The Hindu : Business : Credit policy: another balancing act

Online edition of India's National Newspaper
Monday, May 02, 2005

Business

Business

Credit policy: another balancing act

The monetary policy's principal task of balancing the claims of price stability with the credit requirements is becoming complicated

It is appropriate for the RBI to disseminate monetary information in a structured form every quarter, says C. R. L. Narasimhan.

— Reuters

CALIBRATED MOVE: Reserve Bank of India Governor Y. V. Reddy at a meeting with bankers in Mumbai last week.

CONCERNS OVER inflation dominate the credit policy statement. A 25 basis points increase in the reverse repo rate, the rate at which banks place money with the Reserve Bank of India in the short-term, may be the only monetary measure announced. But the absence of more visible announcements such as variations in the Bank Rate and the CRR (cash reserve ratio) does not in any way lessen the central bank's preoccupation with inflation. On the contrary, the increased reliance on short-term repo rates indicates the shift that has taken place in monetary management. The emergence of open market operations (OMO) as a significant monetary weapon necessitates frequent fine-tuning of the short-term rates.

Contextually too the time has come in India to push these to the forefront. The reverse repo rate was hiked by an identical margin of 0.25 percentage points at the time of the last mid-year review in October 2004. Slightly earlier, the CRR was marked up by 50 basis points (in two stages) to drain Rs. 8,750 crores of liquidity. While excess liquidity continues to be an issue, the RBI has not resorted to a CRR rise, probably because under the reform agenda, statutory pre-emptions are to be phased out. In fact, the CRR has been sharply lowered in stages. Any increase in the CRR is meant to be temporary. As for the Bank Rate, which is now at 6 per cent, one gets the feeling that it will again go back into a period of hibernation. For a very long time this orthodox signalling device was in disuse and even after it was revived in the late 1990s it was seen to have less utility.

Repo rate hike

In any case repo rate manipulations are more subtle and fit into the RBI policy of calibrated responses to the emerging situation. Outlining the measures that it took last year, the RBI listed the following as challenges that prompted a change in the mid-term review (October 2004).

(a) Excess liquidity of over Rs. 81, 000 crores. (b) An unanticipated spurt in the WPI (Wholesale Price Index) inflation in the first half of 2004-05. The problem was compounded by the fact that the seasonal decline in food prices did not materialise because of a deficient monsoon. (c) International commodity prices have remained high and are nowadays getting reflected in domestic prices. (d) Interest rates were at historically low levels and the possiblity of upside risks was correspondingly high. (e) The reaction of the financial markets to all these uncertainties has been adverse.

All these developments occurred at a time when industrial growth was finally picking up after a long period of sluggishness. The monetary and credit policy has always involved a deft balancing of the needs of growth with containing inflationary expectations. The middle of last year was clearly a time for one such act. Working in tandem with the Government, the RBI worked out a package that helped interest rates stabilise albeit at higher levels. More positively, industrial credit grew at a furious pace (the second highest recorded growth in 55 years took place last year). Equally important, the Government's borrowing programme went through without major glitches.

The stance for 2005-06 has naturally been dictated by the same factors. Additionally, prospects for growth look good although it is conceded that the oil shock may upset calculations. The record credit growth of last year needs to be sustained. At the same time a much larger government borrowing programme for this year needs to be accommodated. The interest rate policy nowadays needs to factor in international developments.

External shocks

Interest rates in the U.S. are headed upwards. As for India's external sector, there is every reason to think that the present resilience will sustain. The current account has recently gone into deficit after three years of surplus but the capital account continues to be in surplus.

There is a danger of globally transmitted shocks to the external sector. Hence it is that the stance of monetary policy remains the same as the one set out in the October 2004 mid-year review.

— Provision of appropriate liquidity to meet credit growth and support investment and export demand in the economy while placing equal emphasis on price stability

— Consistent with the above, to pursue an interest rate environment that is conducive to macroeconomic and price stability and maintaining the momentum of growth.

— To consider measures in a calibrated manner, in response to evolving circumstances with a view to stabilising inflationary expectations.

In a welcome move, the RBI now proposes to interact with the markets and the public on monetary policy issues. This year's policy statement has been divided into two parts, Part I being the Annual Monetary Policy statement and Part II an annual statement on regulatory and development policies.

In addition to the customary mid-year review in October, there will be a first quarter review of Part I in July and a third quarter review in January.

Printer friendly page
Send this article to Friends by E-Mail

Business

News Update

Stories in this Section

Credit policy: another balancing act

Jybe: a co-browsing tool

RBI's guarded approach to interest rate changes

Recognised PFs: effect of cancellation of registration

Presumptive income v real income