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.
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 In addition, export credit refinance was withdrawn and replaced with system level liquidity.24
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
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.
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
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).
Source: Reserve Bank of India online information, "RBI Bulletin". Viewed at: http://rbi.org.in/scripts/BS_ViewBulletin.aspx.
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.