Category: RBI News

Dear All

Welcome to the refurbished site of the Reserve Bank of India.

The two most important features of the site are: One, in addition to the default site, the refurbished site also has all the information bifurcated functionwise; two, a much improved search – well, at least we think so but you be the judge.

With this makeover, we also take a small step into social media. We will now use Twitter (albeit one way) to send out alerts on the announcements we make and YouTube to place in public domain our press conferences, interviews of our top management, events, such as, town halls and of course, some films aimed at consumer literacy.

The site can be accessed through most browsers and devices; it also meets accessibility standards.

Please save the url of the refurbished site in your favourites as we will give up the existing site shortly and register or re-register yourselves for receiving RSS feeds for uninterrupted alerts from the Reserve Bank.

Do feel free to give us your feedback by clicking on the feedback button on the right hand corner of the refurbished site.

Thank you for your continued support.

Department of Communication

Reserve Bank of India

Next

1. I wish to thank FEDAI for inviting me on the occasion of their 4th Annual Day. This is an opportune moment to look back and reflect on the developments of the last one year in financial markets and, in particular, the foreign exchange markets. The year 2020 has been one like never before. Faced with an unknown crisis which brought the global economy to a sudden stop, recent policy discourse has been dominated, and rightly so, by the impact of the pandemic. Despite this, regulatory and institutional reforms in the country have moved the domestic financial markets to the next trajectory. Cutting across market segments, these reforms are ushering in a simplified, principle-based regulatory framework that seeks to broad-base markets by easing access, enhancing participation, facilitating innovation, protecting users and promoting fair conduct. Today, I would like to discuss the imperatives and the building blocks of the recent reforms placing them in the context of the big picture of a modern and efficient financial market, equipped to support the aspirations of an open and integrated economy.

2. Given that we are still amidst the pandemic, where near-term macro concerns dominate the discourse, let me start with a few words on the macroeconomic outlook and financial market conditions.

Macroeconomic Outlook

3. After witnessing a sharp contraction in GDP by 23.9% in Q1:2020-21 and a multi-speed normalisation of activity in Q2, the Indian economy has exhibited stronger than expected pick up in momentum of recovery. The global economy has also witnessed a stronger than expected rebound in activity in Q3. The IMF has accordingly revised its assessment for global growth in 2020 to a less severe contraction than what was assessed in June 2020.

4. Even as the growth outlook has improved, downside risks to growth continue due to recent surge in infections in advanced economies and parts of India. We need to be watchful about the sustainability of demand after festivals and a possible reassessment of market expectations surrounding the vaccine. The monetary policy guidance in October emphasised the need to see through temporary inflation pressures and also maintain the accommodative stance at least during the current financial year and into the next financial year.

5. A key source of resilience in recent months has been the comfortable external balance position of India supported by surplus current account balances over two consecutive quarters, resumption of portfolio capital inflows on the back of robust FDI inflows, and sustained build-up of foreign exchange reserves. The Government’s recent policy focus to enhance India’s participation in global value chains, including through production linked incentives for targeted sectors, can leverage on the strong external balance position of India.

Financial Market Developments

6. Let me now turn to financial markets. Domestic financial market conditions were benign at the start of the year but witnessed severe stress and dislocation as the COVID-19 pandemic unfolded. Thinning out of activity impacted market liquidity. Increased volatility of financial prices was observed across most asset classes. Yields hardened in the government securities market and the yield curve steepened sharply amidst concerns about fiscal slippage and sustained sell-off by FPIs. The financing conditions in the commercial paper and corporate bond market also deteriorated, reflecting overall market conditions as well as generalised risk aversion. The Rupee sharply depreciated, with increasing volatility and heightened forward premia. The Reserve Bank acted proactively and nimble-footedly to ease financial market conditions and mitigate risks with a slew of conventional and unconventional measures. Market participants responded with alacrity and together we have been able to ensure stable and resilient markets across all segments. The Reserve Bank remains committed to fostering orderly functioning of financial markets and will continue to evaluate incoming information having a bearing on the financial markets and act, as needed, to mitigate any downside risks.

7. Over the last three decades, the pace of financial market reforms has gathered momentum, albeit occasionally interrupted by financial crises. A calibrated opening up of the Indian economy has occurred since the 1990s. Alongside, the institutional architecture has been deepened keeping in view the specifics of the country context. In the interregnum, the markets have traversed a long distance.

8. Over the years, the bond markets in the country have become broad-based in terms of participation, availability of a variety of instruments and development of repo and derivative markets. The sovereign yield curve now spans up to 40 years and provides a stable pricing backbone for the development of the corporate bond market. The foreign exchange market has also come a long way, with increasing diversity in instruments and participants, and a growing integration of the economy with the global economy. Alongside these changes, significant improvements in the market infrastructure have taken place encompassing state-of-the-art primary issuance process for government securities, an efficient and completely dematerialized depository system within the central bank, electronic trading platforms, trade reporting and central counterparty settlement.

9. Even as the financial markets evolved, some imperfections became evident. Secondary market liquidity in government securities increased but was confined to a few benchmark tenors. The participation base grew but diversity of views remained limited with predominance of “buy and hold” and “long-only” investors. Interest rate derivative markets grew but remained limited to one product – the Overnight Indexed Swap – and to a small set of market participants. Domestic foreign exchange markets also grew but so did the offshore markets, fragmenting the global market for the Indian Rupee and impairing market efficiency. New product development remained constrained, in part, due to limited participation and also due to regulatory restrictions which had developed in response to the past experience with complex products and concerns about valuations and mis-selling. Meanwhile, episodes of misconduct and abuse in global markets raised the imperative of improving governance frameworks to pre-emptively safeguard domestic markets.

10. Notwithstanding these imperfections, the resilience and strong foundation of financial markets, nurtured over time, also presented an opportunity. Markets with a small number of participants tend to become ‘closed user clubs’ with predictable behavioural attributes. Furthermore, speculative flows in thin markets can create distortions. In deep markets, these very flows can add liquidity and make the markets more resilient. A calibrated opening up of the economy can supplement domestic savings and help finance growth and development.

11. Against this backdrop, the Reserve Bank has taken steps to usher in the next phase of reforms to accelerate the pace of liberalisation. The recent reform measures, many of which are in the works, have been fashioned around the four major themes of (i) liberalising financial markets and simplifying market regulation; (ii) internationalising financial markets; (iii) safeguarding the “buy side” – user protection; and (iv) ensuring resilience and safety. Let me discuss each of these themes.

Liberalising financial markets and simplifying market regulations

12. The broad approach driving the recent regulatory initiatives is that any person with a need to access financial markets should be able to do so with ease at minimum cost. Principle-based regulations for interest rate derivatives and foreign exchange derivatives aim at achieving this broad objective. Detailed procedural prescriptions have been replaced with basic principles, thereby allowing – greater operational flexibility for market participants. Earlier restrictions on design of derivative contracts and cancellation and rebooking of foreign exchange derivatives have been dispensed with. Distinctions based on residency have been removed or reduced, bringing foreign participants at par with domestic entities in terms of market entry and exit. While retaining the existence of underlying exposures as the basis for access, greater flexibility and ease of hedging have been brought in by allowing anticipated exposures to be hedged. Users with limited/small hedging requirements have been allowed to enter into contracts equivalent of USD 10 million without the need to establish the existence of underlying exposures.

13. Simplifying regulations and providing procedural flexibilities have also contributed to easing operating conditions and thereby reducing costs and inefficiencies. While some operational constraints are inevitable, especially those warranted by prudential considerations, our approach has been to ease operating conditions within these considerations. Another example of this is the recent passing of the Bilateral Netting of Qualified Financial Contracts Act, 2020, which addresses an important operating constraint. The absence of legal recognition for bilateral netting had discouraged the use of derivatives for effective risk management. The legislation provides the enabling framework for cash and derivative market transactions to be off-set. This will enable optimization of capital requirement for financial institutions and will provide an impetus for the development of derivative markets.

Internationalisation of financial markets

14. Internationalisation of financial markets can lower transaction costs with efficiency gains. Over the last three decades, India has undergone a transformation from being a virtually closed economy to one that is globally connected and open to a much larger volume of international transactions and capital flows than before. Today, the capital account is convertible to a great extent. Inward Foreign Direct Investment (FDI) is allowed in most sectors and outbound FDI by Indian incorporated entities is allowed as a multiple of their net worth. The external commercial borrowing framework has also been significantly liberalised to include more eligible borrowers, even as maturity requirements have been reduced and end-use restrictions have been relaxed.

15. Foreign portfolio investment in Indian debt markets has been expanded within calibrated macro-prudential norms. Limits under the Medium-Term Framework for investment by Foreign Portfolio Investors (FPIs) have been gradually increased and procedures rationalized. A Voluntary Retention Route (VRR) has been introduced, which provides relaxations from macroprudential controls but subject to a minimum retention period. In a major step towards greater internationalisation, the Fully Accessible Route (FAR) was introduced under which non-residents can invest in specified government securities without any restriction. Capital account convertibility will continue to be approached as a process rather than an event, taking cognizance of prevalent macroeconomic conditions. A long term vision with short and medium term goals is the way ahead.

16. As a major milestone towards opening up of markets, banks in India have been permitted to deal in the offshore rupee derivative markets. The measure is expected to reduce the segmentation between onshore and offshore markets, apart from reducing volatility and the cost of hedging. Banks have also been permitted to undertake foreign exchange transactions beyond the usual onshore market hours, thus fostering real time market activity. In a complementary measure, exchanges and banking units in the GIFT City have been permitted to undertake Over the Counter (OTC) and exchange traded Rupee derivatives.

Safeguarding the “buy side” – user protection

17. Safeguarding the interests of the users – the “buy” side of financial markets – is an imperative especially in the context of liberalised markets and introduction of newer and more sophisticated products. A number of initiatives have been taken in this regard, a few of which I would like to mention.

18. With a view to providing greater protection to less sophisticated users, a User Classification Framework segregating users into ‘retail’ and ‘non-retail’ has been introduced for OTC foreign exchange and interest rate derivative transactions. Retail users can be offered only non-complex derivative products while product innovation has been permitted for non-retail users as per their business needs.

19. The issue of fair and transparent pricing of foreign exchange products, especially for MSMEs and other smaller users, has been occupying our attention. Market-makers are now mandated to separately disclose fees /charges when dealing with retail users. Also, an anonymous order matching electronic trading platform, called FX-Retail, has been launched by the Clearing Corporation of India (CCIL), at the behest of the RBI. This platform allows users with small transaction sizes to undertake transactions at best available market rates. These measures are expected to ensure greater transparency and protection of the retail user. Concerted efforts by banks will be needed if the benefits of transparent and competitive pricing are to reach every user of the foreign exchange markets.

20. As derivative markets are liberalized, market conduct needs to be strengthened through robust assessment of product suitability and user appropriateness. Regulatory requirements in this regard are being reviewed in consonance with the overall changes to the regulatory approach.

Ensuring resilience and safety

21. Financial market infrastructure in India has remained resilient even during various financial crises. Learning from international episodes of market failure, several further initiatives have been taken to ensure continued resilience.

22. Fair market conduct is critical to ensure efficient functioning and preserving trust in the financial ecosystem. Hitherto, conduct codes prescribed by market bodies like FIMMDA and FEDAI guided participants in the financial markets. To supplement and strengthen these, a regulatory framework for market abuse has been put in place.

23. The Reserve Bank has been taking measures to implement the G20 over-the-counter (OTC) derivatives market reforms. In line with global trends, electronic trading platforms (ETPs) have been brought under regulatory purview to ensure efficiency of operations and address systemic risks. A draft framework for variation margin for OTC derivatives aimed at reducing counterparty risks from non-centrally cleared derivatives, has been recently issued.

24. Global efforts are underway to put in place a Legal Entity Identifier (LEI) which uniquely identifies financial market participants and enables aggregation of risks. Reserve Bank has also mandated the use of the LEI for participants in the markets it regulates. In fact, we are one of the few countries that has implemented LEI beyond derivative markets to cover transactions in government securities and money markets as well as the credit market (large loans).

25. A key issue which has been engaging global attention is the transition from the LIBOR to alternate reference rates. In India, several measures have been taken to make financial benchmark processes more transparent and robust. Most recently, the administrators of significant financial benchmarks were brought under regulation to ensure robust governance frameworks and process controls. These reforms will stand us in good stead as we prepare ourselves for the LIBOR transition. The Indian Banks’ Association has been working closely with market participants to facilitate the transition to alternate benchmarks and create customer awareness. Achieving a smooth transition from a benchmark entrenched in the financial system will require significant efforts from all stakeholders.

IV. Conclusion

26. I have attempted to set out today the broad themes which have guided the liberalization/reform agenda for financial markets. The recent changes are aimed at enabling financial markets to enhance allocational efficiency in the use of resources and thereby contribute to economic development. With this freedom comes responsibility. The achievement of desired outcomes is contingent on financial institutions and market participants taking forward the reform agenda so that we have vibrant financial markets and efficient financial intermediation. The simplification and flexibility provided in the regulations must reach the end-user. In designing new products and new market segments, risk management systems and responsible market conduct should evolve in tandem as we open up to global players. Market participants and their associations including FEDAI will have to play a critical role in this.

Dear All

Welcome to the refurbished site of the Reserve Bank of India.

The two most important features of the site are: One, in addition to the default site, the refurbished site also has all the information bifurcated functionwise; two, a much improved search – well, at least we think so but you be the judge.

With this makeover, we also take a small step into social media. We will now use Twitter (albeit one way) to send out alerts on the announcements we make and YouTube to place in public domain our press conferences, interviews of our top management, events, such as, town halls and of course, some films aimed at consumer literacy.

The site can be accessed through most browsers and devices; it also meets accessibility standards.

Please save the url of the refurbished site in your favourites as we will give up the existing site shortly and register or re-register yourselves for receiving RSS feeds for uninterrupted alerts from the Reserve Bank.

Do feel free to give us your feedback by clicking on the feedback button on the right hand corner of the refurbished site.

Thank you for your continued support.

Department of Communication

Reserve Bank of India

Next

Dr. Charan Singh, Shri Deepak Sood, Shri Ramesh Iyer, Shri Vineet Agarwal, Shri S. Ramann, Shri Sunil Kanoria, Shri Raman Agarwal, Ladies and Gentlemen,

I thank the Associated Chambers of Commerce and Industry of India for this very kind invitation to address the ‘National E-Summit on Non-Banking Finance Companies’- with the theme “Stability and sustainability of Financial Sector”.

2. At this juncture, NBFC sector is passing through a critical phase. Recent failures of certain large Non-Banking Financial Companies (NBFCs), severe liquidity strain confronting the sector and the consequent financial stability concerns have brought NBFC regulations back into focus. I thought that the time is opportune to talk a little bit on the innovative transformations taking place in the NBFC sector and the regulatory response from the Reserve Bank. It would be contextual to take stock of the direction in which regulatory focus has moved and what could be the future shape of NBFC regulations. This is intended as an analysis to evoke discussion and debate on the subject.

Growth of NBFC sector and the need for prudence

3. NBFCs have come a long way in terms of their scale and diversity of operations. They now play a critical role in financial intermediation and promoting inclusive growth by providing last-mile access of financial services to meet the diversified financial needs of less-banked customers. Over the years, the segment has grown rapidly, with a few of the large NBFCs becoming comparable in size to some of the private sector banks. The sector has also seen advent of many non-traditional players leveraging technology to adopt tech-based innovative business models.

4. Between March 31, 2009 and March 31, 2019, the total assets² of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6 per cent, while the balance sheets of scheduled commercial banks (SCBs) grew at a CAGR of 10.7 per cent. Consequently, the aggregate balance sheet size of NBFCs increased from 9.3 per cent to 18.6 per cent of the aggregate balance sheet size of SCBs during the corresponding period. In absolute terms, the asset size of NBFC sector (including HFCs), as on March 31, 2020, is Rs.51.47 lakh crore³. As at end-March 2020, NBFCs have been the largest net borrowers of funds from the financial system⁴, of which, more than half of the funds were from SCBs, followed by Asset Management Companies-Mutual Funds (AMC-MFs) and Insurance Companies. As the financial intermediation has shifted, so has interconnectedness. Many NBFCs now rely on banking system for funds and emergency liquidity needs. Therefore, it is not enough to understand and confront the vulnerabilities of the banking sector alone. The need of the hour is to understand vulnerabilities in the NBFC sector and how shocks are transmitted to or from the sector.

5. There is an increasingly complex web of inter-linkages of the sector with the banking sector, capital market and other financial sector entities, on both sides of the balance sheet. As such NBFCs, like other financial intermediaries, are increasingly exposed to counterparty, funding, market and asset concentration risks, even before the COVID-19 pandemic impacted financial markets and our lives.

The Pandemic Effect

6. In the aftermath of liquidity stress post IL&FS and DHFL events, the market funding conditions turned difficult for NBFCs. While NBFCs with better governance standards and better operating practices did well, others bore the brunt of the market forces. Smaller NBFCs and Microfinance Institutions (MFIs), who were contributing significantly to the last mile credit delivery, also got impacted as their funding sources got further squeezed. The Reserve Bank acted in a swift and proactive manner to improve access to funding and liquidity by its monetary policy and liquidity measures and resultantly, the cost of funds for NBFCs and HFCs has reduced substantially for all rating categories (Chart-2).

7. It is important to recognize that challenges faced by some of the NBFCs were reflective of inherent fragilities. As financial markets started differentiating between strong/well managed NBFCs and those having perceptible weaknesses, market discipline started to play out – entities with asset-liability mismatches or asset quality concerns faced constraints on market access. RBI, in response, took several calibrated steps to channel credit flow into the NBFC sector and improve the sector’s long-term resilience.

8. As the sector was slowly inching towards normalcy (as can be seen from Table-1 below), the outbreak of COVID-19 and disruptions in economic activity due to lockdowns led to building up of huge stress in the financial system. While the entire financial system was affected, the impact was significantly greater on NBFCs due to their underlying business models, thereby straining their profitability.

The regulatory approach

9. The regulatory approach of the Reserve Bank has adapted to the increase in complexity of the entities within the NBFC sector as well as the growing significance of NBFCs within the financial sector. The core principles of NBFCs regulation, however, has remained intact, i.e., – a) protection of depositors (in case of deposit-accepting companies) and customers; and, b) preserving financial stability. The varying emphasis on these objectives at different points in time has led RBI to deploy different policy tools as appropriate. We must recognise that NBFC regulation has undergone certain fundamental changes in recent years.

10. Let me outline five of these most significant changes in brief –

(i). First and foremost, in line with RBI’s emphasis on ownership-neutral regulations, Government owned NBFCs have been brought under the purview of prudential regulation since May 2018. Considering that Government owned NBFCs account for more than one-third of the sector, predominantly in infrastructure financing, this is a significant change.

(ii). Second, considering the recent turmoil some NBFCs had to face because of liquidity stress, the criticality of sound liquidity risk management by NBFCs has been reinforced with the introduction of the liquidity risk management framework for NBFCs with asset size above Rs.100 crore. All NBFCs, irrespective of size are encouraged to follow the framework. The guidelines emphasize the ‘Principles of Sound Liquidity Risk Management and Supervision’ published by Basel Committee on Banking Supervision. The framework expects the Boards of NBFCs to take an active role in the management of liquidity risk and deploy internal monitoring tools suitable to their business profile. More importantly, the regulations have devised a simplified and tailored Liquidity Coverage Ratio (LCR) meant for large NBFCs. It would prepare large NBFCs to effectively meet cash outflows even under severe liquidity stress scenarios over a 30-day horizon. No doubt, maintaining adequate high-quality liquidity assets would have repercussion on the overall yields of NBFCs, but the regulation is commensurate with the need to mitigate risks associated with maturity/liquidity transformation the NBFCs engage in.

(iii). The third important development is in connection with FinTech based product delivery. It is now well recognised that non-banking financial sector would be a fertile ground for technology-based experimentation in financial products and services. Regulations have sought to create a conducive environment in this regard. For example, the timely introduction of guidelines for P2P lending platforms has ensured orderly growth of the segment anchored in high standards of prudence. Those have made lending platforms a neutral meeting place for lenders and borrowers and keeping them insulated from handling of funds involved in the underlying transactions. Regulations have brought down risks while creating the right environment for legitimate expansion of business opportunities. The ecosystem created under the Account Aggregator (AA) framework is yet another example of proactive regulation in the technology-intense activities. The AA framework has ushered in the required framework for safe, secure and consent-based sharing of information on financial assets of a customer. The critical regulatory aspect to be noted here is that the Account Aggregator does not store or view the data passing through it, thereby leaving no scope for any perverse incentive to abuse/ misuse the financial data. Let me also emphasize that the RBI has been flexible in according registered NBFCs to be completely app-based in financial intermediation.

(iv). The RBI revised the regulatory framework under the principles of proportionality for Core Investment Companies (CICs) with transparency and disclosures being the focus of the revised regulations. The learnings from failure of a large NBFC – a Core Investment Company prompted this regulatory renovation. Large aggregate leverage at the group level aided by complex, multi-layered ownership structures were found to be nurturing the seeds of financial instability and vulnerability. Further, the aggregate risk view was missing at the holding company level. The revised regulatory framework tries to plug regulatory gaps in critical areas in respect of CICs.

(v). Taking over the regulation of Housing Finance Companies (HFCs) is yet another significant move. Changes in the regulatory framework of HFCs have been issued after wide public consultations. The idea is to treat HFCs as a category of NBFC and bring about harmonisation of regulations while allowing HFCs to maintain their unique characteristics and allow them to transition to the revised regulations over a period of time, that is in a gradual manner, to make it least disruptive for the rest of the financial sector.

11. With the growth in size and interconnectedness, NBFCs have increasingly become systemically significant and the prudential regulations for NBFC sector have evolved to give greater focus to the theme of financial stability. However, let’s not forget that regulation-light structure of NBFCs has enabled the flexibility enjoyed by them. This flexibility is the primary advantage of NBFCs over banks, enabling them to serve the last mile of financial intermediation. Therefore, it is imperative to strike a balance between regulating the NBFCs more tightly and the need to provide them the required flexibility. This will remain the cornerstone while we imagine the future of regulation for NBFCs.

The Future

Principle of Proportionality

12. There is a view that any regulatory framework would ideally be designed according to the principle of proportionality. By extension, the spill-over of risks from a systematically important NBFC capable of transmitting perceptible impact on financial stability, must be dealt with in a proportionate manner. So, NBFCs with significant externalities and which contribute substantially to systemic risks must be identified and subjected to a higher degree of regulation. One can also argue that the design of prudential regulatory framework for such NBFCs can be comparable with banks so that beyond a point of criticality to systemic risks, such NBFC should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system. This would make the financial sector sound and resilient while allowing a majority of NBFCs to continue under the regulation-light structure.

13. Within the proportionality paradigm, one must deal with entities which neither belong to the critical ones in terms of systemic risk nor are they too small in their scale and complexity. These NBFCs currently enjoy great degree of regulatory arbitrage vis-à-vis banks. As a group, these entities can contribute to build-up of systemic risks because of the regulatory arbitrage enjoyed by them; hence there is a need to recalibrate the regulations.

14. While dealing with proportionality principle, let me also touch upon the regulation of microfinance sector as well. We all are aware of the circumstances under which the regulatory framework for NBFC-MFIs was framed. Much water has flown under the bridge since then. Several large MFIs have converted into Small Finance Banks. The share of NBFC-MFIs in the overall microfinance sector has come down to a little over 30 per cent. Today we are in a situation, where the regulatory rigour is applicable only to a small part of the microfinance sector. There is a need to re-prioritise the regulatory tools in the microfinance sector so that our regulations are activity-based rather than entity-based. After all, the core of microfinance regulation lies in customer/consumer protection.

15. We need to strike the right balance between the degree of regulation and the need for flexibility – a critical issue I alluded to a while ago. We could perhaps consider a graded regulatory framework for NBFCs calibrated in relation to their contribution to systemic significance.

Regulating the FinTech

16. Let me shift focus to another contemporary area of interest. Although significant regulatory steps have been taken already in the FinTech, the dynamic nature of the FinTech focused NBFCs keeps throwing up new challenges. The NBFC sector has been in the forefront in adopting innovative fintech-led delivery of products and services which are transforming the way one can imagine access to and interaction with these services. The advance technological solutions such as Big Data Analytics and Artificial Intelligence are being adopted by a large number of players to extend credit in an efficient manner over digital platforms. The Reserve Bank has been on the forefront of creating an enabling environment for growth of digital technology for new financial products and services. In fact, in the non-banking space, the RBI has been ahead of the curve and has come out with regulations for new products and services when the industry itself was at nascent stage. Peer to peer (P2P) lending, Account Aggregator (AA), and credit intermediation over “only digital platform” are case in point where the regulations have helped the industry to grow in a systematic and robust manner. While making regulation for the future in FinTech area, orderly growth and customer protection and data security will remain the guiding principles for the RBI.

Ensuring transparency and governance

17. Ensuring good corporate governance in NBFCs is at the core of any regulatory change. This is not an easy objective to meet, as good governance is essentially an aspirational achievement for an entity and it can seldom be founded only on regulatory prescriptions. Good governance would be a natural outcome if promoters/owners and senior management are fundamentally ‘fit and proper’. It is extremely critical that appropriate filtering mechanisms are in place to allow only the genuine and able promoters to start the business of NBFCs. After all, by issuing Certificate of Registration to new NBFCs, we provide them with the regulatory mandate to access public funds multiple times their net worth. Besides, it is necessary that NBFCs do not become conduits in money laundering and terrorist financing in any manner. While the current mechanism within RBI focuses on the above objective for companies seeking registration, there is a need to extend similar rigour of due diligence whenever there is a change in ownership/ control in an existing NBFC.

Consumer protection and fair conduct

18. A consumer of financial services provided by any regulated entity, whether a bank or NBFC, nurtures similar expectation of fair treatment and avenues for grievance redressal. Extension of the scheme of ombudsman to the NBFC sector is certainly a move in this direction. A transparent and self-disciplining mechanism has to be imagined for the future where the changing business models and newer credit delivery mechanisms do not deviate from the objective of fair treatment of the customer.

Conclusions

19. The Global Financial Crisis was primarily attributed to feather-touch regulatory approach, ignoring of the liquidity risks by financial intermediaries and unabated financial innovation. Abundant Liquidity, light touch regulation and financial innovation has also aided the growth of the NBFCs. The financial system today is significantly different from what it was at the outset of the financial crisis more than a decade ago. Regulatory reforms implemented in response to that crisis in India and globally, changes in technology and, more importantly, the growth of NBFCs have contributed to this dynamic landscape. The NBFC sector has become extremely diverse. The business model, customer profile and nature of financial products vary substantially depending on the category of the NBFC. The uniqueness of this sector lies in the inherent diversity of activities carried out by different NBFCs and thus, there can be no ‘one-size-fits-all’ prescription in the regulatory approach for NBFCs. Perhaps a calibrated and graded regulatory framework, proportionate to the systemic significance of entities concerned is the way forward.

20. While on the one hand technological innovation and FinTech based delivery of financial services and products further the objective of improving access of financial products to the members of public, on the other, they push the regulator to recalibrate regulatory interventions to achieve the objective of consumer protection and financial stability. The regulatory challenges in marrying these diverse and sometimes conflicting objectives are many, but clarity of purpose would help us make the right policy choices.

As I conclude, I pray that all of you and your family members stay safe in this long-drawn battle against the pandemic. Let me also wish you a happy and safe Deepawali.

Thank You.

Thank you for this opportunity to interact with eminent business leaders of India and distinguished members of the FICCI. I wish to thank the organisers for hosting this event, undeterred by this still unfolding pandemic that, on a daily basis, tests our resilience and capacity to save lives, households, businesses and the economy.

2. The end-August press release of the National Statistics Office (NSO) was a telling reflection of the ravages of COVID-19. Nevertheless, high frequency indicators of agricultural activity, the purchasing managing index (PMI) for manufacturing and private estimates for unemployment point to some stabilisation of economic activity in Q2, while contractions in several sectors are also easing. The recovery is, however, not yet fully entrenched and moreover, in some sectors, upticks in June and July appear to be levelling off. By all indications, the recovery is likely to be gradual as efforts towards reopening of the economy are confronted with rising infections.

3. The global economy is estimated to have suffered the sharpest contraction in living memory in April-June 2020 on a seasonally adjusted quarter-on-quarter basis. World merchandise trade is estimated to have registered a steep year-on-year decline of more than 18 per cent in Q2 of 2020, according to the Goods Trade Barometer of the World Trade Organisation (WTO). High frequency indicators point to a trough in global economic activity in April-June quarter and a subsequent recovery is underway in several economies, such as the USA, UK, Euro-area and Russia. The global manufacturing and services PMIs rose to 51.8 and 51.9, respectively, in August from 50.6 for both in July. Yet, infections remain stubbornly high in the Americas and are increasing again in many European and Asian countries, causing some of them to renew containment measures.

4. On the back of large policy stimulus and indications of the hesitant economic recovery, global financial markets have turned upbeat. Equity markets in both advanced and emerging market economies have bounced back, scaling new peaks after the ‘COVID crash’ in February-March. Bond yields have hardened in advanced economies on improvement in risk appetite, fuelling shift in investor’s preferences towards riskier assets. Portfolio flows to EMEs have resumed, and this has pushed up EME currencies, aided also by the US dollar’s weakness following the Fed’s recent communication on pursuing an average inflation target. Gold prices moderated after reaching an all-time high in the first week of August 2020 on prospects of economic recovery.

5. Financial market conditions in India have eased significantly across segments in response to the frontloaded cuts in the policy repo rate and large system-wide as well as targeted infusion of liquidity by the RBI. Despite substantial increase in the borrowing programme of the Government, persistently large surplus liquidity conditions have ensured non-disruptive mobilisation of resources at the lowest borrowing costs in a decade. In August 2020, the yield on 10-year G-sec benchmark surged by 35 basis points amidst concerns over inflation and further increase in supply of government papers. Following the RBI’s announcement of special open market operations (OMOs) and other measures to restore orderly functioning of the G-sec market, bond yields have softened and traded in a narrow range in September. Although bank credit growth remains muted, scheduled commercial banks’ investments in commercial paper, bonds, debentures and shares of corporate bodies in this year so far (up to August 28) increased by ₹5,615 crore as against a decline of ₹32,245 crore during the same period of last year. Moreover, the benign financing conditions and the substantial narrowing of spreads have spurred a record issuance of corporate bonds of close to ₹3.2 lakh crore during 2020-21 up to August.

6. The immediate policy response to COVID in India has been to prioritize stabilization of the economy and support a quick recovery. Polices for durable and sustainable high growth in the medium-run after the crisis, nevertheless, are equally important, and in my address today I propose to dwell upon that issue squarely – what could potentially lift up the Indian economy to trend growth as the recovery begins?

7. While interacting with members of the National Council of the Confederation of Indian Industry (CII) on July 27, 2020, I had covered five major dynamic shifts taking place in the economy: (i) fortunes shifting in favour of the farm sector; (ii) changing energy mix in favour of renewables; (iii) leveraging information and communication technology (ICT) and start-ups to power growth; (iv) shifts in supply/value chains, both domestic and global; and (v) infrastructure as the force multiplier of growth. Today, I would like to touch upon five areas that, I feel , would determine our ability to step up and sustain India’s growth in the medium-run: (i) human capital, in particular education and health; (ii) productivity; (iii) exports, which is linked to raising India’s role in the global value chain; (iv) tourism; and (v) food processing and associated productivity gains.

(i) Human Capital: The Importance of Education and Health

8. Investing in people adds to the stock of skills, expertise and knowledge available in a country, and that is critical to maximise its future growth potential. The assignment of importance to education dates back to Plato, Aristotle, Socrates and Kautilya. Its significance for economic development has received progressively increasing attention in recent decades, especially in the work of several Nobel laureates, including T.W. Schultz, Gary Becker, Robert Lucas and James Heckman. There has come about an explicit recognition of education as human capital in endogenous growth theory, backed up by cross-country empirical evidence.

9. In India, states with higher literacy rates are found to have higher per capita income, lesser infant mortality, better health conditions and also lower poverty. Education and skill development, however, contribute less than half a percentage point to our overall labour productivity growth. In order to reap the demographic dividend, we have to raise expenditure on education and acquisition of skills substantially. It is important to recognise that investment in education pays by raising average wages. In its Global Education Monitoring Report 2012, the UNESCO highlighted that every US$1 spent on education generates additional income of about US$10 to US$15. A World Bank (2014) study showed that an additional year of schooling increases earnings by 10 per cent a year. Higher education also contributes to economic development through greater sensitivity to environment/climate change, energy use, civic participation and healthy lifestyle.

10. The New Education Policy 2020 (NEP), a historic and much needed new age reform, has the potential to leverage India’s favourable demographics by prioritising human capital. The goal to increase public investment in the education sector to 6 per cent of GDP must be pursued vigorously. Public-private partnerships (PPPs) can develop necessary infrastructure, without jeopardising financial viability of private investment while ensuring quality education at affordable costs. Indian banks and the financial system would need to respond proactively to opportunities arising from the NEP for new financing.

11. Besides improving access to education, focus on quality of education and research will be critical to shape the outcome of education on economic development. Skill acquisition is more important than mere mean years of schooling. The assessment of quality aspect of education often requires a multi-dimensional approach: reading and language proficiency; mathematics and numeracy proficiency; and scientific knowledge and understanding¹. The emphasis on quality of education must begin at the foundation stage in schools up to plus 2 level. At another level, the formation of the National Research Foundation as announced in the NEP is a welcome step to fund outstanding peer-reviewed research and to actively promote research in universities and colleges. The creation of a National Educational Technology Forum as a platform for use of technology in education is a necessary step to meet the requirement of rapidly changing labour market.

12. Health is another vital component of human capital. Good health increases life expectancy and productive working years. In high income countries, per capita health expenditure in 2017 was about US$ 2937, as against US$ 130 in low middle-income countries (which include India). Initiatives such as the Pradhan Mantri Bharatiya Jan Aushadi Pariyojana (PMBJP) and Pradhan Mantri National Dialysis Programme (PMNDP), free drugs and diagnostic service provision initiatives are expected to improve the quality and affordability of healthcare. The most important step towards providing affordable healthcare has been the launch of the Ayushman Bharat Yojna, which lays down the foundation of a 21st century health care system, covering both government and private sector hospitals.

13. COVID has brought to the fore the importance of easy access to health services to contain the mortality rate, given significant inter-state and intra-state differences in healthcare infrastructure. While laudable crisis time response to scale up health infrastructure has helped in dealing with the health emergency, a more comprehensive approach similar to NEP for the health sector may be warranted, which must also cover deeper penetration of insurance, given the high burden of out of pocket expenses in India, and also preventive care. Greater attention is required to improve the health ecosystem by ensuring creation of new medical colleges, higher number of PG seats and colleges for paramedics and nursing.

(ii) Productivity growth

14. By any reckoning, COVID-19 will leave long lasting scars on productivity levels of countries around the world. According to a recent World Bank assessment², COVID-19 could entail adverse effects on productivity because of dislocation of labour, disruption of value chains and decline in innovations. During earlier episodes of epidemics in the past – Severe Acute Respiratory Syndrome (SARS), Middle East Respiratory Syndrome (MERS), Ebola and Zika – productivity is estimated to have declined by about 4 per cent over three years. The COVID impact on productivity could be expected to be much larger.

15. KLEMS (capital; labour; energy; materials; and services), a database hosted by the RBI, shows that the Indian economy experienced an overall productivity growth of 0.9 per cent per annum, on an average, over the period 1980-81 to 2017-18. In the immediate post-GFC period – from 2008-09 to 2012-13 – there was a decline in productivity by 0.3 per cent annually, while the period thereafter upto 2017-18 recorded annual productivity growth of 2.4 per cent. The contribution of productivity growth to the overall GDP growth of the Indian economy over the period 1980-81 to 2017-18 was about 15 per cent. During 2013-14 to 2017-18, its contribution increased significantly to about 34 per cent.

16. The share of patents applied and granted to India in total patents granted globally has been rising in recent years. India’s share, however, continues to be low at less than 1 per cent. Globally, the private sector plays a major role in R&D expenditure, while in India, a major part of R&D expenditure is incurred by the government, particularly on atomic energy, space research, earth sciences and biotechnology. Stepping up R&D investment in other areas would require more efforts by the private sector, with the government focusing on creating an enabling environment.

17. With a view to further promoting innovations in financial services, the Reserve Bank has announced an Innovation Hub with a focus on new capabilities in financial products and services that can help deepening financial inclusion and efficient banking services. Ongoing efforts are yielding results. India has recently entered the group of top 50 countries in the global innovation index (GII) list of 2020 for the first time. The India Innovation Index, released by Niti Aayog last year, has been widely accepted as a major step in the direction of decentralisation of innovation across all states of the country. Sustaining this process will be vital, given particularly the trend decline in saving and investment rate in India.

(iii) Exports and Global Value Chains (GVCs)

18. In the post global financial crisis (GFC) period, a view has emerged that the era of export-led growth is over, and India missed the opportunity by not prioritizing exports at the right time. Globally, the key impediments to exports post-GFC include: (a) generalized increase in protectionism by trading partners; (b) weak global demand conditions; (c) race to the bottom (to gain unfair competitive advantage, by using a policy mix of competitive depreciation, subsidies, tax and regulatory concessions); and (d) automation, reducing the cost advantages stemming from cheap labour.

19. Notwithstanding these impediments, and also the significant decline in trade intensity of world GDP growth in the post-GFC period, opportunities for expanding exports arise from the vastly altered global landscape for trade where more than two thirds of world trade occurs through global value chains (GVCs)³. The higher the GVC participation of a country, the greater are the gains from trade as it allows participating countries to benefit from the comparative advantage of others participating in the GVC. Services such as transportation, banking, insurance, IT and legal services, branding, marketing and after sale services are integral to GVCs.

20. India’s participation in GVCs has been lower than many emerging and developing economies. India has global presence in low GVC products such as gems and jewellery, rice, meat and shrimps, apparels, cotton, and drugs and pharmaceuticals.

21. Among the sunrise sectors that offer potential for higher exports in the post-COVID period are drugs and pharmaceuticals where India enjoys certain competitive advantages. With strong drug manufacturing expertise at low cost, India is one of the largest suppliers of generic drugs and vaccines. Some Indian manufacturers have already entered into new partnerships with global pharma companies to produce vaccines on a large scale for both domestic and global distribution. The Government has also approved an investment package for promotion of bulk drug parks and a production-linked incentive scheme is in place to enhance domestic production of drug intermediates and active pharmaceutical ingredients. A sharp policy focus on other GVC intensive “network products”, including equipment for IT hardware, electrical appliances, electronics and telecommunications, and automobiles would also provide the cutting edge to India’s export strategy with considerable scope for higher value additions.

22. Domestic policies need to focus on the right mix of local and foreign content in exports while aiming to enhance participation in GVCs. Firms that engage in both imports and exports are found to be far more productive than non-trading firms (World Bank, 2020)⁴. While choosing trade partners through free trade agreements (FTAs), it is also important to learn from global experience and nurture those trade agreements that go beyond traditional market access issues. Provisions relating to investment, competition, and intellectual property rights protection have a larger positive impact on GVC trade and need to be assiduously cultivated and ingrained into India’s export ecosystem.

(iv) Tourism as an Engine of Growth

23. Tourism has been one of the sectors in the economy most severely impacted by COVID-19. At the same time, this is also a sector where pent up demand could drive a V shaped recovery when the situation normalises.

24. India has immense potential to meet a diverse range of tourist interests – religion; adventure; medical treatment; wellness and yoga; sports; film making; and eco-tourism. We have four major biodiversity hotspots, 38 UNESCO World heritage sites⁵, 18 biosphere reserves, over 7,000 km of coastline, rain forests, deserts, tribal habitation and a multi-cultural population. The challenge nevertheless is to scale up our tourism market and enhance its contribution to economic development.

25. As per the Third Report of Tourism Satellite Account for India (TSAI) 2018, the share of tourism in GDP was 5.1 per cent in 2016-17 and the share in employment was 12.2 per cent (with the direct and indirect shares at 5.32 per cent and 6.88 per cent, respectively). In 2018-19, tourism’s share in employment increased further to 12.8 per cent, with the total size of employment at 87.5 million. The employment elasticity in this sector, thus, appears to be high. India attracted 10.89 million foreign tourists in 2019, an increase of 3.2 per cent over the previous year. The foreign exchange earnings generated by the sector during the same period was about ₹2 trillion, a year-on-year increase of more than 8 per cent. The country also jumped six positions to 34 out of 140 counties in the Travel and Tourism Competitiveness Index 2019 of the World Economic Forum (WEF).

26. Recognising the potential of the sector, the Government has provided targeted policy support. The Ministry of Tourism has two major schemes: Swadesh Darshan for Integrated Development of Theme-Based Tourist Circuits; and PRASHAD as a Pilgrimage Rejuvenation and Spiritual, Heritage Augmentation Drive for development of tourism infrastructure in the country, including historical places and heritage cities.

27. The multi-pronged supportive policy interventions in the sector may have to be reviewed and revamped, if tourism has to contribute more to the economy matching its potential. A closer look at some of the global leaders in travel and tourism such as France and Spain would suggest that these countries not only have excellent natural and cultural resources, but policies to support an exceptionally attractive tourist infrastructure, including a high hotel density offering all range of choices, quality public transport systems, networked air connectivity with considerable route capacity, and most importantly, safety and security.

28. Initiatives need to be taken in the direction of improving and integrating various modes of transportation (linking air/train/metro/road/sea) with the provision for single point of booking, e-registration of service providers (travel agents, transport operators, hotels, tourist guides, etc.). Strict provisions of penalty for non-compliance would boost confidence of tourists, alongside an effective and speedy grievance redressal system for both domestic and foreign tourists. Research conducted by a private agency⁶ suggested that if we can increase international tourist arrivals to 20 million (i.e., about double of current arrivals), the incremental income would be US$19.9 billion, benefiting an additional 1 million people in the travel and tourism industry.⁷

(v) Food Processing for Surplus Management

29. COVID has brought the importance of food security and food distribution or supply chain network to the forefront of public policy debate in India. Successive years of record production of foodgrains and horticulture crops has transformed India into a food surplus economy. Recognising this challenge, much of the policy attention in recent years for the sector has focused on addressing post-production frictions, comprising agri-logistics, storage facilities, processing and marketing. Greater focus on processed food is one option that could help in dealing with multi-pronged challenges of surplus management. Development of the food processing industry is likely to benefit the farm sector and the economy through greater value addition to farm output, reducing food wastages, stabilising food prices, expanding export opportunities, encouraging crop diversification, providing direct and indirect employment opportunities, increasing farmers’ income and enhancing consumer choices.

30. Food processing is a sunrise industry. Globally, its importance in the consumer basket has increased over time, led by rising per capita incomes, urbanisation, and change in consumer perceptions regarding quality and safety. Despite having huge growth potential, the food processing industry in India is currently at a nascent stage, accounting for less than 10 per cent of total food produced in the country. As a result, despite being one of the largest producers of several agricultural commodities in the world, India ranks fairly low in the global food processing value chain.

31. There is a need to move up the value chain. Moreover, the food processing industry in India is largely domestically oriented, with exports accounting for only 12 per cent of total output. India can move up in the global agricultural value chain by increasing its share of processed food exports, for which quality standards will be a critical factor.

32. Food processing also offers huge employment potential. In India, while the food processing industry’s contribution to overall Gross Value Added (GVA) is only 1.6 per cent, it accounts for 1.8 million (12.4 per cent) and 5.1 million (14.2 per cent) jobs in registered and un-incorporated sectors, respectively. Recognising this, the government has set the target for raising the share of processed food to 25 per cent of the total agricultural produce by 2025. The food processing sector was also opened up for 100 per cent FDI in 2016 under the automatic route. Further, in 2017, 100 per cent FDI under the government route for retail trading, including through e-commerce, was permitted in respect of food products manufactured and/or produced in India. For ensuring adequate credit flows, the Reserve Bank has accorded priority sector status to the food processing industry in 2015.

Conclusion

33. In my address today, I have highlighted five critical areas that can determine the shape of our post-COVID trend growth. While dealing with the immediate crisis management challenges, we need to strategically prepare for our combined overriding goal – the pursuit of strong and sustainable growth. The private business sector has a critical role in each of the five areas I covered today. The enabling policy environment would evolve around the initiatives taken by India’s businesses to seize these opportunities and actualise the potential of the Indian economy as a rising economic power of the 21st century. COVID-19 has changed our lives and it is increasingly clear that life will never be the same again. We should look upon these fundamental changes as opportunities rather than threats, converting them into game changing new vistas of progress. I do believe that together as a nation, we can certainly do it. Let me conclude on this optimistic note.