I thank the Indian Institute of Technology (IIT), Guwahati and Mr. Ankit Khemka, Convenor, Techniche 2011, for inviting me to address such a talented and bright group of youngsters . I propose to speak to you about inflation which is a matter of concern to all of us. It has been about two years since October 2009 that the Reserve Bank of India announced its exit from the crisis-driven accommodative monetary policy stance. However, inflation continues to remain elevated, despite sustained monetary policy action. Headline inflation, measured by year-on-year changes in the wholesale price index (WPI), averaged 9.6 per cent in 2010-11 and it has continued to be over 9 per cent in the current financial year so far. This spell of high inflation has been the longest since the mid-1990s. It has, therefore, posed a major challenge for policymakers, especially for the Reserve Bank as the key objective of monetary policy is price stability.

Why do we need to worry about inflation?  How did the inflation dynamics evolve over the past two years? What was the monetary policy response? These are primarily the questions that I will address.

Why do we need to worry about inflation?

We need to be concerned about inflation as it has adverse impact on the real economy. First, high and persistent inflation imposes significant socio-economic costs. Given that the burden of inflation is disproportionately large on the poor, high inflation by itself can lead to distributional inequality. Therefore, for a welfare-oriented public policy, low inflation becomes a critical element for ensuring balanced progress. Second, high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. Third, inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. Fourth, as inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. Hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. Fifth, if domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate. Sixth, as inflation rises beyond a threshold, it has an adverse impact on overall growth. The Reserve Bank’s current assessment suggests that the threshold level of inflation for India is in the range of 4-6 per cent¹. If inflation persists beyond this level, it could lower economic growth over the medium-term. These costs, therefore, necessitate monetary policy response to control inflation.

How did the inflation dynamics change?

It is important to appreciate the background in which the inflation surge has occurred. The current phase of high inflation followed the global financial crisis, which affected the India’s economy, though not with the same intensity as advanced countries. Managing inflation in an economy which is recovering from a downturn is much more complex because of associated uncertainties than managing inflation under normal conditions.

Prelude to current inflation surge

In the initial phase of the crisis, it appeared that emerging market economies (EMEs) were better positioned to weather the storm created by the global financial meltdown on the back of their substantial foreign exchange reserve cushion, improved policy frameworks and generally robust banking sector and corporate balance sheets. However, any hope about EMEs escaping unscathed could not be sustained after the failure of Lehman Brothers in September 2008 which triggered global deleveraging and heightened risk aversion. Eventually, EMEs were also adversely affected by the spillover effects: first through contraction in world trade and then from reversal in capital flows.

India, though initially somewhat insulated from the global developments, was eventually impacted significantly by the global shocks through all the channels – trade, finance and expectations channels. In response, the Reserve Bank swiftly introduced a comprehensive range of measures to limit the impact of the adverse global developments on the domestic financial system and the economy. The Reserve Bank, like most central banks, took a number of conventional and unconventional measures to augment domestic and foreign currency liquidity, and sharply reduced the policy rates. In a span of seven months between October 2008 and April 2009, there was unprecedented policy activism. For example: (i) the repo rate was reduced by 425 basis points to 4.75 per cent, (ii) the reverse repo rate was reduced by 275 basis points to 3.25 per cent, (iii) the cash reserve ratio (CRR) of banks was reduced by a cumulative 400 basis points of their net demand and time liabilities (NDTL) to 5.0 per cent, and (iv) the total amount of primary liquidity potentially made available to the financial system was over ` 5.6 trillion or over 10 per cent of GDP. The Government also come up with various fiscal stimulus measures.

In October 2009, it was not easy to exit from the excessively accommodative monetary policy stance for two main reasons.  First, the year-on-year headline WPI inflation had just barely turned positive and was entirely driven by food inflation. Industrial production had started to pick up but exports were still declining. Hence, recovery was not assured. Second, globally, most central banks were in favour of continuing stimulus. On the other hand, domestically, consumer price inflation was high, households’ inflation expectations were rising and surplus liquidity was substantial as reflected in the Reserve Bank’s Liquidity Adjustment Facility (LAF) window. These developments had inflationary consequences.

In its Second Quarter Review of Monetary Policy for 2009-10, the Reserve Bank after wider consultations provided the arguments for and against beginning reversal of monetary easing. On balance of considerations, the Reserve Bank judged that the time was appropriate to sequence the exit in a calibrated way so that while the recovery process was not hampered, inflation expectations remained anchored. The exit process thus began with the closure of the special liquidity facilities instituted during the crisis. This amounted to withdrawal of potential liquidity to the tune of ` 1.7 trillion. 

Phases of Inflation

Hon’ble Information Commissioner, Shri Shailesh Gandhi, Executive Director, Union Bank of India, Shri S. S. Mundra, Secretary, Bank Depositors’ Association, Shri Ashok Rawat, Managing Editor of Moneylife Magazine, Ms. Sucheta Dalal, Ladies & Gentlemen:

It gives me great pleasure to participate in this seminar which is graced by the presence of our Central Information Commissioner, Shri Shailesh Gandhi. Shri Gandhi, as we all know, is one of the pioneers who worked relentlessly towards placing the transparency issue in governance right on top of the public agenda in our country. It is thanks to the earnest and passionate efforts of people like him that the Right to Information movement in India has become part of the overall public policy debate for increased transparency in public life. I extend warm congratulations to the organizers on the timely initiative of organising this seminar and providing an appropriate platform to discuss and deliberate the best plausible approach on making effective use of the Right to Information (RTI) Act to the best advantage of society, without needless friction between information seekers and information providers.

2. As you are all aware, the RTI Act provides a practical regime of right to information for citizens to secure access to information under the control of public authorities, in order to promote transparency and accountability in the working of every public authority. It rests on the fundamental premise of how citizens can meaningfully express their voice and articulate their concerns on the acts of omission and commission of public agencies. It has been said that “information is Oxygen for a democratic society”. Democracy requires an informed citizenry and transparency of information which are vital to its functioning and also to contain corruption and to hold Governments and their instrumentalities accountable to the governed. This truly conforms to the growing recognition of the importance of transparency for effective democratic processes.  As the old saying goes, “Sunshine is the strongest antiseptic”.

3. The RTI has empowered Indian citizens who have found a powerful tool to bring measurability and accountability at all levels of governance. This is also being facilitated by large-scale use of the Act by the media and civil right activists to bring transparency and objectivity in the functioning of various public offices. However, the reach of civil society organizations and social activists is limited owing to the geographical size and population and, perhaps, it is due to this that the impact of the Act has yet to attain its envisioned level. Our data reveals that the number of applications we received from the underdeveloped and backward regions of the country was far less in relation to the developed regions. Thus applications from the North-East (Assam: 4 and Tripura: 2) constituted barely 0.1 percent of the 5,087 applications received during 2010-11. If this is generally the case, there is need for educating people in these regions on RTI.

4. I have been closely associated with the implementation of the RTI Act in my organization right from its inception, first as the CPIO and then as the Appellate Authority and have derived great satisfaction from the assignment. I wish to narrate briefly our own experience in this regard and the challenges that we faced.

• At the outset, the tone was set by our Governor who declared that Reserve Bank of India should welcome RTI Act as an opportunity to improve our corporate governance through greater transparency and accountability. The personal interest taken by the Governor in the implementation of the Act played an important role in sensitizing our staff towards the spirit of the new law.

• We studied systems prevalent in certain other central banks with a view to adopting best practices in systems and procedures. The law was new and its proper implementation was important for the Bank’s reputation. Further, it was necessary to maintain consistency in our responses and ensure that the exemptions available in the Act were applied correctly. We, therefore, began with a centralized model with one CPIO who was an Executive Director and the senior most Deputy Governor as Appellate Authority .Later, after about four years, on gaining sufficient experience on what our stance should be on various types of requests, coupled with the fact that increased awareness of the Act had resulted in a significant rise in the number of applications, a partially decentralised  approach in the implementation of RTI was put in place with effect from November, 2009.

• Accordingly, dissemination of information under RTI is now being done in a decentralized manner by the Central Office Departments with the Heads of various Central Office Departments and the Banking Ombudsmen designated as Central Public Information Officers and an Executive Director as the Appellate Authority. Further, senior officers have been designated as Central Assistant Public Information Officers at each of our 27 Regional Offices and Central Office departments.

•  The RBI website is a storehouse of information on a plethora of topics. We have proactively placed a large amount of information on our website, such as circulars, master circulars, publications and press releases, as also a data base on Indian economy. The Bank has started the process of digitization of records with suitable software solution with scanning, storing indexing and retrieval features.

• At the instance of the Central Information Commission, Reserve Bank of India has formulated a Disclosure Policy under the Right to Information Act, 2005, in respect of the information held by it. The policy, which contains an indicative negative list/classes of information which the Reserve Bank considers as exempt from disclosure under the provisions of the Right to Information Act, 2005, has been hosted on the Reserve Bank of India website. We are probably the first public authority to declare upfront as to what information can be disclosed and what is exempt from disclosure. We believe that such clear enunciation would clear all doubts from the minds of information seekers, and help to bring down the ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5979/3/2011 1:37:00 PM

  Prof. M. S. Swaminathan, Shri A. S. Bhattacharya, CMD, Bank of Maharashtra, Ms Kamala Rajan, Principal, CAB, Shri R. L. Sharma, Vice-Principal, CAB and other members of faculty, distinguished panelists, participants, ladies and gentlemen! It is a pleasure to be here this morning for the “National Seminar on Productivity in Indian Agriculture” organized by CAB, Pune.

  2.   In the Indian context, the policy of self-sufficiency in food which led to Green Revolution had served the country well. The country currently has sufficient stocks of wheat and rice which are above buffer stock norms and food security reserve requirements. However, in the medium to long term, concern over food security is likely to become more intense. This is because land is scarce and its supply is limited. Further, sustained dependence on food imports is not an option that is viable in Indian context. Therefore, food safety net for the present and future population requires enhanced agricultural production and productivity. This is already attracting the attention of the Reserve Bank of India. Thus, this Seminar organized by CAB, Pune is very topical and the theme has great bearing on the future growth of India.

  3.  And who could be a better person than Prof. M. S. Swaminathan to set the tone for this Seminar.  It is indeed a matter of great privilege that Prof. M. S. Swaminathan is in our midst today. Known as the "Father of the Green Revolution in India" for his leadership and success in introducing and further developing high-yielding varieties of wheat in India, his vision is to rid the world of hunger and poverty. Prof. Swaminathan is an advocate of moving India to sustainable development, especially using environmentally sustainable agriculture, sustainable food security and the preservation of biodiversity, which he calls an "evergreen revolution”. He has worked worldwide in collaboration with colleagues and students on a wide range of problems in basic and applied plant breeding, agricultural research and development and the conservation of natural resources. It was only in the fitness of things that he delivered the inaugural address today. Sir, we are overwhelmed by your insightful address and I am sure all of us have immensely benefited listening to his valuable views on a subject which is not only very dear to you but also so vital for the country’s economic growth.

  4.   I also note that the Seminar includes several eminent speakers with vast experience on the subject. There are sessions on agricultural productivity, role of research and technology in improving agricultural productivity, linkages between productivity and farm income, incentivizing productivity enhancing investments, relation between credit growth and productivity growth and mitigation of risks in agriculture. In my address today, coming as do from the RBI, I would broadly focus on major trends/issues in agricultural productivity and credit, and the role of agricultural credit in improving agricultural productivity. I would also touch upon some of the steps that can yield results in the short-term.

  Importance of agriculture

  5.   As you are aware, the recent Indian growth story has been service-led. Services sector has completely replaced agriculture, which was traditionally the largest contributor to India’s GDP. However, the fact that agriculture has the smallest share in GDP of only about 14 per cent today from a high of more than 50 per cent , does not belittle its importance for the Indian economy. This is because first, as we all know, agriculture remains the largest employer having a share of around 60 per cent. Secondly, it holds the key to creation of demand in other sectors and remains by far an important indirect contributor to India’s GDP growth. The agriculture sector needs to grow at least by 4 per cent for the economy to grow at 9 per cent. Thus, though having a small share, the fluctuations in agricultural production can have large and significant impact on overall GDP growth. Thirdly, since food is an important component in basket of commodities used for measuring consumer price indices, it is necessary that food prices are maintained at reasonable levels to ensure food security, especially for the deprived sections of our society.  In fact, food security is emerging as an important policy concern, and the role of agriculture in ensuring equitable access to food has added a new perspective for policy makers.

  Trends in Agricultural Productivity

  6.   I would like to discuss certain trends in agricultural productivity in India. As is well-known, the year 1968 marked the beginning of a turning point in Indian agriculture. The country was dependent on agricultural imports for almost two decades after independence. Production of rice and wheat grew at 28.0 per cent and 23.6 per cent, respectively, during 1967-68 while their yields during the same year grew at 19.6 per cent and 24.4 percent, respectively. This was the first time that such high growth in production and yield of both rice and wheat was witnessed in the country. These levels of growth remain one of the highest achieved so far. The development of high-yielding variety (HYV) of seeds in mid 1960s and the subsequent use of the fertiliser-pesticides-irrigation package, better seeds, improved irrigation and education of farmers led to quantum jumps in the productivity. Consequently, production of wheat, rice and foodgrains grew at an average rate of 21.9 per cent, 10.3 per cent and 10.9 per cent, respectively, during the subsequent years 1967-1970. This may be attributed to significant rise in yield of wheat, rice and foodgrains which grew at an average rate of 11.2 per cent, 7.9 per cent and 8.1 per cent, respectively, during the same years. These growth rates have also been unprecedented. High growth in production and yield continued during the subsequent decades of 1970s and 1980s. Production of wheat, rice and foodgrains during 1970s-1980s grew at an average rate of 5.1 per cent, 4.0 per cent and 3.3 per cent, respectively. The yields of wheat, rice and foodgrains grew at an average ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5969/2/2011 4:17:00 PM

  Good Morning. It is indeed my privilege to be addressing you today in this Conference in which officials from industry and banking sector are participating. Today, I want to reflect on some of the challenges and dilemmas that we face as regulators of the banking system.  A few of these challenges and dilemmas are in the context of the rapidly evolving regulatory landscape in the aftermath of the crisis, very aptly reflected in the theme of this Conference “Global banking- Paradigm shift”.

  2.  It has become almost inevitable these days that the speeches start off referring to the financial crisis and, I wish to make no exception today.  I would briefly allude to the crisis to provide a context for some of the issues I would be touching upon. I recall a quip, “Just when we thought we knew all the answers, someone changed the questions” and I think that the saying best describes what the crisis has done to the hitherto accepted regulators’ wisdom.& The role of regulators has always been very challenging, as they need to keep running just to stay put in a fast evolving financial landscape and have to run harder and faster, to be ahead of the curve. If anything, the crisis has made their role that much harder.

  3.  There are many reasons attributed to the outbreak of crisis and the most notable ones are: inadequate quantity and quality of capital, insufficient liquidity buffers, excessively leveraged financial institutions, inadequate coverage of certain risks, absence of a regulatory framework for addressing systemic risks, proliferation of opaque and poorly understood financial products in search of yields in the backdrop of an era of ‘great moderation’, perverse incentive structure in securitisation process, lack of transparency in OTC markets particularly the CDS, inadequate regulation and supervision, and a burgeoning under/unregulated shadow banking system.

  4.  The most glaring inadequacy has been the absence of a framework to deal with systemic risk.  There has been an underlying assumption that strong institutions make a strong system.  This has been proved to be fallacious as legitimate actions taken by individual institutions for self preservation can destabilise the system.  It will be useful to dwell a bit on the notion of systemic risk. 

  5.  Systemic risk is the risk of disruptions to financial services that is caused by an impairment of all or parts of the financial system, and can have serious negative consequences for the real economy¹. Systemic risk has two facets.One is in terms of its distribution within the system at any given point in time and another is its evolution with time.  The cross-sectional dimension is how risk is distributed within the system at any given point in time.  Systemic risk in this dimension arises due to the inter-connectedness of institutions, balance sheet entanglements, common exposures and, sometimes, even common business models of financial institutions. The time dimension, on the other hand, deals with how aggregate risks in the financial system evolve over time – the procyclicality issues.

  6.  Basel III has been designed to address all the shortcomings that have surfaced in the wake of the crisis including the very important issue of systemic risk.  Many measures have been proposed as part of Basel III framework which raise a lot of implementation issues.  Let me dwell on some of the issues which pose major regulatory challenges and dilemmas.

  I.  Implementation of Basel III

  a) Capital: 

  7. In terms of Basel III guidelines, the capital required, and, particularly, the equity component has become much larger.  While the minimum CRAR remains at 8 per cent, the equity component has been raised from 2 per cent to 4.5 per cent.  In addition, there is a capital conservation buffer of 2.5 per cent composed of equity.  Effectively, therefore, the equity component in capital stands raised from 2 per cent to 7 per cent.  In addition, two more capital components, fully composed of equity, have also been prescribed - (a) Counter Cyclical capital within a range of 0- 2.5 per cent and (b) capital surcharge on Global Systemically Important Financial Institutions (G-SIFIs) within a range of 1- 2.5 per cent.  Indian banks will not be subject to capital surcharge on G-SIFIs at least for quite some time and the countercyclical capital is not required on a continuous basis. Therefore, the immediate concern is of meeting a much higher level of equity component i.e. 7 per cent which, in effect, translates to a higher figure on account of the requirement under Basel III that all deductions are to be adjusted against equity which hitherto were distributed equally between Tier I and II.

  8. The Quantitative Impact Study published in December 2010 by BCBS of 91 large banks (including 3 from India) showed a shortfall of Euro 165 bn and Euro 577 bn in equity component vis-à-vis 4.5 per cent and 7 per cent ratios, respectively.  This is one of the reasons for an extended timeframe for implementation of Basel III from January 1, 2013 to January 1, 2019.  The other reason is to cushion the slowdown in the GDP growth during the transition period on account of much larger capital requirements.  According to a study conducted by the Macroeconomic Assessment Group (MAG), a group of modelling experts formed by the FSB and BCBS, while banks may attempt to raise lending rates and reduce credit growth during transition to higher capital levels, this is likely to have a modest impact on the real economy.  The maximum decline in GDP over baseline forecast would be 0.22 per cent after 35 quarters (0.03 per cent per annum while the additional capital is being built up) followed by GDP recovery towards trend path.   Longer transition period would result in lower costs because, banks will get longer time to build up capital from internal generation and thus there will be a less need to cut back on lending or to raise fresh capital from the market.  The private sector estimate done by Institute ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5958/29/2011 12:00:00 AM

  Distinguished Ladies and Gentlemen

  1. I am glad to be in your midst today to share my thoughts on “Banking, electronic payments and the road ahead”. In fact the subject of my address very well fits the theme of the conference “Global banking: Paradigm shift” and its emphasis on productivity excellence. I am sure the experts whom you would have heard and interacted with over the last two days would have shared their thoughts on the changes and challenges that banking in India and globally is undergoing and has undergone over these last few momentous years, leading as it were to a paradigm shift in the way banks are doing their business and retaining and increasing their customer base. The basic underlying current that runs through this changing landscape is the ever increasing reliance on technology to cater to the needs of customers and process vast number of transactions including payment transactions.

  2. In fact as you all are aware, payment and settlement systems form the backbone of any economy. They are the conduits or the arteries for conducting trade, commerce and other forms of economic activities including remittances in any country. An efficient payments system can be envisaged as the lubricant which speeds up the liquidity flow in the economy, thereby creating the necessary impetus and momentum for economic growth. The payments process is a vital aspect of financial intermediation; it enables the creation and transfer of liquidity among different economic agents. A smooth, well functioning and regulated payments system thus not only ensures efficient utilisation of scarce resources but also eliminates systemic risks. The payments and settlement system is, therefore, a crucial component of the financial infrastructure of any country and more so of a country like ours.

  3. The spectacular growth in financial transactions in the country has necessitated certain radical changes in the payments and settlement system, whether it be in the area of wholesale payments or retail payments. While the changes in the wholesale payments are devoted to providing an efficient channel for transmission of monetary policy signals, and for the smooth functioning of various markets, the changes in the retail payments are aimed at providing efficient and timely payment mechanisms to the citizens of this country. The payment system also assumes importance in the context of domestic financial sector reforms and global financial integration that the country is undergoing currently. Foreign investments (direct and portfolio) are encouraged by the availability of an efficient payments system, as also the need for a low cost remittance facility for migrants to send money to their kith and kin within the country. Improved, faster and cheaper domestic money transfers through the payments system is also a part of the emerging scenario.

  4. Given this scenario, let me through the remainder of this address devote myself to providing a bird’s eye-view of the current payment system landscape in the country; the other significant initiatives that have been undertaken; the game changers that would provide further fillip to this endeavour; identifying the potential goldmine as it were for deepening this process; the enablers to take this process forward; the challenges faced at the industry level; the role of the regulatory framework which could serve as a catalyst; and conclude with what I would call the 5 A’s of payment systems for providing an efficient, robust, safe, cost-effective payment services to our fellow citizens.

  Section 1:  Payment System landscape in India

  5. The stage of payment system development in a country to a large extent depends upon the adoption of technology, introduction of new payment instruments and the confidence of the public in using these payment instruments. In India cash still continues to be the predominant payment mode. This can be gauged from the fact that value of bank notes and coins in circulation as a percentage of narrow money is very high at 60.07% for the year 2009-2010², when compared to other emerging economies like South Africa (18.51%), China(18.83%), Mexico (39.14%). Brazil comes close to India with 52.70% of the value of banknotes and coins in circulation as a percentage of narrow money. This is perhaps a pointer that we have been relatively slow in embracing cashless payment modes and using them as cash substitute. The pre-dominant use of cash could also be attributed to the fact that the process for adoption of non-cash mode of payments started relatively late in the country.

  6. Notwithstanding this, the Reserve Bank has been in the forefront both as operator and facilitator for promoting the use of cashless payment instruments in the country. The technology implementation in banks which have shaped the payment system in turn is largely driven by the recommendations of the various committees set up by RBI. Payment system modernisation started in late eighties with introduction of MICR based cheque clearing in mid eighties.

  7. Paper based clearing: Paper based Clearing accounts for 59% of the total volume of transactions while it represents only 10% of the total value of transactions. RBI has taken a number of initiatives to promote efficiency in paper based clearing such as widespread use of MICR technology at 66 major centres in the country. Simultaneously, the introduction of speed clearing in 2008 has facilitated collection of outstation cheques on a local basis leveraging on core-banking infrastructure of banks. Speed clearing is currently available in 240 centres across the country.
  
  8. Cheque Truncation System was operationalised in the National Capital Region, New Delhi in February 2008. Chennai has been identified as the next centre for roll out of a grid based CTS (to be operationalised by NPCI) which will cover the states of Tamilnadu, Kerala and Karnataka. All activities pertaining to roll out of CTS for Grid-based CTS at Chennai have been completed and the system is ready for roll-out by NPCI.

  9. A new automation software package called ‘Express Cheque Clearing System’ (ECCS) has been developed. ECCS, being implemented jointly ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5948/25/2011 6:09:00 PM

  For the third year in a row, it is my privilege to be addressing this joint conference of FICCI and IBA. I know both corporates and banks attach a lot of value to this conference, and so does the Reserve Bank. A joint forum of FICCI and IBA is an important platform for us in the Reserve Bank to share our views on topics of current relevance with two important segments of the economy - corporates and banks - which have a vital role in, and responsibility for, driving growth and development.

  Indian Banking - Productivity Excellence

  2. The theme of this conference - Indian Banking - Productivity Excellence - has perennial relevance, but is much more relevant now, as going forward incremental growth will depend increasingly on productivity growth. India witnessed a remarkable growth acceleration in the years before the crisis; many of the factors that aided this have been acknowledged. But, as I have said before, one of the unacknowledged drivers of that growth performance has been the improvement in the quantum and quality of financial intermediation led by the commercial banking sector. We need to build on that achievement, and productivity improvement is by far the most vital instrument for doing so.

  3. Over the next two days, you will be contemplating the challenges of productivity improvement in banking. How can I add value to that? I could cover a breadth of issues that warrant attention, but that is clearly not the Reserve Bank’s comparative advantage. Instead, I have decided to focus on a single topic: Corporate Governance of Banks in India. This choice has been motivated by more than one factor. This conference is jointly organized by FICCI which pursues the interests of corporates, and IBA which looks after the interests of banks. I have simply inserted the Reserve Bank’s area of interest, ‘governance’, between corporates and banks so that all our collective interests are covered. And importantly, I believe more effective and enlightened corporate governance of Indian banks can be a vital avenue for improving banking productivity.

  Why is Corporate Governance Important?

  4. Before going into corporate governance of banks in particular, let us recall, just for the sake of context, why corporate governance is important in general. At its most basic level, corporate governance sets up the “rules of the game” to deal with issues arising from separation of ownership and management so that the interests of all stakeholders are protected. Empirical evidence shows that businesses with superior governance practices generate bigger profits, higher returns on equity and larger dividend yields. Importantly, good corporate governance also shows up in such soft areas as employee motivation, work culture, corporate value system and corporate image. Conversely, the failure of high profile companies such as BCCI, Enron, WorldCom and Parmalat was a clear lesson of the damage bad corporate governance can inflict.

  5. Here at home we had a corporate scandal of unprecedented dimensions in Satyam Computers where the company’s CEO admitted to having falsified accounts to the tune of over ` 7000 crore, and that too spread over several years. Even as the judicial process relating to this alleged fraud is still under way, the big question is in what ways was this a failure of corporate governance and how are we fixing those lacunae? We had instances of poor governance in the banking sector as well - erosion of standards in forex derivative transactions and fraud in wealth management schemes - reminding us that we need to work hard to get to best practice in every area of corporate governance.

  How is Corporate Governance of Banks Different?

  6. Banks are different from other corporates in important respects, and that makes corporate governance of banks not only different but also more critical. Banks lubricate the wheels of the real economy, are the conduits of monetary policy transmission and constitute the economy’s payment and settlement system. By the very nature of their business, banks are highly leveraged. They accept large amounts of uncollateralized public funds as deposits in a fiduciary capacity and further leverage those funds through credit creation. The presence of a large and dispersed base of depositors in the stakeholders group sets banks apart from other corporates.

  7. Banks are interconnected in diverse, complex and oftentimes opaque ways underscoring their ‘contagion’ potential. If a corporate fails, the fallout can be restricted to the stakeholders. If a bank fails, the impact can spread rapidly through to other banks with potentially serious consequences for the entire financial system and the macroeconomy.

  8. All economic agents tend to behave in a procyclical manner, and banks are no exception, as aptly summed up by Chuck Prince, the former CEO of Citigroup, who said that one had to keep dancing as long as the music was on! Where banks differ is that their procyclical behaviour hurts not just the institution but the larger economy. Among the many lessons of the crisis is the one that financial markets are not self-correcting. This is in part because the signals of financial instability are difficult to detect in real time. On top of that, banks escape some of the disciplinary pressures of the market as their balance sheets are typically opaque.

  9. Given the centrality of banks to modern financial systems and the macroeconomy, the larger ones become systemically important. That raises a moral hazard issue since systemically important banks will then indulge in excessive risk in the full knowledge that all the gains will be theirs; and should the risks blow up, the government or the central bank will bail them out and thereby the losses can be socialized. Having collectively experienced the biggest financial crisis of our generation over the last three years, we all know that these risks and vulnerabilities of the financial system are not just text book concepts; they are all highly probable real world eventualities.

  10. If banks are ‘special’ in so many ways that ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5938/23/2011 12:00:00 AM

  I thank the Motilal Nehru National Institute of Technology (MNNIT) for giving me this opportunity to address this distinguished gathering. I propose to speak on inflation which is a matter of concern to all of us. What is inflation? Simply put, inflation is the sustained increase in the overall price level. Relative change in prices of goods and services is a desirable attribute of market economy as it reflects productivity changes as well as demand and supply conditions. However, when this process transforms into an acceleration of the overall price level, we need to worry as inflation imposes many socio-economic costs.

  The headline wholesale price index (WPI) inflation averaged 9.6 per cent in 2010-11 as compared with 5.3 per cent per annum in the previous decade. Similarly, the average consumer price inflation, measured by the consumer price index for industrial workers (CPI-IW), was even higher at 10.5 per cent in 2010-11 as compared with 5.9 per cent per annum in the previous decade. Moreover, this elevated level of inflation also persisted through the first quarter of 2011-12. In response to inflationary pressures, the Reserve Bank has raised the policy repo rate 11 times bringing it up from a low of 4.75 per cent in March 2010 to 8.00 per cent by July 2011. It is expected that inflation should come down towards the later part of this year.

  Why has inflation been so high and persisted for so long? This is the theme of my talk today. In my presentation, I propose to address the following questions: Is India an outlier among major countries in terms of recent inflation performance? Has the inflation process changed? What are the causal factors – global and domestic as well as supply and demand? I will conclude with some thoughts on managing the inflation dynamics on the way forward.

  Is India an outlier in the inflation performance among major countries?

  It is important to appreciate the global backdrop in which we are experiencing a resurgence of inflation now. In the last decade, inflation was low, both in advanced countries as well as in emerging and developing economies till the global financial crisis unfolded. Consequently, global economy got into a recession and global output declined by 0.5 per cent in 2009. However, global output growth rebounded to 5.0 per cent in 2010.

  As the global economy recovered from the worst effect of the global financial crisis, inflation picked up in emerging and developing economies. This was because the global recovery was largely driven by emerging market economies (EMEs) what was termed as a two-speed recovery – a faster growth in EMEs accompanied by a slower growth in advanced economies. As output gaps closed, there was increasing inflationary pressure in EMEs, particularly in Asia. According to the International Monetary Fund (IMF), consumer price inflation in developing Asia almost doubled from 3.1 per cent in 2009 to 6.0 per cent in 2010 and is projected to be around the same level in 2011. Latest data suggest that inflation in rapidly growing BRICS¹ remains elevated (Table 1).

  Table 1: Inflation* in BRICS Countries
  Country	2010 (Average)	2011 (Latest)@
  Brazil	5.0	6.9
  Russia	6.9	9.0
  India	9.6	9.4
  China	3.3	6.5
  South Africa	4.3	5.0
  * WPI for India and CPI for other countries. @ June/July (year-on-year)

  Global factors

  With recovery, global commodity prices rebounded given the higher level of commodity intensity of growth in EMEs. There was also an element of financialisation of commodities given the global excess liquidity². Crop loss due to adverse weather conditions in many parts in the world coupled with increased diversion of foodgrains towards biofuel exerted added pressure on global food prices. Thus, global commodity prices including food prices rose sharply. For example, the IMF Commodities Index rose by 24 per cent in 2010 on top of an increase of 43 per cent in 2009. It further rose by 20 per cent in December 2010–April 2011, before moderating by about 2 per cent during June–July 2011. Notwithstanding some softening in the last few months, it is important to recognize that the current level of commodity prices is almost double of that two and half years ago (Table 2).

  Table 2: Global Commodity Prices (IMF Primary Commodity Index: 2005 = 100)
  	Dec-08	Dec-09	Dec-10	Apr-11	Jul-11
  All Commodities	98.4	140.9	174.7	209.9	198.9
  Food	119.6	139.5	176.4	190.9	180.3
  Beverage	132.5	176.7	192.6	216.6	210.0
  Agricultural Raw Materials	87.6	111.2	146.9	171.6	161.5
  Metals	107.5	176.8	233.6	250.1	242.2
  Energy	91.6	137.9	167.1	212.6

  ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5918/13/2011 1:02:00 PM

  Friends,

  1. I am delighted to be in your midst after a long gap of a decade. The occasion brings back reminiscences of late 1990s and the early years of this century when the forex market in India was quite different from what exists today. A nascent market that it was, needed a lot of hand-holding from RBI. The Rupee was always moving down a one-way street and every bout of volatility ( plenty those days, for example, the South East Asian crisis, Nuclear sanctions, Kargil flare up, 9/11 attack, attack on Indian Parliament, etc) hogged the headlines in the newspapers. Volatility was synonymous with rupee depreciation and a specie called ‘rupee appreciation’ was not even born or even conceived those days. RBI’s only task was to wage a battle against the villain of depreciation with the meagre reserves at its behest. This situation made the battle more interesting for the onlookers and hence every episode of volatility was packed with as much thrill as a 20-20 game.

  2. By the end of 2002, the Indian growth story had taken firm roots and capital inflows had resumed, as indeed to the other emerging market economies. The world was also entering into an era of abundant dollar liquidity with the Fed Fund Target rate falling from 6.5% in January 2001 to 1.75% in January 2002, then to 1.25% in January 2003 and finally, to 1% by July 2003. It is a different thing that seeds of a crisis that would overtake the global financial system five years later were allegedly being sown and nurtured by the overhang of cheap global liquidity. But, the markets and market participants were relaxed and we at Reserve Bank were mostly concerned with dealing with the after-effects of capital inflows. The last decade saw unprecedented expansion of the financial markets, in terms of both innovative new products as well as the scale of activity. The Indian markets witnessed huge capital inflows, exerting sharp upward pressure on the Rupee, fuelling expectations and warranting massive intervention by the Reserve Bank. The tide soon turned, however. The onset of global financial crisis post-Lehman caused large capital outflows leading to all time low for the INR. The experience of the last couple of years or so is too recent in all our memories and it would be unnecessary to repeat the same here. Let me mention that even as I speak, the global financial markets are in a state of turbulence with risk aversion and uncertainties resurfacing across the globe in the backdrop of faltering US recovery, the obstinate sovereign debt problem in the EU zone and the downgrade of the US sovereign rating by one of the three large credit rating agencies. I would like to mention two other important developments in this context. Firstly, the conventional thinking on capital controls has undergone a change with wide acknowledgement that capital controls can serve useful public purpose in certain circumstances. Second, the regulators worldwide have initiated steps to refurbish the market infrastructure, particularly for the OTC derivatives, opaqueness of which is often the reason ascribed for the crisis.

  3. As of now, it is not clear how long it would take for the uncertainties to recede from the global financial markets and what would be the final shape of the regulatory framework and market infrastructure. Nevertheless, the vulnerability of the Indian financial system or any system for that matter - to pro-cyclical and uncertain capital flows would remain. Therefore, even as our capital account is virtually open in a de facto sense for individuals and non-financial firms, further opening of the capital account particularly for the financial firms has to be dealt with in a carefully calibrated manner. An instructive way to guide our thoughts would be to distinguish between strategic controls and tactical controls on capital flows. Strategic controls in so far as they relate to capital inflows would involve defining a pecking order of flows (eg. in the Indian context the order is foreign direct investment, portfolio investment and debt) and provide a credible framework of rules of the game which can be used by foreign investors to decide their investment strategy. On the other hand tactical controls would be situation specific – to be imposed when particular circumstances arise and withdrawn when they abate. The exact combination and extent of the control, however, is dynamic and would have to be determined by the country context and international milieu.

  4. It is against this backdrop that I wish to share my thoughts with you on a few major themes that would guide our endeavours for development of markets in the next few years.

  5. During the past few years, the USD-INR exchange rate dynamics have been driven mainly by capital flows. In view of the savings - investment gap on the one hand and persistent current account deficits on the other, capital inflows are necessary for sustaining the growth momentum. Apart from the growth perception of the Indian economy, risk appetite of the global investors and prevailing global liquidity conditions have driven the magnitude and direction of capital flows. While the growth trajectory of the Indian economy has been reasonably stable, the other factors mentioned above have swung from one extreme to another during the last few years resulting in sharp appreciation, depreciation and volatility of the Rupee. Needless to mention, volatility in a key macro-variable like the exchange rate affects optimal decision making of the economic agents in the real sector. As stated in the preamble to the Foreign Exchange Management Act, 1999, the Reserve Bank is committed to maintaining orderliness in the foreign exchange market and in fulfilment of this responsibility, RBI has intervened in the foreign exchange market, whenever necessary, only to curb excessive volatility and restore orderly conditions.

  6. Over the years, the Reserve Bank has made available a wide range of hedging tools to enable firms to manage foreign exchange risk. It is heartening to note that ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5928/13/2011 12:00:00 AM

  Director IDRBT, Shri B Sambamurthy, faculty members and officers of IDRBT, officials from banks, members of the selection panel, my colleagues from Reserve Bank and all the other participants. It is indeed my privilege to be present here today to honour the recipients of the banking technology awards and deliver the key note address for the 7th edition of the awards. I am grateful to IDRBT for giving me this opportunity. My heartiest congratulations to all the winners.

  2. This is a special moment for me to be presenting the awards to banks for their contribution towards adoption and implementation of technology in different domains of their businesses. As I look at this, I feel both humble and inspired.  Humble, because I can honestly say that, a decade ago, I could not have imagined or predicted the impact of technology that is so overwhelmingly prevalent today. Inspired, because banks have employed the present day technology very successfully and have pushed the right levers to bring about a tremendous impact to their business potential. The role of IDRBT in this long and interesting journey has been commendable. It has essayed, to perfection, its role as a service provider and also as an ‘incubator’ for research and development activities in the area of banking technology.

  3. My remarks today are divided into two main parts. In the first part, I would be touching upon the contribution of technology to the Indian banking industry, the role played by IDRBT and the significance of banking technology awards, in fostering the technological developments of banks. In the second part, I would be delving into a few issues in the area of business-technology alignment that are critical in fully leveraging the benefits of technology by banks.

  I.  Contribution of technology in changing the face of banking

  4. Technology adoption has changed the face of banking in India. What started as a mere automation of some routine work processes in banks in the mid 80’s has moved on to become business process re-engineering which has resulted in making banking services branchless, anytime and anywhere; facilitated new product development and, enabled near real time service delivery. Technology has helped banks to reach the doorsteps of the customer by overcoming the limitations on geographical/ physical reach in branch banking and easing the resource and volume constraints posed by the brick and mortar model. All the stakeholders have benefitted from the expansion of delivery channels, product innovation and efficiency enhancement which have been facilitated by technology adoption. Banks, however, need to guard against losing personal touch with their customers in such technology driven environment as this would result in their losing valuable information needed for their business.  Overall, technology that began its journey in Indian banking as an enabler, has now become a business driver, and is poised to be an inseparable part of banking business process. This journey has come to the present stage by virtue of the push given by the Reserve Bank and the whole hearted co-operation by Industry participants.

  Reserve Bank and Banking Technology

  5. Reserve Bank of India started this push with the Rangarajan Committee Report I & II on Computerization in Banks, followed by Saraf and Vasudevan Committee Reports. Some of the significant developments  during this journey have been introduction of MICR based cheque clearing, automation of bank branches, computerization of Govt. business, setting up of IDRBT, commissioning of INFINET, launching of IT based delivery channels, providing guidelines for internet banking, implementation of NFS etc. The role played by the Reserve Bank continues.

  6.  As you all know, RBI has recently released an IT vision document 2011-17, which identifies the key focus areas for banks in India. The document indicates the significance to be accorded to the enhanced use of IT in areas like MIS, regulatory reporting, financial inclusion along with the need for appropriate risk mitigation measures and business continuity management. It envisages banks to work towards utilising technology for cost reduction of small value transactions, improved customer services and effective flow of information within the banks and to the regulator. The document emphasizes the need to move towards integrated IT environment for tapping the synergistic benefits of holistic system implementation.

  Setting up of IDRBT – contribution in banking technology & research

  7. Setting up of the Institute for Development and Research in Banking Technology (IDRBT), Hyderabad in the mid nineties, as a research and technology centre for the banking sector was a major step to facilitate and support the ‘technological revolution’ in banking. It was set up in the year 1994 as an apex level institute for spearheading technology absorption in the Indian Banking and the financial sector. It focuses on the training, research and development activities in the field of information technology. The commissioning of INFINET as the backbone for financial communication has been a major achievement for IDRBT. IDRBT also acts as a Certifying Authority (CA) for issuance of digital certificates for players in the banking and financial sector. Structured Financial Messaging System (SFMS), a secure and common domestic financial messaging solution for intra-bank and interbank applications, developed on the lines of SWIFT was the brainchild of IDRBT. IDRBT has also been active in dynamically assessing the needs of the banking community and in organizing trainings and workshops in relevant IT related areas to address such needs. It has been performing its designated role as an important component of RBI’s banking technology push and continues with its endeavor.

  Reaching for the Skies- Banking Technology Excellence Awards

  8. Institution of the excellence awards is a step in the direction of encouraging effective adoption of technology by banks. Instituted in the year 2001, with the primary objective of encouraging and recognizing excellence in implementation of Technology for better customer service, operational efficiency and expansion of banking services to the hitherto uncovered sections of society, the category of awards has been changing with the change in the technology deployment focus from time ]]>http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=5898/12/2011 5:48:00 PM