The Hindu : Business : RBI policy to focus on inflation, interest rates

Online edition of India's National Newspaper
Tuesday, Oct 26, 2004

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Business

RBI policy to focus on inflation, interest rates

By Oommen A. Ninan

MUMBAI, OCT. 25. Bankers and market participants keenly await the Reserve Bank of India's mid-term Review of Annual Policy for 2004-05 as it comes at a time when the economy is beset with several pressing issues such as rising inflation. While some expect a 25 basis point rise in interest rates, many however feel that the RBI Governor, Y. V. Reddy, is likely to allow the stable interest rate to continue without any upward revision. But he is certainly expected to revise the Gross Domestic Product (GDP) growth and inflation forecast.

GDP growth forecast

"The direction in the movement of interest rates will be clear and the rate may remain stable for the time being with an upward bias. Perhaps Dr. Reddy may revise the earlier projections of inflation and GDP growth,'' said Cherian Varghese, Chairman and Managing Director of Corporation Bank. "There could be some clarity on the utilisation of investment fluctuation reserve by the banking industry. There will be an emphasis on customer service and reduction in transaction cost. We can also expect some guidelines on voting rights, particularly in private-sector banks. There could also more emphasis on infrastructure financing,'' Mr. Varghese added.

"Stable interest rates are expected to continue," said Hemendra Kothari, Chairman, DSP Merrill Lynch. According to him "there are issues on inflation and we have to see what guidance the RBI would give as high oil prices and the burgeoning deficit are major concerns.''

"There is a tough balancing act the RBI has to do,'' said Sanjeet Singh, Economist, ICICI Securities. On the one hand, the growth outlook is somewhat moderated because of relatively poor monsoons and uncertainty on global growth in the face of high oil prices. This is prompting demand for status quo on interest rates from a large section of the economy. On the other hand, a section feels that significant inflationary pressures necessitate a rise in rates. The challenge for the RBI is to contain inflation and at the same time ensure that growth and investment spending do not get too adversely affected. "So all considered some adjustment in interest rates is needed. Thus the possibility of a 25 basis point rise in Repo rate (a benchmark for short-term interest rate) should not be disregarded,'' Mr. Singh felt.

In the past few years, the favourable interest rate environment advocated by the central bank has played a critical role in the growth of the economy. It has supported the resurgence and global competitiveness of Indian industry and the ability of the growing young middle-class to acquire long-term assets and spend on ongoing consumption which in turn contributes to demand and growth.

The Government also seems inclined to keep the interest rate at the current levels, if it is not possible to lower it. The direction of the last Union budget was in favour of benign interest rates, as this would sustain the credit uptake needed to ensure investment growth.

The logic of the Government and RBI is that lower interest rates will continue to contribute to the growth in retail finance, with a cascading effect on sectors such as housing and automobiles and other sectors with strong linkages to these areas. This will also help the agricultural sector access cheaper financing without this facility impairing bank profitability.

Corporates to benefit

Corporates will continue to benefit from lower borrowing costs, making them globally competitive. Continued lower interest rates are required, as this will spur investment in the economy, with the Government having identified heavy investment in key sectors such as infrastructure and manufacturing as being the drivers of growth. This will create a multiplier effect in the economy, leading to the removal of poverty, increased growth and employment, which are the focus areas of the United Progressive Alliance (UPA) Government.

However, inflation remains a major concern. The Union Finance Minister, P. Chidambaram, had felt that rising inflation was a temporary phenomenon and expressed his confidence that the country would overcome the situation.

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