1. Presentation
Economic Environment of Business
The Financial Sector Reforms
Slow but steady …not to forget the socio economic needs …
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The financial Sector Reforms
September 9, 2009
2. GROUP
• AJAY K. DHAMIJA N-1
• SNEHAL SONI N-47
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The financial Sector Reforms
September 9, 2009
3. Coverage
•Introduction
•Major Contours of Reforms
•Banking sector Reforms
•Monitory Policy Reforms
•Financial Markets Reforms
•Forex Market Reforms
•Assesment
•Conclusions
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The financial Sector Reforms
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4. Introduction
• FIVE Principle
– Measured, gradual, cautious and steady sequencing of reforms
– Introduction of mutually reinforcing norms
– Development of an Efficient, Competitive and Stable financial
sector
– Development of Financial Institutions
– Introduction of complementary reforms across Monetary, Fiscal and
external sector
• Broad based reforms touching every sector
– Financial Sector
– Monetary and Fiscal Policy
– Capital Market
– Foreign Exchange Market
– Money and Government Securities Market
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The financial Sector Reforms
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5. In early 1990s Lion in jungle
• Financial Repression
vs
lion in cage
– Extensive Regulations
– Administered Interest rates
– Directed Credit Programmes
– Weak Banking Structure
– Lack of Proper Accounting & Risk management systems
– Lack of transparency in operations
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The financial Sector Reforms
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6. In early 1990s…
– Pre-emption of resources from the banking system by the
Pre-
government to finance its fiscal deficit
– Excessive structural and micro regulation that inhibited financial
innovation and increased transaction costs
– Relatively inadequate level of prudential regulation in the
financial sector
– Poorly developed debt and money markets
– Outdated (often primitive) technological and institutional
structures that made the capital markets and the rest of the
financial system highly inefficient.
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The financial Sector Reforms
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7. Resulting into …
• Government regulated the price at which firms could issue equity,
the rate of interest which they could offer on their bonds, and the
debt equity ratio that was permissible in different Industries
• Working capital management was even more constrained with
detailed regulations on how much inventory the firms could carry
or how much credit they could give to their customers.
• Working capital was financed almost entirely by banks at interest
rates laid down by the central bank
• Working capital finance was related more to the credit need of the
borrower than to creditworthiness
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The financial Sector Reforms
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8. … and …
• Volatility was not something that most finance managers worried
about or needed to.
– The exchange rate of the rupee changed predictably and almost
imperceptibly
– Administered interest rates were changed infrequently and the
changes too were usually quite small
• Financial genius consisted largely of finding one’s way through the
regulatory maze, exploiting loopholes wherever they existed and above
all cultivating relationships with those officials in the banks and
institutions who had some discretionary powers.
• Even an overnight cash surplus could be parked in the overdraft
account where it could earn (or rather save) interest at the firm’s
borrowing rate.
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The financial Sector Reforms
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9. At larger level …
• The balance of payments crisis that threatened the international
credibility of the country and pushed it to the brink of default
• The grave threat of insolvency confronting the banking system which
had for years concealed its problems with the help of defective
accounting policies.
• Hindered efficient allocation of resources
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The financial Sector Reforms
September 9, 2009
10. Major Contours of Reforms
• Removal of existing financial repression
• Creation of an efficient, productive and profitable financial sector
• Enabling the process of price discovery by the market determination of
interest rates that improves allocative efficiency of resources
• Providing operational and functional autonomy to institutions
• Preparing the financial system for increasing international competition
• Opening the external sector in a a calibrated manner
• Promoting financial stability in the wake of domestic and external
shocks
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The financial Sector Reforms
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11. Two phased Reforms
• First Generation (Early 1990):- Ist Phase:
1990):-
– Creating an efficient, productive and profitable financial
sector to function with operational flexibility and
functional autonomy
• Second Generation (Mid 1990 …) :- IInd phase
:-
– Strengthening the financial system and introducing
structural improvements
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The financial Sector Reforms
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12. Major Sectors of Reforms
• Banking Sector
• Monetary Policy
• Financial Markets
• Forex Market
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The financial Sector Reforms
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13. Banking Sector Reforms
• Competition Enhancing Measures
• Measures Enhancing Role of Market Forces
• Prudential Measures
• Institutional and Legal Measures
• Supervisory Measures
• Technology Related Measures
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14. Banking Sector Reforms :
Competition Enhancing Measures
• Operational autonomy to Public Sector banks
• Reduction in public ownership of public sector banks
– Can raise capital from equity market up to 49% of paid up capital
• Transparent Norms related to entry, mergers /amalgamation and
governance issues for Indian private sector, foreign and joint-venture
joint-
banks, NBFC’s and insurance companies
• Permission for foreign investment in the financial sector in the form of
Foreign Direct Investment (FDI) as well as portfolio investment
• Permission to banks to diversify product portfolio and business
activities
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The financial Sector Reforms
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15. Banking Sector Reforms :
Measures Enhancing Role of Market Forces
• Sharp reduction in pre-emption through reserve requirement
pre-
• Market determined pricing for government securities
• Disbanding of administered interest rates
• Enhanced transparency and disclosure norms to facilitate market
discipline
• Introduction of pure inter-bank call money market and developing
inter-
markets for securitized assets
• Auction-based repos-reverse repos for short-term liquidity
Auction- repos- short-
management and Improved payments and settlement
mechanism
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The financial Sector Reforms
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16. Banking Sector Reforms :
Prudential Measures
• Introduction and phased implementation of international best practices
and norms related to:- CRAR, Income recognition, Provisioning and
Exposure
• Strengthen risk management :-
– Assignment of risk-weights to various asset classes
– Norms on connected lending, risk concentration
– Application of marked-to-market principle for investment portfolio and
limits on deployment of fund in sensitive activities
– 'Know Your Customer‘ norms
– 'Anti Money Laundering' guidelines
– Graded provisioning for NPA’s
– Capital charge for market risk
• Guidelines for ownership and governance, securitization and debt
restructuring mechanisms norms, etc
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17. Banking Sector Reforms :
Prudential Measures:- Roadmap for Basel II
Measures:-
• Implementing Basel II with effect from March 31, 2007
• Standardized Approach for credit risk and Basic Indicator
Approach for operational risk (First Phase)
• Migrate to the Internal Rating Based (IRB) Approach after
adequate skills are developed (Second Phase)
• Basel II will require more capital for banks in India
– Presently CRAR is over 12 per cent
– New and Innovative Funding options
Perpetual debt instruments and non-
non-
cumulative preference shares
Redeemable cumulative preference shares
and hybrid debt instruments
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18. Banking Sector Reforms :
Institutional and Legal Measures
• Setting up of Lok Adalats (people’s courts), debt recovery tribunals,
asset reconstruction companies, settlement advisory committees,
corporate debt restructuring mechanism, etc.
• Promulgation of Securitization and Reconstruction of Financial Assets
and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its
subsequent amendment to ensure creditor rights
• Setting up of Credit Information Bureau of India Limited (CIBIL) for
information sharing on defaulters as also other borrowers
• Setting up of Clearing Corporation of India Limited (CCIL) to act as
central counter party for facilitating payments and settlement system
relating to fixed income securities and money market instruments
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The financial Sector Reforms
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19. Banking Sector Reforms :
Supervisory Measures
• Board for Financial Supervision as the apex supervisory authority for
Risk based supervision
• Introduction of CAMELS supervisory rating system
(i.e., capital adequacy, asset quality, management, earning,
liquidity and system and control).
• Consolidated supervision of financial conglomerates
• Recasting of the role of statutory auditors with increased internal
control through strengthening of internal audit
• Strengthening corporate governance
• Fit and proper tests for directors along-with enhanced due diligence on
important shareholders
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The financial Sector Reforms
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20. Banking Sector Reforms :
Technology Related Measures
• INFINET as the communication backbone for the financial
sector
• Negotiated Dealing System (NDS) for screen-based trading in
government securities
• Real Time Gross Settlement (RTGS) System
True test of the success of the banking
reforms would be the extent of NPA’s
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22. Monitory Policy Reforms :
Objectives
• Twin objectives of “Maintaining price stability” and “Ensuring
availability of adequate credit to productive sectors
• Use of broad money (M2) as an intermediate target has been de-
emphasized and a multiple indicator approach has been adopted
• Development of multiple instruments to transmit liquidity and interest
rate signals in the short-term in a flexible and bi-directional manner
• Increase of the inter-linkage between various segments of the financial
market including money, government security and forex markets
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The financial Sector Reforms
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23. Monitory Policy Reforms :
Instruments: Strategic Shift: From Direct to Indirect
• Open market operations (OMO) to deal with overall market liquidity
situation especially those emanating from capital flows
• Introduction of Market Stabilization Scheme (MSS) as an additional
instrument to deal with enduring capital inflows without affecting
short-term liquidity management role of LAF
• Introduction of Liquidity Adjustment Facility (LAF), which operates
through repo and reverse repo auctions Liquidity Adjustment Facility
( LAF )
– To nudge overnight interest rates within a specified corridor.
– TO de-emphasize targeting of bank reserves and focus increasingly on
interest rates.
– reducing the cash reserve ratio (CRR) without loss of monetary control.
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The financial Sector Reforms
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24. LAF + OMO + MSS => Flexibility
Transition from direct instruments of monetary control
such as administered interest rate, reserve requirement,
selective capital control) to indirect instruments like open
market operations, purchase and repurchase of
government securities
• Advantages
– Certain dead weight loss for the system was saved.
– Greater flexibility in determining both the quantum of adjustment
as well as the rates by responding to the needs of the system on
a daily basis.
– Modulation of the supply of funds on a daily basis to meet day-
to-day liquidity mismatches.
– demand for funds are affected through policy rate changes.
– Stabilization of short-term money market rates.
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The financial Sector Reforms
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25. Monitory Policy Reforms :
Developmental Measures
• Discontinuation of automatic monetization through an agreement
between the Government and the Reserve Bank
• Amendment of Securities Contracts Regulation Act (SCRA), to create
the regulatory framework
• Introduction of automated screen-based trading in government
securities through Negotiated Dealing System (NDS).
• Setting up of risk-free payments and system in government securities
through Clearing Corporation of India Limited (CCIL).
• Phased introduction of Real Time Gross Settlement (RTGS) System
• Deepening of inter-bank Repo market Deepening of government
securities market by making the interest rates on such securities
market related
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The financial Sector Reforms
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26. Monitory Policy Reforms :
Institutional Measures
• Setting up of Technical Advisory Committee on Monetary
Policy with outside experts to review macroeconomic and
monetary developments and advise the Reserve Bank on
the stance of monetary policy
• Creation of a separate Financial Market Department within
the RBI
• Development of appropriate trading, payments and
settlement systems along with technological infrastructure.
Success of monetary management such as interest rates, is contingent
upon the extent and speed with which changes in the central bank's
policy rate are transmitted to the spectrum of market interest rates
and exchange rate in the economy and onward to the real sector.
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The financial Sector Reforms
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27. Capital Market Reforms :
• Abolition of capital issues control and the introduction of free pricing of
equity issues (CCI)
• Securities and Exchange Board of India (SEBI) was set up as the apex
regulator of the Indian capital markets.
• Primary market regulations:
– Entry norms for capital issues were tightened
– Disclosure requirements were improved
– Regulations were framed and code of conduct laid down for
merchant bankers
– Underwriters, mutual funds, bankers to the issue and other
intermediaries
• Corporate governance regulations:
– Regulations were framed for insider trading
– Regulatory framework for take overs was revamped
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The financial Sector Reforms
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28. Capital Market Reforms
• Secondary market regulations:
– Capital adequacy and prudential regulations were introduced for brokers,
and other intermediaries
– Dematerialization of scrips was initiated with the creation of a legislative
framework and the setting up of the first depository
– Settlement period was reduced to one week
– Carry forward trading was banned
– Tentative moves were made towards a rolling settlement system.
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The financial Sector Reforms
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29. Reforms in Government Securities
Market
• Institutional Measures
• Increase in Instruments in the Government Securities
Market
• Enabling Measures
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The financial Sector Reforms
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30. Government Securities Market :
Institutional Measures
• Administered interest rates on government securities were replaced
by an auction system for price discovery
• Banks have been permitted to undertake primary dealer business while
primary dealers are being allowed to diversify their business
• Central Government would cease to raise resources on behalf of State
Governments . State Governments' capability in raising resources will
be market determined and based on their own financial health
• Effective April 1, 2006, RBI has withdrawn from participating in
primary market auctions of Government paper
– fully market based system in the G-sec market.
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The financial Sector Reforms
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31. Government Securities Market :
Increase in Instruments
• Market Stabilization Scheme (MSS) has been introduced, which has
expanded the instruments available to the Reserve Bank for managing
the enduring surplus liquidity in the system
– 91-day Treasury bill was introduced for benchmarking
– Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were
issued
– Exchange traded interest rate futures were introduced
– OTC interest rate derivatives like IRS/ FRAs were introduced
• Repo status has been granted to State Government securities in order
to improve secondary market
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The financial Sector Reforms
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32. Government Securities Market :
Enabling Measures
• Foreign Institutional Investors (FIIs) were allowed to invest in
government securities subject to certain limits with non-banks allowed
to participate in repo market
• Introduction of automated screen-based trading in government
securities through Negotiated Dealing System (NDS)
• Setting up of risk-free payments and settlement system in government
securities through Clearing Corporation of India Limited (CCIL)
• Phased introduction of Real Time Gross Settlement System (RTGS).
• Introduction of trading in government securities on stock exchanges
for promoting retailing and Non-banks participation
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The financial Sector Reforms
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33. Reforms in Foreign Exchange Market
• Exchange Rate Regime
• Finance Mobilization
• Institutional Framework
• Increase in Instruments in the Foreign Exchange Market
• Liberalization Measures
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The financial Sector Reforms
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34. Reforms in Foreign Exchange Market :
Exchange Rate Regime
• Evolution of exchange rate regime from a single-currency fixed-
exchange rate system to fixing the value of rupee against a basket of
currencies and further to market-determined floating exchange rate
regime
• Adoption of convertibility of rupee for current account transactions
with acceptance of Article VIII of the Articles of Agreement of the IMF
• De facto full capital account convertibility for non residents
• Calibrated liberalization of transactions undertaken for capital account
purposes in the case of residents
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The financial Sector Reforms
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35. Reforms in Foreign Exchange Market :
Finance Mobilization
• Indian companies were allowed to raise equity in international markets
subject to various restrictions.
• Indian companies were allowed to borrow in international markets
subject to a minimum maturity, a ceiling on the maximum interest
rate, and annual caps on aggregate external commercial borrowings
by all entities put together.
• Indian mutual funds were allowed to invest a small portion of their
assets abroad.
• Indian companies were given access to long dated forward contracts
and to cross currency options.
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The financial Sector Reforms
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36. Reforms in Foreign Exchange Market :
Institutional Framework
• Replacement of the earlier Foreign Exchange Regulation Act (FERA),
1973 by the market friendly Foreign Exchange Management Act, 1999
(FEMA)
• Delegation of considerable powers by RBI to Authorized Dealers to
release foreign exchange for a variety of purposes
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The financial Sector Reforms
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37. Reforms in Foreign Exchange Market :
Increase in Instruments
• Development of rupee-foreign currency swap market
• Introduction of additional hedging instruments, such as, foreign
currency-rupee options
• Permission to use innovative products like cross-currency options,
interest rate swaps (IRS) and currency swaps, caps/collars and forward
rate agreements (FRAs) in the international forex market.
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The financial Sector Reforms
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38. Reforms in Foreign Exchange Market :
Liberalization Measures
• Authorized dealers permitted to initiate trading positions, borrow and
invest in overseas market subject to certain specifications and
ratification by respective Banks’ Boards
• Banks are also permitted to fix interest rates on non-resident deposits,
subject to certain specifications
• Use of derivative products for asset-liability management and fix
overnight open position limits and gap limits in the foreign exchange
market, subject to ratification by RBI
• Permission to various participants in the foreign exchange market,
including exporters, Indians investing abroad, FIIs, to avail forward
cover and enter into swap transactions without any limit subject to
genuine underlying exposure
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The financial Sector Reforms
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39. Reforms in Foreign Exchange Market :
Liberalization Measures
• FII’s and NRI’s permitted to trade in exchange-traded derivative
contracts subject to certain conditions
• Foreign exchange earners permitted to maintain foreign currency
accounts
• Residents are permitted to open such accounts within the general limit
of US $ 200,000 per year
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40. Financial Sector and Monetary
Policy Reforms : An assessment
Progress of Commercial Banking in India
1969 1980 1991 1995 2000 2005
1 2 3 4 5 6 7
1 Commercial Banks 73 154 272 284 298 288
2 No. of Bank Offices 8,262 34,594 60,570 64,234 67,868 68,339
Rural and semi
-urban bank offices 5,172 23,227 46,550 46,602 47,693 47491
3 Population per
Office (’000s) 64 16 14 15 15 16
4 Per capita
Deposit (Rs.) 88 738 2,368 4,242 8,542 16,699
5 Per capita Credit
(Rs.) 68 457 1,434 2,320 4,555 10,135
6 Priority Sector
Advances@ (%) 15 37 39 34 35 40
7 Deposits (% of
National Income) 16 36 48 48 54 65
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41. Financial Sector and Monetary
Policy Reforms : An Assessment
Distribution of Commercial Banks According to Risk-weighted
Capital Adequacy
Year <4% 4-9 % 9-10 % >10 % Total
1 2 3 4 5 6
1995-96 8 9 33 42 92
2000-01 3 2 11 84 100
2004-05 1 1 8 78 88
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The financial Sector Reforms
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43. Financial Sector and Monetary
Policy Reforms : An Assessment
Select Productivity Indicators of Scheduled Commercial Banks
(Rs. million at 1993-94 prices)
Year Business Profit per Business
per employee Employee per branch
1992 5.4 0.02 109.9
1996 6.0 0.01 119.6
2000 9.7 0.05 179.4
2005 17.3 0.13 267.0
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44. Financial Sector and Monetary
Policy Reforms : An Assessment
Despite record high international crude oil prices, inflation remains low
and inflation expectations also remain stable.
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The financial Sector Reforms
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45. Financial Sector and Monetary
Policy Reforms : An Assessment
Fresh issuances under the MSS were suspended between November 2005 and April 2006
due to tight liquidity. Redemptions of securities/Treasury Bills issued earlier – along with
active management of liquidity through repo/reverse repo operations under Liquidity
Adjustment Facility - provided liquidity to the market and imparted stability to financial
markets. With liquidity conditions improving, it was decided to again start issuing
securities under the MSS from May 2006 onwards.
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46. Forex Reforms : An Assessment
Exchange rate exhibiting reasonable two-way movement
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The financial Sector Reforms
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47. Financial Sector and Monetary
Policy Reforms : An Assessment
Credit Delivery increased from 30 per cent during 1999-00 to 41 per cent
during 2004-05 and further to 48 per cent during 2005-06.
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The financial Sector Reforms
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48. Conclusion
• Financial system in India, through a measured,
gradual, cautious, and steady process, has
undergone substantial transformation
• Reasonably sophisticated, diverse and resilient
system through well-sequenced and coordinated
policy measures aimed at making the Indian financial
sector more competitive, efficient, and stable
• Effective monetary management has enabled price
stability while ensuring availability of credit to
support investment demand and growth in the
economy.
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49. Conclusion
• The multi-pronged approach towards managing
capital account in conjunction with prudential and
cautious approach to financial liberalisation has
ensured financial stability in contrast to the
experience of many developing and emerging
economies
• Monetary policy and financial sector reforms in India
had to be fine tuned to meet the challenges
emanating from all global and domestic shocks.
• Viewed in this light, the success in maintaining price
and financial stability is all the more creditworthy.
• The overall objective of maintaining price stability in
the context of economic growth and financial stability
will remain
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50. Thank You
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