The Hindu : Business : Credit policy is for individuals too

Online edition of India's National Newspaper
Monday, Nov 01, 2004

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Business

Credit policy is for individuals too

For bank depositors there is very little to cheer. High growth bank business, especially involving home loans, has been cautioned.

THE MID-YEAR review of the monetary and credit policy announced recently has as its central theme the management of inflationary expectations. However, there has been only one overt inflation — fighting signal — an increase in the repo rate by 0.25 percentage points to 4.75 per cent. The repo rate is the rate at which the Reserve Bank of India takes money from banks against securities. Its increase is an indication that the central bank is still concerned about excess liquidity, notwithstanding the fact that it had marked up the CRR by 0.50 percentage points only recently. The CRR hike, by impounding funds with banks, reduces the level of liquidity.

What impact does the mid-year review have on individuals? Even a policy statement so completely oriented towards banks and other market participants can have meanings for the common man. Inflation, of course, is everyone's concern. This time, its principal cause — persistently high oil and commodity prices — affects individuals directly without having to be articulated by monetary policy. In fact monetary policy can only address the consequences of `supply side shocks.' For that matter there is very little that anyone can do about oil and commodity prices. Cushioning the shock through tax reduction and asking the oil companies to bear part of the burden are temporary solutions. Ultimately the economy has to bear the brunt of the high oil prices.

End of cheap credit

For the common man, the one clear message from the monetary policy is that the era of historically low interest rates has come to an end. The RBI has sharply raised the inflation target from 5 to 6.5 per cent and says that maintenance of price stability will be a prime goal, ranking on a par with its other objective of providing liquidity for credit and investment needs. The two goals may conflict with each other. For, if in the process of targeting inflation the RBI were to signal (more aggressively than now) a higher interest rate or take steps to contract liquidity, the cost and volume of credit will be affected. Naturally, retail borrowers — home loans and other forms of retail lending have almost wholly lifted the aggregate credit offtake (until recently anyway) — will have to pay more. They may also be faced with a situation where the lenders will be less forthcoming in pushing their loan products.

Caution on home loans

The RBI has cautioned home loan providers by raising the risk weightage on home loans portfolio by 0.25 percentage points, a move which will require banks to assign more capital. Further, it has called upon the banks to ensure the quality of lending. Having stated as much earlier, the RBI sends out a message that reckless lending to home loan clients can be very costly to the system as a whole. The home loan scenario will be watched with considerable interest from now on. With the likelihood of interest rates hardening, banks and institutions have already become wary of giving fixed rate loans.

For depositors the review has no positive message. Those who have invested in fixed deposits — and their numbers are substantial — are already earning a negative return. Perhaps there is little that the central bank can do to ameliorate their lot. In a decontrolled interest rate regime it is for the banks to increase their deposit interest rate structure.

One of the key reasons for their not offering an `inflation beating' interest rate on their deposits is that there is simply no competition while collecting deposits. Only when other investment avenues such as mutual funds become more attractive will bank deposits face some semblance of competition. Finally, the credit policy review has placed in a proper perspective the impact of global oil prices on the domestic price situation. The central bank has pointed out that every dollar increase in crude prices could potentially add 15 basis points to WPI inflation as a direct effect and another 15 basis points as indirect effect. If the entire global price increase since January had been passed on to domestic consumers the current inflation rate of 7.1 would have been higher by 1.1 percentage points and by another 1.1 percentage points with a lag due to indirect effect. Clearly global oil prices are the biggest worry for the RBI as indeed they are for the common man.

C. R. L. Narasimhan

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