Framework for the conduct of macroprudential policy in India: experiences and perspectives

In India, we have a relatively long history of experience with conduct of macroprudential policy. The Reserve Bank has, over the years, attempted to address systemic risks in both its dimensions – the time dimension or procyclicality, and the cross sectional dimension – within a macroprudential framework. The article will review India’s experiences/experiments with macroprudential policy prior to the crisis, during the crisis and more recently, the experience of using countercyclical policy to address the challenges posed by a sharp increase in volatility of exchange rates together with a heightened external deficit. The use of macroprudential policy in India has been extensive and multi-faceted – spanning the banking and non-banking financial sector; addressing asset price spirals and credit booms; encompassing capital flows and systemic liquidity management; dealing with large and complex financial institutions; calibrating the development of the OTC derivative markets; and tackling interconnectedness in the banking and financial sector and between the financial and the real sector. The article will also touch upon the institutional arrangements for financial stability in India, pre and post the crisis. Prior to the crisis, no agency was explicitly granted a mandate for financial stability though the Reserve Bank acted as the implicit systemic regulator. Post crisis, institutional arrangements have been strengthened with the setting up of an inter-agency Financial Stability and Development Council. The article will finally attempt to present the lessons emanating from India’s experience with operationalising a macroprudential policy framework, especially with regard to some of the major emerging questions – signal extraction, use of rules versus discretion in policy making, coordination with other policy segments (primarily monetary policy), assessing the impact of the policy measures, etc. It will then touch upon some of the challenges, viz. developing a framework for systemic risk assessment, assessing and plugging data gaps, and also focus on the challenges for extending the scope of macroprudential policy beyond the financial sector to the corporate sector, specifically for managing risks arising out of corporate leverage and un-hedged foreign exchange exposures, and to the sovereigns.