On Trade-off and the Impossibility

 The  “Trilemma” of Exchange Rate Management and Autonomous Monetary 

Policy under CAC 

1

The trilemma

CAC

ERM

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Some Definitions

Fiscal Deficit = Total Expenditure – Total Receipts = [Revenue Expenditure +Capital Expenditure] = [interest payments +subsidies + defence expenditure + Capital Expenditure] – Total ReceiptsPrimary Deficit = Fiscal Deficit – interest payments = [subsidies + defence expenditure + Capital Expenditure] – Total Receipts

3

4

CAC

Capital Imports

ER Appreciation Reserve Accumulation

Rise in Mo

Rise in M3

Rise in prices OMO

Interest payment

s

Rise in FD

Cut in PD

Cut in subsidies

Cut in public investment

• Forex Inflows and Monetary Sterilization in India (Rs. Crore)

Source: GOI, Economic Survey 2007-08

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Financial Year

public sector banks

private banks

foreign banks

FY2001 43.7 36.7 33.5

FY2002 43.1 40.9 34.0

FY2003 42.5 44.4 33.9

FY2004 44.0 47.4 34.8

. Priority sector lending as percentage of NBCs

Source: Basic statistical returns, RBI, various issues.

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Source: Basic statistical returns, RBI, various issues.

Loans to SSI sector in priority sector (in %)

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FY2001 FY2002 FY2003 FY2004Gross Bank creditFood procurement 8.5 10.1 7.4 4.7Non-food 91.5 89.9 92.6 95.3Priority 32.9 32.7 31.6 34.5Industry-Large 34.7 32.1 35.1 32.3Wholesale trade 3.8 3.8 3.4 3.3Others of which 20.1 21.3 22.5 25.2Housing 3.4 4.2 5.5 6.8Consumer durables 1.2 1.3 1.1 1.1NBFCs 1.7 1.8 2.1 2.2Individuals against shares 0.4 0.3 0.3 0.3Real estate 0.4 0.5 0.9 0.7Personal 3.9 4.4 4.2 4.6

Advances against fixed deposits 4.3 4.0 3.4 3.4Tourism 0.2 0.3 0.4 0.4

Composition of gross banking credit of SCBs (FY2001-FY2004)

Source: RBI Report on Trends & Progress of Banking in India, various issues.

Note: Only the important items have been listed under others.Source: RBI Report on Trends & Progress of Banking in India, various issues. 8

Amount outstanding(Rs bn)

As % to retail

Impaired credit %

Net NPA as a % of net advances

Housing loan 894.49 47.3 1.9 1.4Consumer durables 62.56 3.3 6.6 4.0Creditcard receivables 61.67 3.3 6.3 2.4Other-personal loans 871.7 46.1 2.6 1.6Total 1890.41 100.0 2.5 1.6% to total 22.0Total Loans and advances 8590.92

Retail portfolio of banks 2004-05

Source: RBI Report on trends and progress, of Banks 2004

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% of average assets

Mortgages

Car loans

Two-wheeler

Personal

Top-tierCorporate

Credit card

SME

Yield 8.0 9.5 18.0 15.0 6.0 24.0 9.5Interest cost*

3.5 3.5 3.5 3.5 3.5 3.5 3.5

Lending spread

4.5 6.0 14.5 11.5 2.5 20.5 6.0

Profitability of loans (%)

Source: As discussed with banks.*The interest rate on cash balances with RBI is 3.5%.

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Profit range (percentages)

Industry Services

Above 1000 1 4Between 100-990

6 38

Between 50-99 7 257

Between 10-49 12 311

Between 0-9 1625 549

Between (-).01 to (-) 20

499 176

Less than (-) 20 363 324

Total no of firms

2513 1659

On Profit ranges: Number of industrial units as at end of March 2005

Source: CMIE, Prowess Online data

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2002-3 2003-4 2004-5

Total

investments

50200 73510 83841

Securities of

financial

institutions

12463

(24.82)

22053

(30.0)

25836

(30.81)

Shares and

debenture

s* of

subsidiaries

12928

(25.75)

15344

(20.87)

19560

(23.32)

Industrial

securities

21942

(43.02)

30490

(41.47)

29053

(34.65)

*Debentures include privately placed debentures with financial institutions.Figures in brackets indicate percentages.Source: Reserve Bank of India Bulletin September 2006

Corporate Investments (Rs Crores)

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Sales range Quick assets* to

current liabilities

Gross fixed asset

formation to

total use of funds

Net fixed assets

to total net assets

Rs 50-100 crores 51.9 43.2 40.0

Rs 100-500 crores 53.4 44.1 42.2

Rs500-1000

crores

58.5 41.3 42.2

> Rs 1000 crores 50.4 38.0 40.8

Selected Financial Ratios of Public Limited Companies (percentages) 2004-05.

Source: Reserve Bank of India Bulletin September 2006 13

*Quick assets comprise of (a) sundry debtors (b) book value of quoted investments and (c) cash and bank balances

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Fiscal deficit,Primary Deficit and Interest Payments: As Percenrage of GDP

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Components of Expenditure under Primary Deficit as Percentages of GDP