1. Changes in monetary policy post 2007
RBI Annual Monetary Policy 2010-11
Repo rate and Reverse repo rate increased by 25 bps to 5.25% and 3.75% respectively, with
immediate effect. Impact: Repo is the rate at which banks borrow from RBI and Reverse Repo is the
rate at which banks deploy their surplus funds with RBI. Both these rates are used by financial
system for overnight lending and borrowing purposes. An increase in these policy rates imply
borrowing and lending costs for banks would increase and this should lead to overall increase in
interest rates like credit, deposit etc. The higher interest rates will in turn lead to lower demand
and thereby lower inflation. The move was in line with market expectations
Cash reserve ratio (CRR) increased by 25 bps to 6.00%, to apply from fortnight beginning from 24
April 2010. Impact: When banks raise demand and time deposits, they are required to keep a
certain percent with RBI. This percent is called CRR. An increase in CRR implies banks would be
required to keep higher percentage of fresh deposits with RBI. This will lead to lower liquidity in the
system. Higher liquidity leads to asset price inflation and also leads to build up of inflationary
expectations. Before the policy, market participants were divided over CRR. Some felt CRR should
not be raised as liquidity would be needed to manage the government borrowing program, 3-G
auctions and credit growth. Others felt CRR should be increased to check excess liquidity into the
system which was feeding into asset price inflation and general inflationary expectations. Some in
the second group even advocated a 50 bps hike in CRR.
By increasing the rate by 25 bps, RBI has signalled that though it wants to tighten liquidity it also
wants to keep ample liquidity to meet the outflows. Governor’s statement added that in 2010-11,
despite lower budgeted borrowings, fresh issuance will be around Rs 342300 cr compared to Rs
251000 cr last year.
RBI’s Domestic Outlook for 2010-11
Table 1: RBI’s Indicative Projections (All Fig In %, YoY)
2009-10 targets 2009-10
2010-11 targets
(Jan 10 Policy) Actual Numbers (Apr 10 Policy)
GDP
7.5
Expected at 7.2 8 with an upward
by CSO
bias
Inflation (based on WPI, 8.5
9.9
5.5
for March end)
Money Supply (March 16.5
17.3
17
end)
Credit (March end)
16
17
20
Deposit (March end)
17
17.1
18
Source: RBI
Growth: RBI revised its growth forecast upwards for 2010-11 at 8% with an upward bias compared
to 2009-10 figure of 7.5%. It said “Indian economy is firmly on the recovery path.” RBI’s business
outlook survey shows corporate are optimistic over the business environment. Growth in industrial
sector and services has picked up in second half of 2009-10 and is expected to continue. The
exports and import sector has also registered a strong growth. It is important to note that RBI has
placed the growth under the assumption of a normal monsoon. India could have achieved a near

2. 8% growth in 2009-10 itself, if monsoons were better. Table 2 looks at growth forecasts of Indian
economy for 2010-11 by various agencies
Table 2:Projections of GDP Growth by various agencies for 2010-11 (in %,
YoY)
2009-10
2010-11
RBI
7.5 with an upward 8 with an upward bias
bias
PM’s Economic Advisory Council 7.2
8.2
Ministry of Finance
7.2
8.5 (+/- 0.25)
IMF
6.7
8
Asian Development Bank
7.2
8.2
OECD
6.1
7.3
RBI’s Survey of Professional 7.2
8.5
Forecasters
Inflation: RBI’s inflation projection for March – 11 is at 5.5% compared to FY March-10 estimate of
8.5% with an upward bias (the final figure was at 9.9%). RBI said inflation is no longer driven by
supply side factors alone. First WPI non-food manufactured products (weight: 52.2 per cent)
inflation, increased sharply from (-) 0.4%in November 2009, to 4.7% in March 2010. Fuel price
inflation also surged from (-) 0.7 per cent in November 2009 to 12.7% in March 2010. Further,
contribution of non-food items to overall WPI inflation, which was negative at (-) 0.4% in November
2009 rose sharply to 53.3% by March 2010. So, overall demand pressures on inflation are also
beginning to show signs. These movements were visible in March 2010 itself, pushing RBI to increase
rates before the official policy in April 2010.
Monetary Aggregates: RBI has increased the projections of all three monetary aggregates for
2010-11. These projections have been made consistent with higher expected growth in 2010-11.
Higher growth will lead to more demand for credit. Then management of government borrowing
program will remain a challenge as well. High growth coupled with the borrowing program will
need higher financial resources. Therefore, projections for money supply, credit and deposit are
raised to 17%, 20% and 18% respectively. However, higher growth in money supply would also lead
to build up of higher inflation and inflationary expectations.
Growth in M3 is higher than M1 between April-November 2009. From Dec-2009 onwards, the
growth rate in M1 is higher than M3. The difference in M1 and M3 comes from the growth rate in
time and demand deposits. Growth in Time deposits is higher than demand deposits between AprilNovember 2009. From December 2009, onwards growth in demand deposits picks up. This in turn
reflects in differences in growth rate of M1 and M3. The growth rate in currency is volatile. It
declines 15% in August 2009 and then again increases to 17.9% in December 2009. It then declines
to 15.6% in March 2010. Hence, the difference between M1 and M3 comes from surge in growth of
demand deposits and decline in growth of time deposits.
This could be interpreted in two ways. First, spending on consumption and production is increasing
as economy has recovered from recession. Second, it could be people are spending now as they
expect higher inflation in future. Higher inflation in future could also lead to higher returns on
assets and property in future; therefore people prefer to spend now.
It will be interesting to watch trends in M1 and M3 from now on as well.
RBI also outlined downside risks with its projections:

3. First, there is still substantial uncertainty about the pace and shape of global recovery
Second, if the global recovery does gain momentum, commodity and energy prices, which have
been on the rise during the last one year, may harden further. This could put upwards pressure on
inflation
Third, monsoon will continue to play a vital role both from domestic demand and inflation
perspective.
Fourth, policies in advanced economies are likely to remain highly expansionary. High liquidity in
global markets coupled with higher growth in emerging economies foreign capital flows are
expected to remain higher. This will put pressure on exchange rate policy. RBI usually does not
comment on its exchange rate policy. As the economic situation is exceptional, RBI also
commented on India’s exchange rate policy.
Policy Stance
The policy stance remains unchanged from January 2010 policy.
Table 3: Comparing RBI’s Policy Stance
October 2009 Policy
January 2010 Policy
April 2010 Policy
Watch inflation trend and be Anchor inflation expectations,
prepared to respond swiftly while being prepared to
respond appropriately, swiftly
and effectively
Monitor liquidity to meet and effectively to further
of
inflationary
credit demands of productive build-up
sectors while securing price pressures.
Anchor inflation expectations,
while being prepared to
respond appropriately, swiftly
and effectively to further
build-up
of
inflationary
pressures.
Actively manage liquidity to
ensure that the growth in
demand for credit by both the
private and public sectors is
satisfied in a non-disruptive
way.
Actively manage liquidity to
ensure that the growth in
demand for credit by both the
private and public sectors is
satisfied in a non-disruptive
way.
and financial stability
Maintain
monetary
and
interest rate regime consistent
with price and financial
stability, and supportive of the
growth process
Maintain an interest rate Maintain an interest rate
regime consistent with price, regime consistent with price,
output and financial stability.
output and financial stability.
Summary: Given the economic outlook, policy ahead is going to remain challenging. There are
many trade-offs RBI has to manage. It needs to manage high inflation without impacting the
growth process. The recent inflation numbers show rising demand side pressures on inflation. The
market participants are already looking at an increase of around 100-150 bps by March 2011 end.
The higher interest rates would make it difficult to manage the government borrowing program
and also invite more capital flows. High interest rates could also lead to higher lending costs for the
corporate sector. The challenges are not limited to domestic factors alone. The concerns remain on
future outlook of advanced economies which complicates the policy process further.
DEVELOPMENTS IN THE MONETARY POLICY ARENA:
The outflow of foreign exchange, as a fall out of the crisis, also meant tightening of liquidity situation
in the economy. To deal with the liquidity crunch and the virtual freezing of international credit, the
monetary stance underwent an abrupt change in the second half of 2008/09. The RBI responded to

4. the emergent situation by facilitating monetary expansion through decreases in the CRR, RR and RRR rates, and the statutory liquidity ratio (SLR).
The RR was reduced by 400 basis points in five tranches from 9.0 in August 2008 to 5.0 percent
beginning March 5, 2009. The R-RR was lowered by 250 basis points in three tranches from 6.0 (as
was prevalent in November 2008) to 3.5 percent from March 5, 2009. The R-RR and RRs were again
reduced by 25 basis points each with effect from April, 2009. SLR was lowered by 100 basis points
from 25 percent of net demand and time liabilities (NDTL) to 24 percent with effect from the
fortnight beginning November 2008. The CRR was lowered by 400 basis points in four tranches
from 9.0 to 5.0 percent with effect from January 2009.
10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
Repo rate
Reverse repo rate
Dec-06
Apr-07
Aug-07
Dec-07
Apr-08
Aug-08
Dec-08
Apr-09
Aug-09
Mar-10
Jul-10
Nov-10
Cash-reserve ratio
It decided to retain the repo rate at 6.25 per cent and the reverse repo rate at 5.25 per cent under
its Liquidity Adjustment Facility (LAF). It also retained the Cash Reserve Ratio (CRR) at 6 per cent of
net demand and time liabilities (NDTL) of scheduled banks as per 2010 annual report.
Economic Recovery:
From all accounts, except for the agricultural sector as noted above, economic recovery seems to be
well underway. Economic growth stood at 7 percent during the first half of the current fiscal year
and the advance estimates for GDP growth for 2009-10 is 7.2 percent. The recovery in GDP growth
for 2009-10, as indicated in the advance estimates, is broad based. Seven out of eight sectors/subsectors show a growth rate of 6.5 percent or higher. The exception, as of April 2010 9 anticipated, is
agriculture and allied sectors where the growth rate is estimated to be minus 0.2 percent over 2008
09. Sectors including mining and quarrying; manufacturing; and electricity, gas and water supply
have significantly improved their growth rates at over 8 percent in comparison with 2008-09. When
compared to countries across the world, India stands out as one of the best performing economies.
Although there is a clear moderation in growth from 9 percent levels to 7+ percent, the pace still
makes India the fastest growing major economy after the People’s Republic of China.
In order for India’s growth to be much more inclusive than what it has been, much higher level of
public spending is needed in sectors, such as health and education along with the implementation of
sectarian reforms so as to ensure timely and efficient service delivery. Plan allocations for 2010-11
for the social sectors have been stepped up, as can be seen from the figures below, this process
however needs to be strengthened and sustained over time.
Inclusive Development:
• The spending on social sector has been increased to Rs.137,674 crore (US$ 30 billion) in
2010-11, which is 37 percent of the total plan outlay in 2010-11.

5. • Another 25 percent of the plan allocations are devoted to the development of rural infrastructure.
Education
• Plan allocation for school education increased by 16 percent from Rs.26,800 (US$ 6 billion) in
2009-10 to Rs.31,036 crore (US$ 7 billion) in 2010-11.
• In addition, States will have access to Rs.3,675 crore (US$ 792 million) for elementary education
under the Thirteenth Finance Commission grants for 2010-11.
Health
• Plan allocation to Ministry of Health & Family Welfare increased from Rs 19,534 crore (US$ 4
billion) in 2009-10 to Rs 22,300 crore (US$ 5 billion) for 2010-11.
As expected, the measures undertaken by government of India to counter the effects of the global
meltdown on the Indian economy have resulted in shortfall in revenues and substantial increases in
government expenditures, leading to deviation from the fiscal consolidation path mandated under
the Fiscal Responsibility and Budget Management (FRBM) Act.
INDUSTRY IN LINE WITH RBI MONETARY POLICY CHANGES
Industry today widely welcomed the changes introduced in the credit policy review, commending it
for pausing on rate hikes and injecting liquidity into the banking system by lowering the Statutory
Liquidity Ratio (SLR) by one percentage point. It said this will help short-term rates to cool down and
help maintain stability in the macroeconomic environment. The Reserve Bank of India (RBI) in its
policy review earlier in the day kept key interest rates on hold, but said inflation was significantly
above its comfort level.
However, the RBI brought down the SLR, or the minimum mandated amount of bonds that banks
need to keep as a percentage of deposits, to 24 per cent from 25 per cent.
It decided to retain the repo rate at 6.25 per cent and the reverse repo rate at 5.25 per cent under
its Liquidity Adjustment Facility (LAF). It also retained the Cash Reserve Ratio (CRR) at 6 per cent of
net demand and time liabilities (NDTL) of scheduled banks.