rose significantly over recent weeks, primarily on growing concerns over the debt crisis in the Eurozone.

As the euro came under severe pressure following the European finance ministers failure to come up with measures to resolve the debt crisis in the region, local banks continued building positions in the US dollar. On the domestic Indian market, persistent inflation, a widening trade deficit, and the fall in local shares all contributed to the rupee depreciation. India's foreign-exchange reserves fell to USD312.23 billion on 7 October from USD295.79 a year earlier. As the rupee dipped to near two-year lows in recent weeks, the Reserve Bank of India has been seen selling US dollars to curb the volatility in the in the currency market for the first time in 2011, which led to a slight depletion of foreign reserves. In addition, the build-up of reserves moderated on rising trade deficit and weaker foreign capital inflows as both global trade and investors confidence already started feeling the pinch from rising global economic and financial uncertainty. The government is slowly laying the groundwork for full currency convertibility in the medium term. In the last few years, the government has announced the easing of two-way foreign-exchange transactions, a major step in preparation for the capital-account convertibility of the rupee. The new measures make it easier for mutual funds, corporations, and individuals to invest in overseas assets. Currently, the Indian rupee is fully convertible on the current account, and partially convertible on the capital account, which implies the free convertibility of foreign currencies to the rupee for the purposes of effecting investments in India. Full convertibility to the capital account would enable the rupee to be converted to foreign currencies, at a predetermined fixed rate, without restriction. Capital-account convertibility is expected to receive a fresh impetus through the announcement of additional liberalization measures in the medium term. Currently, controls preventing the free outflow of capital are fueling rapid money-supply growth generated by central bank intervention to neutralize the impact of huge foreign capital inflows on the exchange rate. The scale of such interventions is reflected in the rapid growth of foreign-exchange reserves, and high levels of liquidity are also supporting rapid credit growth. Capital-account liberalization would also support more productive allocation of resources, by allowing domestic companies access to global financing. Reconciling the need for time to complete reforms with the end goal of full capital-account liberalization, the government has adopted a three-stage process, which is due to be completed during the medium term. Gradual relaxation of controls is proceeding. The latest measures include an increase in the aggregate overseas investment ceiling for mutual funds now to USD5 billion, up from USD4 billion, while Indian companies are now permitted to invest up to 400% of their net worth in joint ventures and subsidiaries without the prior approval of the government. Indian companies listed on domestic bourses are now permitted to invest up to 50% of their net worth in portfolio investments, compared with the previous benchmark of 35%, while the limit on prepayment of external loans by domestic companies without prior central bank approval was raised by USD100 million to USD500 million.

Economic Policy: Monetary Policy and Outlook

Created on 11 Nov 2011

Page 13 of 27

Economic Policy: Monetary Policy and Outlook

While another interest-rate hike is likely warranted before the end of 2011, gradual monetary policy reversal can be expected in 2012. Following its latest 25-basis-point rate hike on 16 September 2011, the central bank will likely push through another hike of a similar magnitude before the end of 2011, possibly even in October, given that inflation is still running significantly above its usual comfort zone of 56%. The recent petrol price hike by the state-owned companies will also likely spark a new inflation episode, suggesting that another hike might be imperative to preserve the current anti-inflationary stance. Nonetheless, the undertone of the latest monetary policy announcement suggests that the aggressive 19-month long tightening cycle might be coming to an end, given the softening in economic activity and rising external risks to growth. The Reserve Bank of India (RBI) has previously downplayed worries about slowing economic growth in India and repeatedly stated that containing inflation was the bank's sole mandate. However, as both domestic and global economic conditions worsened since July's policy meeting, the RBI now seems to be more cautious in its future policy approach. Extensive government expenditures have created vast amounts of public debt. Government borrowing already remains steep exerting upward pressure on market interest rates and raising borrowing costs for businesses and consumers. In an environment of rising growth and inflation, the RBI has to balance the need to keep interest rates low to aid the bond market in absorbing the flood of new public debt as well.

Monetary Policy Indicators 2008 Policy Interest Rate (%, end of period) Short-term Interest Rate (%, end of period) Long-term Interest Rate (%, end of period) 6.50 13.31 7.86 2009 4.75 12.19 7.02 2010 6.25 9.98 7.83 2011 8.50 9.75 8.34 2012 8.25 10.98 8.53 2013 7.75 10.27 8.58 2014 8.84 10.41 8.70 2015 9.21 10.48 8.81

Source: Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the 15th of each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release of the GIIF bank. Download this table in Microsoft Excel format

Created on 11 Nov 2011

Page 14 of 27

Copyright of India Country Monitor is the property of IHS Global Insight (USA), Inc. and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.