The Hindu : Business : RBI's concern over rising prices

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Monday, Nov 01, 2004

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RBI's concern over rising prices

The monetary authorities are concerned over the zooming crude prices in world markets and the all-pervasive effect of dearer crude and petro products on the economy.

THE GOVERNOR of the Reserve Bank, Y. V. Reddy, has undertaken the mid-term review of the Credit Policy for 2004-05 with circumspection as he is keen to ensure price stability with a moderation of inflationary pressures while aiding economic growth at the desired rate with appropriate decisions to be taken whenever necessary. The monetary authorities are concerned over the zooming crude prices in world markets and the all-pervasive effect of dearer crude and petro products on the economy.

The inflation rate had risen to the peak level of 8.33 per cent during the last week of August but had declined to 7.1 per cent in the week ended October 9 and the Government has deferred its decision to revise selling prices for gasoline and diesel. As even the lower inflation rate is much higher than the 4.32 per cent in April this year, it is felt that inflationary pressures should be carefully watched.

Continued high oil prices will impact the Gross Domestic Product (GDP) growth. The estimate for the current year has already been lowered to 6 - 6.5 per cent from 6.5-7 per cent indicated in April.

Global oil prices have softened and it is to be hoped that they will not again climb up as they did recently when the rate shot up to over $55 per barrel after dropping to $44. It is, therefore, anticipated that the inflation rate will be around 6.5 per cent in 2004-05 against the earlier anticipation of 5 per cent.

In view of the strong economic revival in the past 12 months and the anxiety of the UPA Government to create conditions for hastening growth, the Bank Rate has been left unchanged at 6 per cent contrary to expectations in some quarters and the Cash Reserve Ratio (CRR) at 5 per cent. The repo rate, however, will be higher by 0.25 percentage point at 4.75 per cent in order to minimise the existing liquidity and encourage repo operations in a big way. The hike in the repo rate and the raising of the ceiling of interest rates applicable to external deposits by 50 basis points above the U.S. dollar LIBOR have led to the impression in money market circles that the policy of cheaper money cannot be pursued unless the abnormalities in the economic situation disappear completely.

The Bank Rate was reduced to 6 per cent on April 29, 2003 in stages from 8 per cent on March 10, 2001. The CRR was lowered to 4.5 per cent from 4.75 per cent with effect from June 14, 2003. Subsequently, the CRR was hiked to 5 per cent in two stages. The amount immobilised was Rs. 8,000 crores.

The reaction to the latest RBI decisions in industry and stock market circles has been favourable and the BSE index staged a smart recovery to 5715.62 on October 28 from 5559.04 on October 26. In Friday's session, however, the index finished lower at 5672.27 due to profit taking.

The half-yearly results from established industrial enterprises have also been encouraging and the feeling is gaining ground that equity values will remain at high levels though sentiment in the gilt-edged market is still inclined to be cautious, if not bearish.

Sizable fresh borrowing

The scheduled commercial banks also have to lighten their holdings of government and approved securities as there is a surge in demand for bank credit.

It is also feared that institutions having sizable holdings of medium and long dated securities will sustain significant losses, especially as the Union Finance Minister has indicated that fresh borrowing will be on a 'marginally' costlier basis in coming months.

The Central Exchequer has to complete its gross borrowing through market loans for 2004- - 05 in November-March. Up to October 21, gross market borrowing amounted to 75,044 crores constituting 49.8 per cent of the Budget estimates. If there is an enlargement of the fiscal deficit on account of higher non-plan expenditure, fresh borrowing may have to be on a larger scale.

The money market may witness stringent conditions during the busy season and it may be considered desirable to reduce the CRR by at least half percentage point to the earlier level of 4.5 per cent early next year.

While fresh developments in the money market circles have to be watched, it is heartening to note that incremental bank credit at Rs. 95,120 crores in the current financial year up to October 1, constituted 99.5 per cent of incremental deposits of Rs.95,598 crores. In the corresponding period a year ago, incremental bank credit at Rs. 28,927 crores accounted for only 27.09 per cent of incremental deposits.

The strong demand for credit is indicative of a fairly high level of economic activity, as exports have risen by 24.4 per cent to $ 33.75 billion in April-September against $ 27.13 billion a year ago. With an increase in the oil import bill to $ 14.54 billion from $ 9.21 billion and in non-oil imports to $ 31.87 billion from $ 25.34 billion, the trade deficit has increased to $12.65 billion from $ 7.42 billion.

In spite of a bigger trade gap, a surplus of $ 1.9 billion has been reported on current account in April-September. This is due to the fact that invisible receipts have been rising at a faster rate and the balance of payments position remains sound.

Banks in a dilemma

Though the credit deposit ratio of SCBs has been rising significantly, it is worried that treasury operations will not be as rewarding as in 2003-04 and that it may even be necessary for many institutions to make provisions against depreciation in value of government and approved securities as has already done by Corporation Bank and others out of the profits for April-September.

The apprehensions in this regard were responsible for a significant drop in equity values of banks. There are reports that every effort may be made by the Union Finance Ministry to avoid a big increase in coupon rates of new loans as well as in their current and redemption yields.

If crude prices decline in world markets in the coming months and the yields of food and cash crops in the rabi season also turnout to be better than anticipated, it may even be possible to achieve a growth of 6.25 - 6.75 per cent in GDP. As the troubles now experienced by the economy are due mainly to imported inflation, any favourable trend in prices in world markets for various products will have a triggering effect.

P. A. Seshan

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