The Indian economy has recovered strongly. The government's poverty alleviation programs have focused on generation of employment in rural areas. The overall deficit of the consolidated public sector has risen sharply in recent years, erasing most of the consolidation that was achieved during the first half of the 1990s. The paper discusses the monetary and financial market developments, reforms and performance, external sector, trade policy, and structural policy developments in India. The new government has taken a number of initiatives committed to structural reform.


The Indian economy has recovered strongly. The government's poverty alleviation programs have focused on generation of employment in rural areas. The overall deficit of the consolidated public sector has risen sharply in recent years, erasing most of the consolidation that was achieved during the first half of the 1990s. The paper discusses the monetary and financial market developments, reforms and performance, external sector, trade policy, and structural policy developments in India. The new government has taken a number of initiatives committed to structural reform.

IV. Monetary and Financial Market Developments1

A. Monetary Policy and Interest Rate Developments

1. The substantial downward pressure on the rupee that began in August 1997 ended the easing trend in monetary policy that had been in place since early 1996. The Reserve Bank of India (RBI) initially sought to secure a soft landing for the currency through intervention in the spot and forward markets and a modest tightening in monetary policy in November 1997. A more decisive move was made in January 1998 when the cash reserve ratio (CRR) was raised to IOV2 percent and the Bank and repurchase (repo) rates were both increased by 2 percentage points to 11 percent and 9 percent, respectively (Chart IV.1 and Table IV.1).


INDIA: Monetary Indicators, 1995-2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A004

Sources: Data provided by the Indian authorities; and Reuters.
Table IV.1.

India: Selected Monetary Indicators, 1994/95-2000/01


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Source: Reserve Bank of India.

New broad money series. See Box IV.4 for details.

Relates to five major banks

2. This tightening of monetary conditions had little impact on the yields of short-dated government paper, as the RBI absorbed securities through private placements. However, secondary market yields on longer-dated paper increased sharply, resulting in a steepening of the yield curve (Chart IV.2). Banks also raised their prime lending rates (PLRs) by 1 percentage point to 14 percent, while the discount rate on commercial paper (CP) rose sharply as the risk premia attached to the corporate sector increased with the uncertainty generated by the regional crisis.2


INDIA: Financial Market Developments, 1995-2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A004

Sources: Data provided by the Indian authorities; and Reuters.1/ Difference between 10-year secondary market yield of central government securities and 91-day Treasury bill yield. Increases indicate a steeper yield curve.2/ Prime lending rate of the State Bank of India.

3. As stability returned to the foreign exchange market, the RBI eased monetary conditions during March-June 1998, reducing the Bank Rate, repo rate, and CRR to 9 percent, 5 percent, and 10 percent, respectively. The increase in bond yields that had taken place at the beginning of the year was reversed, the yield curve flattened, and banks reduced their PLRs to 12¾–13 percent by end-April.

4. Renewed downward pressure on the exchange rate in the wake of the Russian default and the increase in domestic inflationary pressures necessitated further monetary tightening in August 1998. However, concerned about the weakness in the industrial sector, the RBI sought to engineer an increase in short-term rates, while leaving bank borrowing rates unchanged. To this end, the repo rate and CRR were raised to 8 percent and 11 percent, respectively, but the Bank Rate was left unchanged. In response, Treasury bill yields rose sharply, but yields on longer-dated securities were more stable and the PLR was unchanged.

5. During 1999 and early 2000, the focus of monetary policy shifted toward supporting the recovery in the industrial sector. The CRR was cut to 10½ percent in March 1999 and the Bank and repo rates were reduced to 8 percent and 6 percent, respectively. In the April 1999 Monetary and Credit Policy Statement, the RBI stated a “bias toward easing as circumstances permit” and reduced the CRR by a further ½ percentage point. This was followed by a phased cut in the CRR to 9 percent in November 1999, and the Bank Rate, repo rate, and CRR were reduced further to 7 percent, 5 percent, and 8 percent, respectively in April 2000.

6. Market interest rates generally declined during 1999 and into 2000, although the magnitude of the decline has varied across the yield curve, and did not kept pace with the fall in inflation during 1999 so that real interest rates increased (Table IV.2 and Chart IV.3; see Box IV.1 for a discussion of real interest rates). Overnight call interest rates remained quite high for much of the year, moving above the Bank Rate for extended periods, most noticeably during August-November.3 However, yields on 14- and 91-day Treasury bills declined moderately, while 10-year bond yields fell by nearly 2 percentage points to 10½ percent. These developments have led to a considerable flattening of the yield curve.

Table IV.2.

India: Real Interest Rates, 1983/84-1999/00

(In Percent)

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Sources: Data provided by the Indian authorities; International Financial Statistics; Consensus Forecasts; and staff calculations.Key: WPI: Wholesale Price IndexWPIM Manufactured subcomponent of the WPICPI: Consumer Price IndexWPIE: Estimate of (WPI) inflation expectations derived from Consensus Forecasts.

INDIA: Real Interest Rates, 1996-2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A004

Sources: Data provided by the Indian authorities; Consensus Forecasts, and staff calculations.

7. The PLR fell to 12–12½ percent following the monetary easing in early 1999, but the considerable competition banks faced for deposits from other financial institutions, mutual funds, and government-sponsored small saving schemes limited the scope for further cuts in their lending rates. While the rates of return on small savings schemes were reduced by 1–1½ percentage points effective from January 1, 1999, these investments remained attractive given their tax advantages. However, following the reduction in rates on provident fund accounts, from 12 percent to 11 percent in early 2000, and the easing of monetary policy in April, banks reduced their PLRs to 11¼–11¾ percent. Commercial paper (CP) rates have also declined to around 10–12 percent. Indeed, CP rates for high quality corporates have been below the PLR as banks have sought to provide credit to blue-chip borrowers at more competitive interest rates.

India: Real Interest Rates

The level of real interest rates in an economy is an important determinant of economic activity. Indeed, as India has moved away from a highly-regulated financial system toward a more market determined framework, the real interest rate is likely to have become an increasingly important factor in credit allocation and economic activity.

The real interest rate is calculated as the nominal interest rate on a financial asset less the expected inflation rate over the maturity period of the asset. The calculation, however, is complicated both by the choice of the interest rate and by the proxy for inflation expectations. A number of interest rates could be used, and given that the correlation between interest rates at different maturities and in different asset classes is not high in India, the choice is important in determining the result. Inflation expectations could be proxied by the actual inflation rate over the preceding twelve months—with the wholesale price index (WPI), the manufacturing sector subcomponent of the WPI, or the consumer price index (CPI) being the most likely price measures to use—or by the inflation forecasts contained in Consensus Forecasts.1

Real interest rates do appear to have been higher than usual during the past year (Table IV.2 and Chart IV.3). While the level of real interest rates is lower when the estimates of inflation expectations are used (because expected inflation has generally been higher than actual inflation), they still remain above their recent and historical averages. Further, comparing real interest rates to the level that would be expected on the basis of an econometric relationship between real interest rates and the output gap suggests that real rates have been higher than would be expected at this stage of the economic cycle.2

A number of structural factors could help explain the high level of real interest rates. Chief among these are: the large stock of nonperforming loans in the banking system; the still high pre-emptions of bank assets; the large government borrowing requirement; and the attractive, nonmarket-determined rates of interest offered on government-sponsored saving schemes, which also carry attractive tax benefits.

1 Consensus Forecasts asks economic forecasters for their projections of CPI and WPI inflation for both the current and following financial years.2 The equation estimated was as follows: realrt = c + ogapt-1, where realr is the real interest rate, c is a constant, and ogap is the output gap (derived from the Hodrick-Prescott filter). The output gap was defined using industrial output rather than GDP.

India: Reforms Introduced in the April and October 1999 Monetary and Credit Policy Statements

Operation of monetary policy

  • An Interim Liquidity Adjustment Facility (ILAF) was introduced. As part of this the general refinance facility was replaced by a collateralized lending facility under which banks can borrow 0.25 percent of their fortnightly average outstanding deposits (in 1997/98) for two weeks at the Bank Rate and a further 0.25 percent at the Bank Rate plus 2 percentage points.

  • Nonbank participants in the money markets were given access to RBI repos.

  • In order to simplify commercial banks’ cash management, the RBI introduced a two week lag in the maintenance of the stipulated CRR requirement by banks. For example, the CRR to be maintained in the fortnight beginning January 1, 2000 was based on net demand and time liabilities as at December 17, 2000.

Government securities and money markets

  • The number of primary dealers (PDs) was increased from 10 to 13. Minimum bidding commitments are now being obtained from each PD to ensure that the notified auction amount is fully absorbed.

  • A calendar of Treasury bill issues was announced for the entire year. A 182-day Treasury bill was introduced with bi-weekly auctions.

  • Regulation of money market mutual funds was transferred to SEBI, while guidelines for the trading forward rate agreements/interest rate swaps were introduced.

Interest rates

  • The 30 percent interest surcharge on import finance that had been introduced in January 1998 was withdrawn. The minimum 20 percent interest rate on overdue export bills was withdrawn, with banks allowed to set this rate at their own discretion.1 Banks were also given greater flexibility in determining their lending rates.

Capital account

  • The minimum maturity of foreign currency nonresident (FCNR(B)) deposits was raised from six months to one year. At the same time, the requirement that banks maintain an incremental CRR of 10 percent on liabilities incurred since April 11, 1997 was withdrawn.

1 On May 25, 2000, the RBI imposed a 50 percent surcharge on the lending rate for import financing and a minimum 25 percent per annum rate on overdue export bills.

India: April 2000 Monetary and Credit Policy Statement

Monetary policy: The statement left policy-related interest rates and the CRR unchanged—although it indicated policy would continue to be geared toward supporting growth, it also stressed the need to guard against emerging inflation pressures. For 2000/01, the RBI projected real GDP growth of 6½–7 percent and an inflation rate of around 4½ percent. An M3 target was not announced, in line with the new “multiple indicator” approach, but M3 growth was projected at 15 percent.

RBI liquidity management: The statement announced the replacement of the Interim Liquidity Adjustment Facility (ILAF) with a full-fledged Liquidity Adjustment Facility (LAF) in a phased manner. In the first phase, effective June 5, 2000, the additional collateralized lending facility (ACLF), through which banks and primary dealers borrow at the Bank Rate plus 200 basis points, would be replaced with daily, variable rate, repo auctions with same-day settlement. The fixed repo system will be abolished at this stage. The LAF, operating through auction-based repos and reverse repos, would set a corridor for money market rates and help develop the shorter-end of the yield curve.

Money market reforms: In order to integrate the money and foreign exchange markets, rupee interest rate derivatives will be permitted to be benchmarked to foreign exchange forward rates, in addition to existing money and debt market rates. The minimum maturity of certificates of deposits was reduced from three months to 15 days, bringing them on par with commercial paper and term deposits.

Financial sector reforms: The statement introduced specific guidelines for bank participation in the insurance business, restrictions on floating rate loans were removed, and banks were given greater autonomy in setting rates on deposits. Development finance institutions were given approval, in principle, to convert to universal banks, subject to meeting all prudential norms applicable to banks.

Prudential reforms: In a move towards consolidated supervision, banks were asked, on a voluntary basis, to include the risk-weighted components of their subsidiaries into their own balance sheets. Banks were also advised to earmark additional capital over a period of time, beginning in March 2001, to avoid any loss of net worth once the balance sheets are consolidated. The RBI indicated that it would develop a plan in line with best international practices to move toward risk-based supervision from the transaction-based supervision now being practiced; it would revise prudential norms for non-Statutory Liquidity Requirement investments by banks; and review the possibility of extending to NBFCs the bank guidelines on asset liability management and risk management.

B. Monetary Aggregates

8. Reserve money grew by 14½ percent in 1998/99, compared with 13¼ percent in 1997/98 (Chart IV.4 and Table IV.3). On the liabilities side, the pickup in reserve money growth was fueled by strong increases in currency in circulation on account of the turnaround in the agricultural sector (which is more cash reliant that other sectors) and the sharp rise in primary product prices which required the holding of higher cash balances for transaction purposes. Growth in bankers deposits with the RBI was considerably lower than in 1997/98, as funds held by the RBI under the incremental CRR introduced in May 1991 were released.4 On the assets side, net foreign assets of the RBI continued to rise strongly, albeit at a slightly slower rate than in 1997/98, driven by the RBI’s purchase of the proceeds from the RIB issue in the foreign exchange market in August 1998. RBI credit to government rose strongly, contributing 7¾ percentage points to reserve money growth, as the government finances continued to deteriorate. RBI credit to banks rose substantially as recourse to its refinance facilities increased with the move of money market interest rates above those on export refinance facilities following the tightening of monetary policy in August 1998 (export refinance rates were actually reduced to 7 percent from August 1998 until March 31, 1999).


INDIA: Selected Monetary Indicators, 1995-2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A004

Sources: Data provided by the Indian authorities; and staff estimates.1/ Twelve-month increase in credit to the private sector as a ratio of the twelve-month increase in commercial bank deposits.
Table IV.3:

India: Reserve Money, 1996/97-1999/00 1/

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Source: Data provided by the Indian authorities.

Except for March 31, all other quarters are on a last reporting Friday basis.

9. Reserve money growth eased considerably to 8 percent (y/y) in 1999/00, primarily due to a decline in bankers balances with the RBI as the CRR was reduced during the year. RBI credit to government actually declined over the year despite the continued deterioration in the fiscal situation as the RBI was able to sell securities into the market, both to commercial banks and other financial institutions. The strong external sector performance resulted in a significant increase in the RBI’s net foreign assets, which contributed 10¾ percentage points to reserve money growth.

10. Broad money growth, at 19¼ percent, remained strong in 1998/99, and once again exceeded the RBI’s indicative target range for the year of 15–15½ percent (Table IV.4).5 The contribution of net foreign assets, at 4¾ percentage points, was unchanged from 1997/98 as the proceeds from the RIB issue offset weakness in other capital inflows. Net credit to government contributed 6¾ percentage points to broad money growth, somewhat higher than in 1997/98. Bank credit to the commercial sector slowed during 1998/99 in line with the weakening of activity in the industrial sector, contributing 7½ percentage points to broad money growth compared to 8¼ percentage points in 1997/98. In recent years, bank finance to the commercial sector has increasingly been provided through channels other than direct lending. Commercial bank subscriptions to commercial paper and other similar instruments accounted for around one third of total bank financing of the commercial sector in 1998/99, broadly the same as in 1997/98. Investment in commercial paper does not carry any priority lending requirements, and banks are also able to offer more competitive interest rates to blue-chip borrowers through this channel as direct lending cannot be at an interest rate below the PLR.

Table IV.4.

India: Monetary Survey, 1996/97-1999/00 1/

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Source: Data provided by the Indian authorities.

End-year data are a consolidation of March 31 data for the RBI and the last reporting Friday data for commercial banks.

Includes RBI commercial credit, bank holdings of securities, and credit to cooperatives.

India: Revised Monetary Aggregates

In its October 1999 Monthly Bulletin, the RBI published new monetary data based on the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation. The major methodological change is the introduction of the residency concept in the calculation of the aggregates. A number of other modifications to the coverage and construction of the monetary aggregates have also been made.

Reserve money (MO)

  • RBI refinance to the National Bank for Agriculture and Rural Development (NABARD) is classified as RBI credit to the commercial sector rather than to banks.

Intermediate monetary aggregate (NM2)

  • A new intermediate aggregate has been introduced (between Ml and M3) which includes currency and residents’ short-term bank deposits, defined as deposits with a contracted maturity up to, and including, one year (M1 only includes noninterest bearing deposits). However, not all commercial banks are in a position to provide this deposit breakdown at present, so the data on short-term bank deposits is estimated from a sample of large public sector banks (45 percent of the time deposits of these banks were short-term).

Broad money (NM3)

  • Broad money is defined as NM2 plus long-term deposits of residents as well as call/term borrowings from nonbank sources. The crucial difference between the old M3 series and NM3 is the exclusion of nonresident repatriable foreign currency fixed liabilities which were previously included in time deposits, but which will now be classified as a foreign liability of the banking system. Also excluded from NM3 are pension and provident fund assets which had previously been included in other liabilities of the banking system.

Credit aggregates

  • Bank investments in securities not eligible for inclusion under the SLR (such as commercial paper and purchases of shares/debentures/bonds) are included in bank credit to the commercial sector. Further, net commercial bank lending to primary dealers, which is currently treated as an interbank transaction, will be included as bank credit to the commercial sector.

The new series for broad money (NM3) shows a lower growth rate during the course of most of 1998 and 1999 due to the exclusion of non-resident Indian (NRI) foreign currency repatriable fixed deposits from the definition of deposits. The RBI will continue to publish data for both the old and new series, particularly given the lags that currently exist in the publication of the new data.

11. Broad money growth slowed to 13½ percent (y/y) in 1999/00, well below the 15½–16 percent target range announced for the year by the RBI in its April Monetary and Credit Policy Statement. However, this growth rate was distorted by the last reporting Friday falling on March 24 in 1999/00, one full week ahead of the book closing at the end of the financial year. This meant that the full impact of “window dressing,” which usually results in a year-end increase in deposits, was not as apparent in the 1999/00 data, leading to a sharp drop in the end-March growth rate. Indeed, broad money grew by 17 percent (y/y) in February 2000, and growth returned to 16 percent in April. Credit to the commercial sector has picked up strongly in recent months, contributing 8% percentage points to broad money growth in 1999/00, as activity in the industrial sector accelerated, while net bank credit to the government has slowed somewhat as the fiscal deficit has increasingly been financed outside the banking system. Government securities, however, remain attractive to the commercial banks as they continue to seek to strengthen their balance sheets, and their holdings of government and other approved securities stood at 34¼ percent of net demand and time liabilities in March 2000, well above the 25 percent SLR requirement.

12. Financing provided by the all-India Financial Institutions (AIFIs) slowed during 1998/99. These institutions are traditionally term lenders as opposed to the working capital finance provided by the commercial banks, although this distinction is becoming blurred. Sanctions and disbursements rose by 19¼ percent and 7½ percent, respectively, compared to growth rates of 44½ percent and 29 percent in 1997/98. This slowdown can probably be attributed to a number of factors that discouraged investment expenditure including: the slowing in industrial activity; the uncertain external environment; domestic uncertainties related to political developments and international sanctions. However, disbursements by the AIFIs picked up during the first eleven months of 1999/00 as industrial activity accelerated.


Prepared by Tim Callen.


Commercial banks are now free to set most interest rates. Exceptions are on small loans (less than Rs 200,000), on which the rate cannot exceed the PLR, export credit, and savings accounts, where the rate is currently set at 4 percent. Most banks currently charge a spread of 4 percent over PLR on their lending. In the October 1999 Monetary and Credit Policy Statement, the RBI announced that commercial banks would be given greater flexibility to determine their PLRs on certain types of lending.


In recent years, the 3–4 day repo rate and the Bank Rate have defined an informal corridor in which the call rate moves. The repo rate, the rate at which the RBI absorbs liquidity from the system, provides the floor to this corridor, and the Bank Rate, the rate at which the RBI provides liquidity through the Interim Liquidity Adjustment Facility, the upper band. This, however, is an imperfect corridor both because the maturities of the RBFs repo and refinance operations differ from the largely overnight transactions in the call money market and because there are limits on access to RBI lending facilities at the Bank Rate (additional RBI financing is only available at the Bank Rate plus 200 basis points). Boxes IV.2 and IV.3 outline reforms introduced by the RBI in its recent Monetary and Credit Policy Statements.


In May 1998, the RBI announced that it would release the remaining two-thirds (one-third was released in October 1992) of the balances held under the 10 percent incremental CRR imposed between May 1991 and April 1992. These were released in installments between May 1998 and March 1999.


The RBI has recently released broad money data calculated under a revised methodology (see Box III.4). However, a detailed breakdown is only published from March 1999, and there is a significant lag in publication, so the discussion here focuses on the old M3 series. If the proceeds from the Resurgent India Bond (RIB) issue were excluded from broad money (in line with the residency criteria), then growth in 1998/99 would have been 17 percent.

India: Recent Economic Developments
Author: International Monetary Fund