:2020-21.
With a projected growth of (+) 0.1 per cent in Q3:2020-21 and (+) 0.7 per cent in Q4:2020-
21, real GDP was expected to contract by 7.5 per cent in 2020-21, lower than the contraction
of 9.5 per cent in the October 2020 assessment.

In 2021- 22, the expansion was projected to gather pace at (+) 21.9 per cent to (+) 6.5 per
cent, with risks broadly balanced.
Inflation pressures, however, turned out to be higher than anticipated, with CPI inflation
inching up to 7.6 per cent in October 2020 on a broad-based surge in food and core inflation
and outlook remaining adverse with continuing high retail price margins, rising crude oil
prices and stickiness imparted on account of cost-push pressures.
Reflecting these pressures, the inflation projections were revised upwards to 6.8-5.8 per cent
in 2020-21 and 5.2-4.6 per cent in H1:2021-22, with risks broadly balanced.
However, with the signs of recovery far from being broad-based and dependent on sustained
policy support, the MPC voted unanimously to maintain status quo on the policy repo rate
and continue with the accommodative stance as set out in its October resolution.

In the run up to the sixth bi-monthly policy in February 2021, inflation moderated sharply to
4.6 per cent in December 2020. Taking into account the significant correction in food
inflation on the one hand and the persisting core inflation pressures on the other,
the projection for CPI inflation was revised to 5.2 per cent in 2020- 21, 5.2 per cent to 5.0
per cent in H1:2021-22 and 4.3 per cent in 2021-22, with risks broadly balanced.

On the growth outlook, the MPC was of the view that rural demand was likely to remain
resilient on good prospects of agriculture while urban demand and demand for contact-
intensive services were expected to strengthen with the substantial fall in COVID-19 cases
and the spread of vaccination.

Consumer confidence was reviving, and business expectations remained upbeat. Taking into
account these considerations and the Union Budget 2021-22 proposals, real GDP growth was
projected at 10.5 per cent in 2021-22 – in the range of 26.2 to 8.3 per cent in H1 and 6.0 per
cent .

Given the softening in inflation as also the need for continued policy support to rest the
growth recovery on a firmer footing, the MPC unanimously voted for keeping the policy repo
rate unchanged at 4 per cent and continue with the accommodative stance till the prospects of
a sustained recovery are well secured while closely monitoring the evolving outlook for
inflation.

The Operating Framework: Liquidity Management

➢ The operating framework of monetary policy aims at aligning the operating target –
the weighted average call rate (WACR) – with the policy repo rate through proactive
liquidity management, consistent with the stance of monetary policy. In the face of
COVID-19 related stress and the large contraction in output, The concatenation of
heightened financial stress, widening spreads, and seizure of market liquidity
exacerbated by highly volatile capital flows on account of the pandemic warranted
proactive measures by the Reserve Bank starting Q4:2019-20.

Total liquidity augmenting measures announced by the Reserve Bank (up to March 31, 2021)
since February 2020 have aggregated to `13.6 lakh crore (6.9 per cent of nominal GDP for
2020-21). The main drivers of liquidity were the Reserve Bank’s forex operations and
expansion in currency in circulation (CiC) – liquidity injection through the former more than
offset the leakage from the heightened precautionary currency demand during the pandemic
(Chart III.1a).

The conventional and unconventional monetary policy measures augmented system liquidity.
The consequent large liquidity surplus was mopped up through overnight fixed rate reverse
repos under the liquidity adjustment facility (LAF) (Chart III.1b).

➢ In Q1:2020-21, the expansion in CiC drained system liquidity by `2.13 lakh crore which
was more than offset by liquidity injections through
(i) targeted long-term repo operations (TLTROs) (`87,891 crore),
 (ii) OMO purchases (`1.2 lakh crore) and
(iii) the forex operations (`1.0 lakh crore).

Additionally, the Reserve Bank announced special liquidity facility for mutual funds (SLFMF)
worth `50,000 crore although its utilisation was confined to only `2,430 crore. Moreover, the
Reserve Bank provided special refinance facilities for a total amount of `65,000 crore to All
India Financial Institutions (AIFIs) comprising
25,000 crores to National Bank for Agriculture and Rural Development (NABARD) for
refinancing regional rural banks (RRBs), cooperative banks and micro finance institutions
(MFIs);
(i) 15,000 crores to Small Industries Development Bank of India (SIDBI) for on-
lending/refinancing.
(ii) 10,000 crores to National Housing Bank (NHB) for supporting housing finance
companies (HFCs); and
(iii) 15,000 crores to Export Import Bank of India (EXIM Bank) to enable it to avail
US dollar swap facility for its foreign exchange requirements.3 Overall, the surplus
liquidity resulted in average daily net absorption under the LAF amounting to `4.72
lakh crore during the quarter.
During Q1:2020-21, the Reserve Bank also conducted one special OMO involving
simultaneous purchase and sale of securities, which were liquidity neutral, to
distribute liquidity more evenly across the yield curve and improve transmission.

In order to encourage banks to deploy surplus funds in investments and

loans in productive sectors of the economy, the fi xed rate reverse repo rate
under the LAF was reduced by 25 bps (from 4.0 per cent to 3.75 per cent)
without concomitant changes in the MSF and the repo rate on April 17,
2020, thereby widening the asymmetric corridor.

➢ 16 In 2020-21, forex purchase operations augmented system liquidity by

`2.1 lakh crore while the Reserve Bank injected `27,862 crores through
OMOs, even as expansion in CiC remained muted

➢ As a result, surplus liquidity persisted, although the average daily net

absorption moderated to `3.9 lakh crore during the quarter. As part of the
Aatma Nirbhar Bharat package, the Government of India (GoI) approved a
scheme of `30,000 crore to improve liquidity position of NBFCs (including
MFIs)/HFCs with a view to avoiding any potential systemic risks to the fi
nancial sector. Under the scheme introduced on July 1, 2020, the Reserve
Bank provided liquidity by subscribing to government guaranteed special
securities issued by a Special Purpose Vehicle (SPV).
 ➢ 17 To reduce the cost of funds, banks that had availed of funds under LTROs
in February March 2020 at the then prevailing repo rate (5.15 per cent) were
given an option in September 2020 of reversing these transactions before
maturity by availing fresh funds at the reduced repo rate of 4.0 per cent.

Banks repaid `1,23,572 crore under this facility – nearly 98.8 per cent of `1,25,117
crore availed under the various LTROs.

The Reserve Bank also conducted five special OMOs during Q2:2020-21.
Furthermore, the Reserve Bank increased the limits under Held-to-Maturity (HTM)
category from 19.5 per cent to 22 per cent of net demand and time liabilities (NDTL)
in respect of statutory liquidity ratio (SLR) securities acquired on or after September
1, 2020 to engender orderly market conditions.

EXPANSION IN CURRENCY DEMAND

In 2020-21, expansion in currency demand (`95,181 crore) and the Reserve Bank’s
forex purchase operations (`2.0 lakh crore) were the main drivers of liquidity.

In addition, durable liquidity amounting to `89,140 crore was injected through

OMOs; the Reserve Bank also conducted six auctions of special OMOs during this
period. Consequently, net absorptions under the LAF rose to `5.33 lakh crore during
the quarter.
Banks returned TLTRO funds amounting to `37,348 crore – about 33.1 per cent of
the total amount of `1,12,900 crore availed – under a scheme similar to the return
of LTRO funds.

To nurture the revival of activity in specific sectors that have multiplier effects on
growth through both forward and backward linkages, the Reserve Bank announced
‘On tap TLTROs’ with tenors of up to three years for a total amount of up to
`1,00,000 crore at a floating rate linked to the policy repo rate.

Liquidity availed by banks under the scheme is required to be deployed in corporate

bonds, commercial papers, and non-convertible debentures issued by entities in
specific sectors over and above the outstanding level of their investments in such
instruments as on September 30, 2020.

The liquidity availed under the scheme can also be used to extend bank loans to
these sectors. Furthermore, as a special case, the Reserve Bank conducted three
OMOs in State Development Loans (SDLs) to improve their liquidity and facilitate
efficient pricing in 2020-21.
 ➢ The Reserve Bank also stressed that financial market stability and the
orderly evolution of the yield curve are public goods, the benefits of which
accrue to all stakeholders in the economy.

Following the COVID-19 outbreak, staff and IT resources were severely affected
and the thinning out of activity impacted financial market liquidity and increased
volatility in the prices of financial products.

Accordingly, it was decided to shorten trading hours for various markets regulated
by the Reserve Bank effective April 7, 2020.

Subsequently, with the phased removal of lockdown and easing of restrictions on

movement of people and resumption of normal functioning of offices, it was
decided to restore the trading hours
in a phased manner beginning November 9, 2020.

During amidst very large surplus liquidity conditions, the Reserve Bank on
January 8, 2021 announced steps to move towards normal liquidity management
operations in a phased manner and accordingly it conducted five 14-day variable
rate reverse repo (VRRR) auctions of `2 lakh crore each on January 15, January 29,
February 12, February 26 and March 12, 2021.

The liquidity absorbed through the fixed rate reverse repo increased from a
fortnightly average of `4.3 lakh crore during January 16-29, 2021 to `4.9 lakh crore
during January 30 - March 31, 2021.

The Reserve Bank also reiterated its commitment to provide ample liquidity in the
system. With the paramount objective of reviving the economy, the Reserve Bank
announced additional measures on February 5, 2021 which included.

(i) allowing lending by banks to NBFCs under the TLTRO on Tap scheme for
incremental lending to specified stressed sectors
(ii) gradual restoration of the CRR in two phases in a non-disruptive manner to 3.5
per cent effective from March 27, 2021 and 4.0 per cent effective from May 22,
2021

extension of relaxation in availing funds under MSF by dipping into SLR up to 3.0
per cent of NDTL until September 30, 2021; and

exemption from CRR maintenance for credit flow to new micro, small, and medium
enterprise (MSME) borrowers, for exposures up to `25 lakh per borrower for credit
extended up to October 1, 2021.

➢ To meet any additional/ unforeseen demand for liquidity and to provide

flexibility to the banking system in year-end liquidity management, the
Reserve Bank decided to conduct two fine-tuning variable rate repo auctions
 of ` 25,000 crore each on March 26 and March 31, 2021 of 11-day and 5-
day tenors, respectively.

Furthermore, it was decided not to conduct the 14-day VRRR auction on March 26
to ensure the availability of ample liquidity for managing year-end requirements

DEPOSITS AND LENDING RATES

Bearing testimony to the effectiveness of the liquidity operations undertaken and

the forward guidance provided during 2020-21, interest rates declined, and spreads
narrowed across market segments (Table III.1).

Abundance of liquidity in the system, coupled with reductions

PRICES AND COSTS
In 2020-21, inflation breached the upper tolerance band of 6 per cent for six consecutive
months in the post-lockdown period (June-November 2020) due to a series of cost-push
shocks – supply chain disruptions; weather shocks; higher crude oil and other commodity
prices; and higher taxes.

The sharp correction during December-January was reversed on adverse base effects in
February. Core inflation remained sticky at elevated levels. Costs of farm and industrial
inputs recovered with the gradual unlocking of the economy and rural wage growth
moderated although it remained higher than in the pre-lockdown period.

In the months following the publication of the October 2020 MPR, inflationary pressures got
accentuated and headline inflation1 remained above the upper tolerance threshold. Core
inflation also stayed sticky at elevated levels.
During December 2020-January 2021, however, there was a sharp correction and inflation
eased significantly, moving closer to the target, only to reverse to 5.0 per cent in February
2021,

The Reserve Bank of India (RBI) Act enjoins the RBI to set out deviations of actual inflation
outcomes from projections, if any, and explain the underlying reasons thereof. The October
2020 MPR had projected

In actual inflation was 100 basis points (bps) above projection (Chart II.2). A sharp,
unanticipated increase in food inflation – double-digit inflation in eggs, meat and fish (due to
fragmented supply chains), pulses (tight demand supply balance), edible oils (high
international prices), and vegetables (unseasonal rains) –

led to this substantial overshoot. Retail price margins for food also increased, with the
persistence of supply chain disruptions. International crude oil prices (Indian basket) jumped
from the baseline assumption of US$ 40.9 per barrel for H2:2020-21 to US$ 61.2 per barrel
by February 2021. Gold prices remained elevated in :2020-21 over COVID-19 concerns,
supported by highly accommodative
Consumer Prices

The sharp upward movement of inflation to a peak of 7.6 per cent in October 2020 came
about from a pickup in price momentum in food as well as in the core category.2 Thereafter,
strong favourable base effects brought about a moderation in headline inflation to 6.9 per cent
in November 2020, more than offsetting positive momentum in all these components.
In December 2020, a negative momentum in headline inflation due to a sharp decline in food
prices, along with favourable base effects, resulted in headline inflation declining by 2.3
percentage points. In January 2021, headline inflation moderated further due to a large
negative momentum engendered by food prices. In February 2021, an adverse base effect of
around 70 bps resulted in a substantial pick-up in inflation
Reflecting broad-based price pressures, the distribution of CPI group/sub-group inflation in
2020-21 was centred at 4.9 per cent, higher than the sub-4 per cent levels seen in recent years
with several sub-groups exhibiting double-digit inflation, the inflation distribution also
exhibited a fat tail, pushing mean headline inflation in excess of 6.0 per cent. The diffusion
indices of price changes in CPI items on a non-seasonally adjusted
DEMAND AND OUTPUT

Economic activity in India in 2020-21 turned out to be more resilient than anticipated in the
October 2020 MPR, supported by a significant decline in new COVID-19 infections from the
mid-September 2020 peak and the rollout of the vaccination drive from mid-January 2021.
After the unprecedented contraction in real gross domestic product (GDP) recorded
sequential upturn in and regained positive territory in with the ambit of the recovery
broadening to encompass a wider spectrum of sectors since then. On the supply side too, the
sustained resilience of agriculture and allied activities was complemented by manufacturing
and services sector activity gaining some momentum. As a result, real gross value added
(GVA) recorded positive growth in and is expected to be positive in also.

FINANCIAL MARKETS AND LIQUIDY

In 2020-21, global financial markets remained largely buoyant, fuelled by optimism around a
speedy vaccine-led recovery. Growing inflation concerns over fiscal stimulus amidst
extremely accommodative monetary policies rattled global bond markets in February 2021.
Long-term sovereign bond yields jumped sharply in the US and induced bouts of volatility
across financial markets and regions of the world. The consequent yield curve steepening
resulted in portfolio reallocation and corrections in equity prices.
Despite the recent declines, stock indices remain elevated on anticipation of stronger
recovery. In the currency markets, the US dollar appreciated in the first quarter of 2021
driven by rising bond yields while EME currencies faced depreciation pressures from bouts
of capital outflows.
IV.1 Domestic Financial Markets
During:2020-21, domestic financial markets continued to post recovery in market activity
amidst easy liquidity conditions.
Nevertheless, concerns about a surge in infections in a few states, global bond sell-off, the
large government borrowing and uncertainty about the pace and scale of economic recovery
kept market sentiments subdued. IV

1.1 Money Market

The money market remained largely stable during H2:2020-21, reflecting surplus liquidity
conditions. The weighted average call rate (WACR) in the unsecured overnight money
market eased and slipped below the reverse repo rate, beginning the second half of October
2020 The negative spread of WACR relative to the reverse repo rate averaged 14 bps in In
the overnight call money segment, the weighted average rate (WAR) of traded deals
generally remained above the reverse repo rate while that of reported deals remained below1 .
In 2021 (January-March), the global economy gradually regained momentum of recovery
gathered in 2020, which had encountered headwinds in as many advanced economies (AEs)
and some emerging market economies (EMEs) had to reimpose restrictions/lockdowns in the
wake of second/third wave of infections coupled with the newer and more virulent strains of
the virus.

Mass vaccination drives are underway in several countries, but rapid mutations of the virus,
concerns over the effectiveness of available vaccines and limited access to vaccines in many
countries keep the near-term outlook clouded and the recovery remains fragile, incomplete,
uneven and divergent. Prolonged monetary accommodation, easy financial conditions and
rounds of fiscal stimulus buoyed stock markets around the world, with strong rallies pushing
equity valuations to record levels in February 2021 to a point of disconnect with the real
economy.

In the bond market, short term yields remain anchored on low policy rates, but longer-term
yields have surged since the second half of February 2021 across the world on rising inflation
expectations and apprehensions about possible reversal of monetary policy stances.
In turn, equity and currency markets have experienced bouts of volatility.
Commodity prices continue to spiral up under a combination of supply disruptions and
revival of demand, translating into intensifying input price pressures on account of severely
stretched supply chains. Consequently, inflation risks are widely perceived to be rising in an
environment of exceptional monetary and fiscal accommodation, leading to turbulence in
global financial markets and capital outflows from emerging markets in the second half of
2021.

Global Economic Conditions

Economic activity across major AEs and EMEs posted a strong recovery in Q3:2020,
following a record plunge in Q2 amidst widespread lockdowns. As stated earlier, activity
stalled again in Q4 as countries battled new waves of infections and speedily communicable
mutations of the virus. With inoculations underway, high frequency indicators, however,
point to some pickup in 2021.
Nonetheless, activity remains below the pre-pandemic levels even as GDP contractions ease
across major economies. The US economy contracted by 3.5 per cent in 2020, marking an
abrupt halt to its expansion for more than a decade .
Notwithstanding steady decline in the unemployment rate from a record level of April 2020,
labour market conditions remain weak and fragile with employment well below the Federal
Reserve's (Fed's) goal of full employment. Incoming data for 2021 suggest some stabilisation
– retail sales picked up sharply in January before moderating in February on severe winter
weather, and the Institute for Supply Management (ISM)’s manufacturing purchasing
managers' index (PMI) in March posted its strongest expansion since December 1983.
US$1.9 trillion fiscal stimulus by the new administration has boosted prospects for the US
economy.

QUATERLY PROJECTION POLICY

The Quarterly Projection Model (QPM) in the RBI’s Forecast and Policy Analysis System
(FPAS) is the workhorse model for generating medium term projections and undertaking
policy scenario analysis, consistent with the central bank’s mandate under the flexible
inflation targeting (FIT) framework (Benes et al., 2016).
The QPM is a forward looking, open economy, calibrated, new-Keynesian gap model, and
incorporates specific characteristics of the Indian economy.
With a view to enriching the model’s analytics and to capture monetary-fiscal-external-real
sector interactions more comprehensively, the model structure has been expanded and the
parameters of the QPM recalibrated, taking into account pre-COVID period data and latest
empirical findings. In terms of its structure, the augmented QPM model (QPM 2.0)
incorporates:
a) fiscal-monetary dynamics, disaggregated fuel pricing (oil price, exchange rate and
fuel taxes) and c) balance of payments and exchange rate interactions.
b) The fiscal block in QPM 2.0 decomposes the primary deficit into structural (cyclically
adjusted) and cyclical components, with shocks to the structural component impacting
inflation through aggregate demand and country risk premia.
The monetary policy stance affects the fiscal position through the interest rate channel
(Escolano, 2010).

The fuel block incorporates India’s complex system of pricing – items like petrol and diesel
are priced on the basis of international oil prices, exchange rate and fuel taxes (excise duty
and value added tax (VAT)); liquified petroleum gas (LPG) and kerosene prices are market
determined but with lagged pass-through; and prices of electricity are administered by state
governments.
The cost-push implications are also incorporated in the enhanced aggregate supply block.

Finally, the balance of payments module incorporates determinants of current and capital
accounts and their interaction with the exchange rate management, guided by the objective of
containing excess volatility in the foreign exchange market.
This recognises the costs associated with spurts in volatility in the exchange rate (e.g.,
balance-sheet effects, dynamic Dutch disease) due to sudden surges or reversals in capital
flows (Ghosh et al., 2016).
The model properties of these features can be best represented through impulse response
functions which trace out the impact on key macroeconomic variables in response to shocks.

First, an expansionary structural fiscal shock contributes to demand pressures and creates a
positive output gap. Increasing debt could contribute to depreciation of the currency through
elevated country risk premia.

The positive output gap and currency depreciation together lead to higher inflation,
warranting monetary policy action On the other hand, if the fiscal deficit shock is cyclical, it
has a modest impact on inflation.
Second, an increase in fuel taxes feeds into higher fuel prices and ex-food fuel inflation
through the cost-push channel.

Headline inflation goes up by 25 bps in response to a fuel tax increase of `10 per litre
Inflation expectations edge higher and remain entrenched, if tax reversals do not happen.

Demand conditions also remain subdued for a longer period. Finally, the impact of capital
flows depends, inter alia, on the RBI’s decision to intervene and sterilise. In case of a capital
outflow shock of one percentage point (of nominal GDP) and assuming the RBI intervenes
and sterilises 70 per cent of these capital outflows, the reserves will deplete by 0.7 percentage
points of nominal GDP.
The exchange rate will depreciate, inducing inflationary pressure In the case of no
intervention, the exchange rate depreciation will be relatively higher
A historical decomposition of the shocks suggests that the FIT framework helped in
anchoring inflation expectations during 2016-20 leading to lower headline as well as core
inflation.
The disinflation during the post-FIT period was also supported by favourable supply shocks,
both food and fuel, benign external factors and prudent fiscal policy
During 2019-20, liquidity conditions remained in surplus mode starting from June 2019.
The Reserve Bank employed multiple tools to manage both frictional and durable liquidity.
While liquidity amounting to `1.37 lakh crore was injected through variable rate repos of
maturities ranging from overnight to 16 days in addition to the regular 14-day repos, surplus
liquidity of `284.4 lakh crore was absorbed through reverse repos of maturities ranging from
overnight to 63 days during 2019-20.
The Reserve Bank also injected durable liquidity of `1.1 lakh crore through purchase of
securities under OMOs during the year.

The Reserve Bank’s forex operations and drawdown of Government of India (GoI) cash
balances were the main drivers of liquidity expansion, which more than offset the leakage of
liquidity due to currency demand during 2019- 20.

The surplus liquidity was mopped up through reverse repos of varying maturities under the
LAF. With capital inflows gaining momentum during the second half of the year (except in
the latter half of March), forex operations largely mirrored net LAF positions In the first two
months of 2019-20,

i.e., April and May 2019, liquidity conditions were in deficit on account of restrained
government spending on the back of the model code of conduct in the run up to the general
election and high demand for cash.

The Reserve Bank conducted a USD/INR buy/sell swap auction of US$ 5 billion (`34,874
crore) for a tenor of 3 years in April and two OMO purchase auctions in May amounting to
`25,000 crore to inject durable liquidity into the system. It also injected liquidity of `51,403
crore on a daily net average basis under the LAF during these two months.
The situation changed in June – along with the shift in policy stance to accommodative –
when liquidity conditions turned into surplus due to increased spending after the government
formation at the Centre, net forex purchases by the Reserve Bank and return of currency to
the banking system post-elections.
The Reserve Bank also conducted two OMO purchase auctions amounting to `27,500 crore
during the month (Chart III.2). Surplus liquidity of `51,710 crore (on a daily net average
basis) was absorbed under the LAF in June.

Surplus liquidity conditions

built up during 2019-20 mainly on account of

(i) drawdown of GoI cash balances.
(ii) return of currency to the banking system; and
(iii) the Reserve Bank’s net forex purchase operations, especially in September 2019.
The absorption of liquidity on a daily net average basis under the LAF soared to
`1.31 lakh crore during in contrast to a net injection of `17,409 crore in Q1:2019-
20. Simultaneously, transient liquidity needs were met through variable rate repos
of smaller tenors (1-3 days) in addition to the regular 14-day term repos.
(iv) With the persistence of surplus liquidity conditions, the average daily net liquidity.
absorption under the LAF increased to `2.33 lakh crore in 2019-20.
Expecting the continuance of surplus liquidity, the Reserve Bank conducted four longer
term reverse repo auctions in November – two of 21 days and one each of 42 days and 35
days tenor – thereby absorbing `78,934 crore. Forex operations coupled with the
drawdown of GoI cash balances increased systemic liquidity.
The Reserve Bank also conducted four simultaneous purchase and sale of securities under
OMOs (special OMOs) between December 23, 2019 and January 23, 2020, which
augmented net banking system liquidity by `11,724 crore.
With a view to reinforcing monetary transmission and augmenting credit flows to
productive sectors, the Reserve Bank conducted five LTROs at fixed repo rate (one of
one year and four of three years tenors) between February 17 and March 18, 2020,
providing banks with durable liquidity of `1.25 lakh crore at reasonable cost relative to
prevailing market rates.
With the government continuing to rely on ways and means advances/overdraft
(WMA/OD) almost entirely during the quarter, average absorption of surplus liquidity
further increased to `3.06 lakh crore in 2019-20.

Net average absorption of surplus liquidity further soared to `4.72 lakh crore in 2020-21,
reflecting several liquidity augmenting measures and sustained government spending
through higher average recourse to WMA/OD (of `0.61 lakh crore) during this period.
Following the declaration of COVID-19 as a pandemic by the World Health Organisation
(WHO) on March 11, global financial markets were gripped by bearish sentiments.
Heightened global turbulence resulted in a significant tightening of financial conditions in
domestic financial markets beginning March 11, 2020.

The Reserve Bank undertook several conventional and unconventional measures in

March to unfreeze financial market activity and revitalise financial institutions to function
normally in the face of COVID-19 related dislocations. These measures, inter alia,
included:
(i) two 6-month USD/INR sell/buy swap auctions on March 16 and March 23, 2020
to meet the increased demand for US dollars, which cumulatively provided dollar
liquidity of US $ 2.7 billion; (ii) three OMO purchases on March 20, 24 and 26,
2020 to inject `40,000 crore cumulatively.
(ii) announcement of TLTRO auctions of up to three years’ tenor of appropriate sizes
for a total amount of up to `1 lakh crore on March 27, 2020 for investment in
corporate bonds, commercial paper, and non-convertible debentures
(iii) reduction in the CRR requirement of banks by 100 bps – from 4.0 per cent of net
demand and time liabilities (NDTL) to 3.0 per cent – effective fortnight beginning
March 28, 2020, for a period of one year ending March 26, 2021, augmenting
primary liquidity in the banking system by about `1.37 lakh crore; and
(iv) raising banks’ limit for borrowing overnight under the MSF by dipping into their
Statutory Liquidity Ratio (SLR) to 3 per cent of NDTL from 2 per cent (effective
up to June 30, 2020 and subsequently extended up to September 30, 2020),
allowing the banking system to avail an additional `1,37,000 crore of liquidity.
(v) In order to maintain adequate liquidity in the system and its constituents in the
face of COVID-19 related dislocations, facilitate and incentivise bank credit
flows, ease financial stress and enable the normal functioning of markets, the
Reserve Bank took further liquidity injection measures on April 17, 2020 targeted
at specific sectors and entities. These included:
(vi) TLTRO 2.0 auctions for an initial aggregate amount of `50,000 crore in tranches
of appropriate sizes,6 with funds to be invested in investment grade bonds,
commercial paper, and non-convertible debentures of non-banking financial
companies (NBFCs), with at least 50 per cent of the total amount availed going to
small and mid-sized NBFCs and micro finance institutions (MFIs);
(vii) special refinance facilities for a total amount of `50,000 crore at the policy repo
rate to the National Bank for Agriculture and Rural Development (NABARD), the
Small Industries Development Bank of India (SIDBI) and the National Housing
Bank (NHB).

The inter se allocation of funds was `25,000 crore to NABARD for refinancing regional
rural banks (RRBs), cooperative banks and MFIs; `15,000 crore to SIDBI for on-
lending/refinancing; and `10,000 crore to NHB for supporting housing finance companies
(HFCs). Furthermore, the Reserve Bank announced a special liquidity facility for mutual
funds (SLF-MF) of `50,000 crore on April 27, 2020 to alleviate intensified liquidity
pressures faced by them. Banks availed `2,430 crore under this facility.

In order to enable Export-Import Bank of India (EXIM Bank) to meet its foreign currency
resource requirements, the Reserve Bank extended a line of credit of `15,000 crore to the
EXIM Bank on May 22, 2020 for a period of 90 days (with rollover up to one year) so as
to enable it to avail a US dollar swap facility.

Following the monetary and liquidity measures announced on March 27, April 17 and
May 22, 2020, financial conditions eased as reflected in the variation in spreads on money
and bond market instruments .
Corporate bond market activity revived, with several corporates making new issuances.
Overall, the Reserve Bank’s various operations (including forex purchases, OMOs,
 LTROs and TLTROs) injected durable liquidity of `5.76 lakh crore in 2019-20 and `3.09
lakh crore in Q1:2020-21

Given surplus liquidity conditions, finetuning operations through variable rate reverse
repo auctions with maturities ranging from overnight to 3 days were extensively used for
absorbing liquidity till February 14, 2020. As a pre-emptive measure to tide over any
frictional liquidity requirements caused by dislocations due to COVID-19, three fine-
tuning variable rate repo auctions of 12-16 days maturity were conducted on March 23,
March 24, and March 26, 2020, injecting `89,517 crore

As a special case, SPDs were allowed to participate in these auctions along with other
eligible participants. Furthermore, the Reserve Bank temporarily enhanced liquidity
available to SPDs under the Standing Liquidity Facility (SLF) from `2,800 crore to
`10,000 crore in order to facilitate their year-end liquidity management.

Operating Target and Policy Rate

An operating target is a specific number, for an interest rate or another financial metric, that a
central bank sets in order to guide its monetary policy.
Once the operating target is set, the central bank executes its policies, which are designed to
loosen or tighten the supply of money in the economy in order to achieve and maintain the
target.

The operating procedure of monetary policy1 revolves around the implementation of

monetary policy decisions –
“The plumbing in its architecture” (Patra et al., 2016). As enjoined by the RBI Act, the
decision of the MPC on the policy rate has to be operationalised by the RBI so that it alters
the spending behaviour of economic agents and, in turn, achieves the RBI’s mandate on
inflation and growth. Since monetary policy is characterised by “inside” and “outside” lags in
policy formulation and implementation,2 the challenge for an efficient operating procedure is
to
(i) Minimise the transmission lag from changes in the policy rate to the operating
target – a variable that can be controlled by monetary policy actions – rapidly and
efficiently; and
(ii) Ensure that changes in the operating target are transmitted as fully as feasible
across the interest rate term structure in the economy. In pursuit of the legislative
mandate, details of the changes in operating procedure and their rationale are
presented in the bi-annual Monetary Policy Reports.
The weighted average call rate (WACR) – which represents the unsecured segment of the
overnight money market and is best reflective of systemic liquidity mismatches at the margin
– was explicitly chosen as the operating target of monetary policy in India.

An interest rate corridor – the liquidity adjustment facility (LAF) – has been defined since
May 2011 by the interest rate on the marginal standing facility (MSF) as the upper bound
(ceiling), the fixed overnight reverse repo rate as the lower bound (floor) and the policy
reporate in between (RBI, 2011).
The LAF corridor effectively defines the operating procedure of monetary policy. Once the
policy repo rate is announced, liquidity operations are conducted to keep the WACR closely
aligned to the repo rate. While the operating target and the LAF corridor framework have
remained unchanged during the FIT period, several refinements have been introduced
regarding
(i) The width of the corridor;
(ii) The choice of liquidity management instruments; and (iii) finetuning
regular/durable market operations, all intended to anchor the term structure of
interest rates to the policy repo rate in order to strengthen transmission.

During 2019-20, the WACR – the operating target – remained within the corridor with a
downward bias (9 bps below the repo rate on an average basis), reflecting sustained
surplus liquidity

The WACR spiked in the typical financial year-end phenomenon, accentuated by reduced
market participation because of the COVID-19 induced nation-wide lockdown. With the
LAF corridor becoming asymmetric and with the persistence of surplus liquidity, the
WACR continued to trade below the repo rate in Monetary Policy Transmission
Monetary transmission – changes in banks’ deposit and lending rates in response to the
changes in the policy repo rate – improved during 2019-20, especially in the second half
of the year
This was catalysed by the mandated linking of the interest rates on new loans to certain
sectors such as personal and MSE loans, effective October 2019, to an external
benchmark, viz., the policy repo rate, 3-month, 6-month T-bill rates or any other
benchmark published by Financial Benchmark India Pvt. Ltd. (FBIL).

Monetary policy transmission constitutes a ‘black box’ (Bernanke and Gertler, 1995). Several
channels of transmission have been identified in the literature and the cross-country
experience:
 (i) The credit or bank lending channel, which assumes importance in a bank-
dominated financial system such as India’s;
(ii) The exchange rate channel operating through relative prices of tradables and
non-tradables;
(iii) The asset price channel impacting wealth/income accruing from holdings of
financial assets; and
(iv) the expectations channel encapsulating the perceptions of households and
businesses on the state of the economy and its outlook. These conduits of
transmission intertwine and operate in conjunction and are difficult to disentangle.
There is a loose consensus, however, in great measure associated with the
development and growing sophistication of financial markets, that the interest rate
channel is dominant (Bernanke and Blinder, 1992).
(v) Since the 2000s, this has provided the rationale for the choice of the operating
procedure in India. During FIT, this operating procedure has been reinforced by
practitioner innovations and communication strategies. In the process, trade-offs
have surfaced, which warrant careful evaluation in order to draw lessons for the
operationalisation of FIT in India, going forward.

Given this motivation, this chapter sets out to review the performance of the extant operating
framework and its efficacy. The rest of the Chapter is structured in the following manner
Section 2 presents the stylised facts of the operating procedure and the transmission
mechanism juxtaposed against the cross-country experience.

Section 3 addresses specific tensions stemming from the operating procedure and the
monetary transmission mechanism, some aspects of which engaged public discourse over the
past four years. This section also recommends steps needed to fine-tune the operating
procedure and facilitate better transmission. Finally, Section 4 concludes by laying out the
challenges lying ahead.

Some Stylised Facts

Refinements in the operating framework have been undertaken in response to the changing
macroeconomic and financial environment to sharpen the role of the repo rate as the single
policy rate, to establish the 14-day term repo as the main instrument for providing liquidity
over the reserve maintenance period and to enable a flexible framework that could shift
seamlessly from a deficit mode in consonance with a tightening stance to a surplus mode in
support of an accommodative stance (Table IV.1).
In February 2020, the culmination of these reforms was placed in the public domain with a
view to clearly communicating the objectives and the toolkit for liquidity management

During the period of FIT,4 liquidity management operations underwent severe stress on two
occasions. The first test came with the surplus liquidity glut post-demonetisation, which
prompted the RBI to impose an unprecedented incremental cash reserve ratio (CRR) of 100
per cent for one fortnight (RBI, 2017). The second shock is the outbreak of COVID-19 when
market seizure caused a collapse in trading activity, warranting the use of extraordinary
system-wide as well as targeted liquidity measures to restore normalcy (RBI, 2020).

Reforms in the Operating Framework

The New Operating Framework of Monetary Policy (May 2011) Revised Liquidity
Management Framework (September 2014) Modified Liquidity Framework (April 2016)
• Repo Rate - Single policy rate.
• Weighted average overnight call money rate (WACR) is the operating target.
• Corridor of +/- 100 bps around the Repo Rate.
• 100 bps above the repo rate for the Marginal Standing Facility (MSF) and 100 bps below
the repo rate for the reverse repo rate.
• Full accommodation of liquidity demand at the fixed repo rate, albeit with an indicative
comfort zone of +/-1 per cent of net demand and time liabilities (NDTL) of the banking
system.
• Transmission of the changes in Repo Rate through the WACR to the term structure of
interest rates.
• Access to assured liquidity of about 1 per cent of NDTL on an average
• Bank-wise overnight fixed rate repos of 0.25 per cent of NDTL, and the balance through
14-day variable rate term repos.
• More frequent auctions of 14-day term repos during a fortnight (every Tuesday and Friday
of a week).
• Introduction of variable rate fine-tuning repo/reverse repo auctions.
• The corridor around the Repo rate narrowed from +/- 100 bps to +/- 50 bps.
• Commitment to progressively lower the ex-ante system level liquidity deficit to a position
closer to neutrality in the medium run.
The salient features of the extant framework operationalized on February
14, 2020

The liquidity management corridor is retained and the weighted average call rate (WACR)
remains the operating target.
The width of the corridor was retained at 50 basis points (bps)6
14-day term repo/reverse repo operation at a variable rate and conducted to coincide with the
cash reserve ratio (CRR) maintenance cycle is the main liquidity management tool for
managing frictional liquidity requirements; the daily fixed rate repo and four 14- day term
repos conducted every fortnight earlier stand withdrawn.

The main liquidity operation is supported by fine-tuning operations, overnight and/or longer
tenor, to tide over any unanticipated liquidity changes during the reserve maintenance period;
if required, the RBI will conduct variable rate repo/reverse repo operations of more than 14
days tenor.
Liquidity management instruments include fixed and variable rate repo/reverse repo auctions,
outright open market operations (OMOs), forex swaps and other instruments.
The daily minimum CRR maintenance requirement is retained at 90 per cent7
Standalone Primary Dealers (SPDs) are allowed to participate directly in all overnight
liquidity management operations.
Transparency in communication is enhanced through (a) dissemination of both flow and
stock impact of liquidity operations; and (b) publication of a quantitative assessment of
durable liquidity conditions of the banking system with a fortnightly lag.
 CHAPTER 4
DATA ANALYSIS AND INTERPRETION
In the months following the publication of the October 2020 MPR, inflationary pressures got
accentuated and headline inflation1 remained above the upper tolerance threshold. Core
inflation also stayed sticky at elevated levels.
During December 2020-January 2021, however, there was a sharp correction and inflation
eased significantly, moving closer to the target, only to reverse to 5.0 per cent in February
2021, primarily due to adverse base effects.
Core inflation (CPI inflation excluding food and fuel) surged to a 28-month high of 6.0 per
cent in February 2021 under the combined effects of rising industrial raw material prices,
record high petroleum product prices and the higher cost of doing business in the post-
lockdown period (Chart II.1)
The Reserve Bank of India (RBI) Act enjoins the RBI to set out deviations of actual inflation
outcomes from projections, if any, and explain the underlying reasons thereof.
CPI excluding Food and Fuel CPI inflation excluding food and fuel, or core inflation,
remained sticky and hovered between 5.4 per cent and 6.0 per cent during September 2020 to
February 2021. Excluding petrol, diesel, gold and silver also, core inflation remained elevated
(between 4.5 per cent and 5.1 per cent) over this period (Chart II.13).
While the price build-up in the core categories was similar to the historical average,
considerable variation was observed across subgroups: transport and communication, pan,
tobacco and intoxicants, personal care and effects, health and recreation and amusement
exhibited .
Real GDP contracted by 8.0 per cent in 2020-21, according to the National Statistical
Office’s (NSO) second advance estimates (SAE), although some slack can be attributed to
on-budgeting of past subsidy payments in Q4 (Chart III.1a and Table III.1).
The recovery in 2020-21 was on the back of revival in government expenditure and fixed
investment and easing of the contraction in private consumption. Quarter-on-quarter
seasonally adjusted annualised (qoq-SAAR) growth rates, however, moderated in Q3 and Q4
suggesting some flattening of momentum (Chart III.1b).
Economic activity in India in 2020-21 turned out to be more resilient than anticipated in the
October 2020 MPR, supported by a significant decline in new COVID-19 infections from the
mid-September 2020 peak and the rollout of the vaccination drive from mid January 2021.
After the unprecedented contraction in real gross domestic product (GDP) recorded
sequential upturn and regained positive territory in with the ambit of the recovery
broadening to encompass a wider spectrum of sectors since then. On the supply side too, the
sustained resilience of agriculture and allied activities was complemented by manufacturing
and services sector activity gaining some momentum
GDP GROWTH

The October 2020 Monetary Policy Report (MPR) projected GDP growth at (-) 9.8 per cent
for 2020- 21, (-) 5.6 per cent and 0.5 per cent for Q4, with risks tilted to the downside.
Actual outcomes in terms of the NSO’s SAE overshot these projections by 250 and 600 basis
points in and , respectively (Chart III.2), which may be largely attributed to faster than
anticipated reduction in new COVID-19 infections in the country. The upside surprise is
largely stemmed from a better-than-expected performance in gross fixed capital formation.
Data for 2020-21 are expected on May 31, 2021.
With the global economy gradually emerging from one of its deepest recessions, India’s
exports surpassed the pre-pandemic level and entered the expansionary zone from December
2020.
Import’s contraction became softer in 2020-21 and eventually turned positive from
December 2020 after a gap of 9 months (Chart III.14).
The positive contribution of net external demand to y-o-y growth fell in with improvement in
imports outpacing exports. The contribution of net external demand to growth is estimated to
improve in According to data released by the Directorate General of Commercial Intelligence
and Statistics (DGCI&S), the pace of contraction in India’s merchandise exports, which
peaked in 020-21 due to the disruptions caused by the COVID-19, moderated .
on the back of a gradual recovery in global demand conditions. Merchandise exports
expanded for the third month in a row in February 2021
Non-oil exports rose by 3.1 per cent in and 7.5 per cent during January-February 2021 . At
the disaggregated level, drugs and pharmaceuticals, iron ore and agricultural products pushed
up non-oil export growth. Overall, during April-February 2020-21, merchandise exports
contracted by 12.2 per cent.
Gross value added (GVA) – the measure of aggregate supply – contracted by 6.5 per cent in
2020-21 as per the SAE released by the NSO.
GVA posted a growth of 1.8 per cent in H2:2020-21 in contrast to a downturn of 14.9 per
cent in H1:2020-21. The momentum in growth – Q-o-Q-SAAR – eased during Q3 and Q4
from Q2 (Chart III.18).
Agriculture and allied activities remained resilient during 2020-21, partially offsetting the
contraction in other components of GVA.
INDUSTRIAL SECTOR

Industrial sector GVA was driven by the manufacturing sector emerging out of contraction in
although in there has been some setback due to sharp retrenchment of production of capital
goods and consumer non-durables (Chart III.21).
In contrast, the mining sector continued to languish, throttled by supply bottlenecks. Crude
oil and natural gas production dropped due to lack of critical infrastructure and equipment,
and operational difficulties amidst the pandemic.
Natural gas production crossed the preCOVID levels in January 2021 following the start of
production in KG-D6 field, which bodes well for the outlook
The index of industrial production (IIP) emerged out of a prolonged contraction in September
2020 but it lost momentum again in November and January 2021
The improvement in manufacturing activity in was driven by basic metals, chemical and
chemical products, motor vehicles and electrical equipment.
LIQUIDITY POSITION

The money market remained largely stable during 2020-21, reflecting surplus liquidity
conditions.
The weighted average call rate (WACR) in the unsecured overnight money market eased and
slipped below the reverse repo rate, beginning the second half of October 2020 (Chart IV.1)
The negative spread of WACR relative to the reverse repo rate averaged 14 bps in
In the overnight call money segment, the weighted average rate (WAR) of traded deals
generally remained above the reverse repo rate while that of reported deals remained below .
The share of the reported deals in the total volume of the call money segment increased to 54
per cent in 2020-21 from 46 per cent in H1, thereby pulling down the WACR below the
reverse repo rate
CREDIT MARKET

Credit offtake improved with the momentum picking up beginning October and registering a
positive growth (financial year basis) since November.
Non-food credit by scheduled commercial banks (SCBs) rose by 6.4 per cent
( as on March 12) as compared with 6.1 per cent a year ago (Chart IV.16).
The percentage has decreased from October 19 and slowly it got deviated and it tend to be
negative till 2020 and the points also got decreased in march 2021
Domestic equities, however, witnessed cautious trading towards the end of the month due to
uncertainty surrounding the outcome of the US presidential elections.
In November, the BSE Sensex gained by 11.4 per cent, supported by FPI inflows, positive
developments on the vaccine and the Government’s approval of a `1.5 lakh crore production-
linked incentive (PLI) scheme for 10 manufacturing sectors. Equity markets extended their
gains in December 2020 amidst betterthan-expected GDP data for 2020-21
In January 2021, domestic markets surged on the back of upbeat corporate results for 2020-
21
and accelerated roll-out of COVID-19 vaccines. The benchmark index closed above 50000
for the first time on February 3, 2021 and scaled an all-time high of 52154 on February 15,
2021 riding on the budget euphoria.
Credit growth accelerated across all bank groups, especially public sector banks (PSBs)
(Chart IV.17a).
Of the incremental credit extended by SCBs on a y-o-y basis (March 12, 2021 over March 13,
2020), 53.8 per cent was provided by PSBs, 45.7 per cent by private sector banks and 0.5 per
cent by foreign banks (Chart IV.17b).
Among major sectors5 , credit to agriculture grew by 10.2 per cent (y-o-y) in February 2021
– the highest since April 2017 (Chart IV.18a).
Credit growth to the services sector also remained strong. Credit to the industrial sector,
however, contracted marginally by 0.2 per cent, mainly due to a decline in credit to large
industries (which account for more than 80 per cent of credit to the industrial sector)
On the positive side, credit to medium industries registered a robust growth of 21.0 per cent,
reflecting the measures taken by the Government of India and the RBI for enhancing credit
flows to the MSME sector.
Chapter 5
Summary,
Findings and
suggestions
TO NIRMALA SITARAMAN TO MONETARY POOLICY
IMPACTED THE BANK SLR CRR CHANGES
SUMMARY

Monetary management the monetary policy is a policy formulated by the central bank, i.e.,
RBI (Reserve Bank of India) and relates to the monetary matters of the country. The policy
involves measures taken to regulate the supply of money, availability, and cost of credit in
the economy.
The policy also oversees distribution of credit among users as well as the borrowing and
lending rates of interest. In a developing country like India, the monetary policy is significant
in the promotion of economic growth.
In the policy it is stated the different things which are mentioned in the monetary policy as in
the covid situation there it a has loss to the economy as result there is a massive change Price
stability
Where here there is the summary what exactly has been made in this monetary management

Price stability implies promoting economic development with considerable emphasis on price
stability. The centre of focus is to facilitate the environment which is favourable to the
architecture that enables the developmental projects to run swiftly while also maintaining
reasonable price stability. And here they tried to control it

Monetary policy is a set of tools that a nation's central bank has available to promote sustainable
economic growth by controlling the overall supply of money that is available to the nation's
banks, its consumers, and its businesses.

The goal is to keep the economy humming along at a rate that is neither too hot nor too cold.
The central bank may force up interest rates on borrowing in order to discourage spending or
force down interest rates to inspire more borrowing and spending.
The main weapon at its disposal is the nation's money. The central bank sets the rates it charges
to loan money to the nation's banks. When it raises or lowers its rates, all financial institutions
tweak the rates they charge all their customers, from big businesses borrowing for major
projects to home buyers applying for mortgages.
All of those customers are rate- sensitive. They're more likely to borrow when rates are low
and put off borrowing when rates are high.
By managing the money supply, a central bank aims to influence macroeconomic factors
including inflation, the rate of consumption, economic growth, and overall liquidity.

In addition to modifying the interest rate, a central bank may buy or sell government bonds,
regulate foreign exchange (forex) rates, and revise the amount of cash that the banks are
required to maintain as reserves.
Economists, analysts, and investors eagerly await monetary policy decisions and even the
minutes of meetings in which they are discussed. This is news that has a long-lasting impact
on the overall economy as well as on specific industry sectors and markets.

Controlled expansion of bank credit

One of the important functions of RBI is the controlled expansion of bank credit and money
supply with special attention to seasonal requirement for credit without affecting the output.in
the covid situation where there is no controlled bank credit and hence the management also
tried to resolve the issue
Promotion of fixed investment
The aim here is to increase the productivity of investment by restraining non essential fixed
investment.
Restriction of inventories and stocks
Overfilling of stocks and products becoming outdated due to excess of stock often results in
sickness of the unit. To avoid this problem, the central monetary authority carries out this
essential function of restricting the inventories. The main objective of this policy is to avoid
over-stocking and idle money in the organisation.
There has been a drastic change in food and other commodities where the inflation has also,
raised and there is no scope of improvement due to covid 19 as the huge amount of the
money has been paid for vaccines whereas the Gross domestic product has decreased
There has been a major impact on the cash reserves and the statutory liquid ratio etc .
The banking sector is the lifeline of any modern economy. It is one of the important financial
pillars of the financial sector, which plays a vital role in the functioning of an economy.
It is very important for economic development of a country that its financing requirements of
trade, industry and agriculture are met with higher degree of commitment and responsibility.
Thus, the development of a country is integrally linked with the development of banking. In a
modern economy, banks are to be considered not as dealers in money but as the leaders of
development. They play an important role in the mobilization of deposits and disbursement of
credit to various sectors of the economy.

The banking system reflects the economic health of the country. The strength of an economy
depends on the strength and efficiency of the financial system, which in turn depends on a
sound and solvent banking system.

A sound banking system efficiently mobilized savings in productive sectors and a solvent
banking system ensures that the bank is capable of meeting its obligation to the depositors.
However, for the year 2020-21, real GDP growth was expected to be negative. On inflation,
though the release of June CPI was still not normalised in terms of data coverage, headline
inflation ruled above the upper tolerance threshold of 6 per cent.
Issues in data reliability, coupled with high retail mark-ups amidst the pandemic added
uncertainty to the inflation outlook. Accordingly, the MPC decided to pause and remain
watchful for a durable reduction in inflation to use the available space to support the revival
of the economy.
The October 2020 policy2 was held in a setting in which high frequency indicators suggested
recovery of economic activity in 2020-21, after a record contraction in real GDP in 2020-21.
Headline CPI inflation continued to remain above the upper tolerance threshold as price
pressures accentuated across food, fuel, and core sub-groups due to supply disruptions, high
retail margins, high indirect taxes on petroleum products and higher cost of doing business in
the post-lockdown period.
The rebound from the COVID-19 induced slump has been sharper than anticipated and
economic activity is expected to rebound strongly in 2021-22. Headline consumer price index
(CPI) inflation receded into the tolerance band beginning December 2020. Core inflation
pressures remain elevated, reflecting pass-through from higher crude oil and non-oil
commodity prices, high fuel and other taxes post-COVID and increased operating costs.
The evolving COVID-19 trajectory and progress on vaccination remain the key drivers of
economic activity and inflation, globally and in India
Section 45-ZA of the RBI Act, 1934 requires that the Central Government shall, in
consultation with the Reserve Bank of India (RBI), determine the inflation target in terms of
consumer price index (CPI), once in every five years. Accordingly, in a notification on March
31, 2021,
In 2020-21, global financial markets remained largely buoyant, fuelled by optimism around a
speedy vaccine-led recovery. Growing inflation concerns over fiscal stimulus amidst
extremely accommodative monetary policies rattled global bond markets in February 2021.
Long-term sovereign bond yields jumped sharply in the US and induced bouts of volatility
across financial markets and regions of the world.
The consequent yield curve steepening resulted in portfolio reallocation and corrections in
equity prices.
Despite the recent declines, stock indices remain elevated on anticipation of stronger
recovery. In the currency markets, the US dollar appreciated in the first quarter of 2021
driven by rising bond yields while EME currencies faced depreciation pressures from bouts
of capital outflows.
Findings

1 Monetary policy and liquidity operations during 2020-21 were geared towards mitigating the
adverse impact of the unprecedented economic devastation brought by the COVID-19
pandemic on the Indian economy.

2. Supply disruptions imposed persistent upside price pressures, with inflation ruling above the
upper tolerance band for six consecutive months during June-November 2020.

3. The monetary policy committee maintained status quo on the policy repo rate during June
2020 to February 2021 after a sizeable cut of 115 basis points (bps) during March-May 2020.
Given the growth-inflation dynamics, the MPC decided to continue with the accommodative
stance as long as necessary to revive growth on a durable basis and mitigate the impact of
COVID-19 on the economy, while ensuring that inflation remains within the target going
forward.

4. These decisions were in consonance with the objective of achieving the medium-term target
for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while
supporting growth.

5. During 2020-21, the Reserve Bank undertook several conventional and unconventional
measures to address liquidity constraints in the face of COVID-19 related dislocations

6. Surplus liquidity conditions, coupled with the external benchmark-based pricing of floating
rate loans, led to a considerable improvement in monetary transmission during 2020-21.

7. Interest rates on outstanding loans declined for a majority of the sectors. The external
benchmark-linked framework incentivised banks to adjust their term as well as saving deposit
rates to protect their net interest margins, thereby improving monetary transmission.

8. 2020-21, real GDP growth was expected to be negative. On inflation, though the release of
June CPI was still not normalised in terms of data coverage, headline inflation ruled above the
upper tolerance threshold of 6 per cent. Issues in data reliability, coupled with high retail mark-
ups amidst the pandemic added uncertainty to the inflation outlook.

Accordingly, the MPC decided to pause and remain watchful for a durable reduction in
inflation to use the available space to support the revival of the economy.

9. There is an instensive changes in liquidity positions in the pandemic as the results went
into negative
Suggestions
The operations in financial system should be sufficiently transparent, both facilitate a proper
Empirical understanding of the functioning of the system its feature and evolution promote t
Efficiency of the system given in the value of the high quality and accurate information
For its functioning. The undertaking analysis is obviously a critical element to understanding
Of the financial system this analysis should not only on operation of the financial system and
its broader international linkages. A number of the analytical methods may be employed for
understanding the financial statements.
a) The functioning of the financial system and its broader macroeconomic and global
linkages should be well understood, as should the products, services, institutions, systems,
and markets have connected with the financial system.
b) Surveillance tools and mechanisms should be established to ensure a comprehensive, on-
going monitoring of domestic and international financial system developments,
macroeconomic trends, and emerging risks.
c) Market failure analysis should be conducted to assess the efficiency of the financial
system and, in particular, understand the risks to which the financial system and related
participants may be susceptible. The potentially global and dynamic nature of these risks
should be considered as part of this analysis.
d) Governmental authorities should have the requisite expertise and resources to conduct
appropriate surveillance and analysis on a timely basis and formulate sound policy and
regulation.
e) Given the complexity and rapid evolution of the financial system, the international nature
of the financial system and global macroeconomic linkages, and the related challenges
associated with effective surveillance and analysis, there should be continuous:
i) information-sharing within and across jurisdictions, through formal and informal channels,
subject to professional secrecy standards applicable to governmental authorities in the context
of any exchange of confidential information
ii) collaborative analysis and discussion of the financial system and related developments,
risks, and possible contagion channels, domestically and internationally
iii) research and analysis, conducted at the domestic and international level, and effective
mechanisms to promote such collaboration and information-sharing.
1. Lower the short-term interest rates
The adjustments to short-term interest rates are the main monetary policy tool for a central
bank. Commercial banks can usually take out short-term loans from the central bank to meet
their liquidity shortages. In return for the loans, the central bank charges a short-term interest
rate. By decreasing the short-term interest rates, the central bank reduces the cost of
borrowing to commercial banks.
Subsequently, the banks lower the interest rates they charge their consumers for loans.
Therefore, whenever the central bank lowers interest rates, the money supply in the economy
increases.
2. Reduce the reserve requirements
Commercial banks are obliged to hold a minimum amount of reserves with a central bank. In
order to increase the money supply, the central bank may reduce reserve requirements. In
such a case, commercial banks would have extra funds to be lent out to their clients.

3. Expand open market operations (buy securities)

The central bank may also use open market operations with government-issued securities to
affect the money supply in the economy. It may decide to buy large amounts of the
government-issued securities (e.g., government bonds) from institutional investors to inject
additional cash into the domestic economy.
Bibliography
Rakesh Mohan & Partha Ray (2018), Indian Monetary Policy in the Time of Inflation
Targeting and Demonetisation, Brookings India.
•https://en.wikipedia.org/wiki/Monetary_policy_of_India#cite_note-16
•https://www.bankbazaar.com/finance-tools/emi-calculator/monetary-policy.html
•http://planningcommission.nic.in/plans/planrel/fiveyr/11th/11_v1/11th_vol1.pdf
•https://en.wikipedia.org/wiki/Five-Year_Plans_of_India
http://mospi.nic.in/sites/default/files/Statistical_year_book_india_chapters/Five%20Year%20
Plan%20write up_0.pdf
Annexure
Page 87 and 89