Trade policy review report by the secretariat

1.3  Monetary and Exchange Rate Policy

1. 
   The Reserve Bank of India (RBI) formulates, implements, and monitors monetary policy. On 20 February 2015, the Government signed an agreement with the RBI on a monetary policy framework, which is intended to meet the challenge of an increasingly complex economy.²² The main objective of monetary policy to be operated by the Reserve Bank will primarily be to maintain price stability while keeping in mind growth objectives. As per the agreement, the RBI will aim to bring inflation below 6% by January 2016 and the target for financial year 2016-17 and all subsequent years will be 4% with a band of +/- 2 percentage points. Inflation is the year-on-year change in the monthly Consumer Price Index – Combined expressed in percentage terms. The RBI is required to publish the operating target(s) and establish an operating procedure of monetary policy through which the operating target will be achieved so as to explain the deviation from the target band for three consecutive quarters from 2016-17.
   
2. 
   The RBI has recently been focusing on containing inflation and tightening its monetary policy stance, although in 2015 this stance was slightly eased. In May 2011, following the change in policy stance to fix only one rate, the repo rate was increased to 7.25%.²³ The rate was then increased several times, to 8% on 28 January 2014. On 15 January 2015, the rate was lowered by 0.25 percentage point to 7.75%, and on 4 March 2015 it was brought down by 25 basis points to 7.5%. In the Sixth Bi-Monthly Monetary Policy statement of 2014-15 issued on 3 February 2015, the statutory liquidity ratio (SLR) of scheduled commercial banks was lowered by 0.5 percentage points from 22% to 21.5% of their net time deposit liabilities (NDTL) with effect from 7 February 2015. In addition, export credit refinance was withdrawn and replaced with system level liquidity.²⁴
   
3. 
   Regarding other monetary policy measures, banks were required, inter alia, to meet at least 99% of the cash reserve ratio (CRR) on a daily basis, and limit the provision of liquidity under the Liquidity Adjustment Facility (LAF) to 0.5% of the bank's own NDTL; the statutory liquidity ratio (SLR) of scheduled commercial banks was lowered by 0.5 percentage points from 22% to 21.5% of their NDTL in February 2015.²⁵
   
4. 
   Reforms in India's monetary policy are gradually being adopted in accordance with an RBI expert committee's recommendation in January 2014²⁶, such as the adoption of the CPI, instead of the wholesale price index (WPI)²⁷, as the key measure of inflation, and making a transition from a quarterly to a bi-monthly monetary policy cycle since April 2014.
   
5. 
   India's exchange rate is classified by the IMF as floating, determined by the interbank market. The RBI may intervene in the market when deemed necessary, such as to modulate excessive volatility in order to maintain orderly conditions, in accordance with its general monetary policy stance. In 2014, subject to certain conditions, India allowed all residents and non-residents (except citizens of Pakistan and Bangladesh) to take out Indian rupee notes up to Rs 25,000 when leaving the country²⁸; in the case of Nepal and Bhutan there is no limit on rupee notes to be carried into or taken out of India for denomination below Rs 100 only.
   

1.4  Balance of Payments

13. 
    India's current account deficit increased up until 2012-13; it declined significantly. While India posts a structural merchandise trade deficit, it has a sizeable surplus in the services balance. During the period under review, the merchandise trade deficit moderated and the services trade surplus increased (Table 1.4).
    

Table 1.4 Balance of payments, 2010-15

(US$ million)

	2010-11	2011-12	2012-13	2013-14	2014-15^a
Current account	-47,909	-78,179	-87,843	-32,358	-17,940
Goods and services balance	-83,084	-125,661	-130,741	-74,644	-37,145
Goods balance	-127,164	-189,690	-195,656	-147,609	-73,214
Exports f.o.b.	256,318	309,843	306,581	318,607	166,974
Imports c.i.f.	383,481	499,533	502,237	466,216	240,188
Services balance	44,080	64,029	64,914	72,965	36,069
Receipts	124,635	140,935	145,677	151,475	75,925
Transportation	14,298	18,257	17,334	17,380	8,992
Travel	15,793	18,462	17,999	17,922	9,225
Construction	677	804	1,004	1,339	841
Insurance and pension	1,945	2,632	2,227	2,121	1,138
Financial	6,508	5,967	4,949	6,650	2,944
Charges for use of intellectual property	193	281	302	585	274
Computer, information, and telecommunications	55,217	63,972	67,785	72,010	36,257
Other business	22,823	24,557	28,447	28,482	14,144
Personal, cultural, and recreational	227	393	911	1,323	624
Government goods and services, n.e.s.	531	478	574	488	270
Other	6,424	5,133	3,962	2,809	1,089
Payments	80,555	76,906	80,763	78,510	39,856
Transportation	13,947	16,454	14,806	14,792	8,041
Travel	11,026	13,762	11,823	11,810	7,961
Construction	1,157	1,006	1,220	1,236	564
Insurance and pension	1,400	1,497	1,409	1,116	565
Financial	7,483	7,984	4,633	5,814	2,266
Charges for use of intellectual property	2,424	3,207	4,159	3,980	2,314
Computer, information, and telecommunications	3,748	3,258	3,511	3,928	2,025
Other business	26,626	25,467	30,349	27,189	13,086
Personal, cultural, and recreational	543	275	616	831	738
Government goods and services, n.e.s.	820	780	813	979	500
Other	11,382	3,214	7,011	6,525	1,674
Income balance	-17,951	-15,987	-21,455	-23,028	13,554
Credit	9,587	10,144	10,276	11,352	5,319
Debit	27,537	26,130	31,731	34,380	18,873
Secondary income	53,125	63,469	64,353	65,315	32,759
Credit	55,618	66,129	67,696	69,948	35,016
Debit	2,494	2,660	3,343	4,633	2,258
Capital account	40	-61	-294	659	3
Gross acquisitions/disposals of non-produced non-financial assets	25	-86	-71	6	5
Capital transfers	16	25	-223	652	9
Financial account	50,505	80,673	85,449	32,581	20,459
Direct investment	11,834	22,061	19,819	21,564	16,183
Foreign direct investment in India	29,029	32,952	26,953	30,763	16,763
India's direct investment abroad	-17,195	-10,892	-7,134	-9,199	580
Portfolio investment	28,243	16,573	26,704	4,802	22,202
Portfolio investment in India	29,422	16,812	27,582	5,009	22,337
Portfolio investment by India	-1,179	-239	-878	-207	135
Financial derivatives (other than reserves) and employee stock options	0	0	-45,173	2,006	26
Other investment	23,478	29,208	45,173	19,717	176
Other equity	2,049	597	187	20	0
Currency and deposits	3,768	12,095	15,312	39,386	6,702
Loans	18,295	16,770	10,726	-1,129	3,210
Trade credit and advances	12,034	6,668	21,657	-5,044	69
Other	-12,668	-6,922	-2,708	-13,443	338
Reserve assets	-13,050	12,831	-3,826	-15,508	18,076
Errors and omission	-2,636	-2,432	2,688	-882	2,522

a April to September 2014.

Source: Reserve Bank of India online information, "RBI Bulletin". Viewed at: http://rbi.org.in/scripts/BS_ViewBulletin.aspx.

1. 
   India's current account deficit reflects the extent by which gross domestic investment needs exceed gross domestic savings; during the review period, public investment was consistently greater than public sector savings. The financing of the current account deficit has not been a problem: there have been large capital inflows on average, both as foreign direct investment (FDI) and as portfolio investment. Nonetheless, capital inflows have been highly volatile in recent years; there was substantial decline in portfolio investment in 2013-14. The Government has adopted measures to increase capital inflows; these include: (i) increasing the cap for foreign institutional investment in government securities²⁹ and corporate bonds, deregulating the interest rate on non residents' deposits, allowing public financial institutions to raise funds abroad through quasi sovereign bonds, and easing restrictions on external commercial borrowing.³⁰ It would appear that net portfolio investment in India rose in 2014-15. The authorities consider that these measures, in combination with a decline in the current account deficit and revival in equity flows, have helped in building up foreign exchange reserves in 2013-14 and 2014-15 to date.