The Hindu : Opinion / Editorials : The message is clear on interest rates

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Friday, Jun 10, 2005

Opinion

Opinion - Editorials

The message is clear on interest rates

More than a month after the Reserve Bank of India unveiled its annual policy statement for 2005-06, there are very few indications of the way interest rates are headed even over the short term. The RBI announced a 0.25 percentage point hike in the reverse repo rate but left all other monetary variables, including the bank rate and the cash reserve ratio, unchanged. The reverse repo rate is the rate at which banks place their short-term surplus funds with the central bank. By increasing it, the RBI is signalling a monetary tightening. Given the abundant liquidity in the system, short-term interest rates have not gone up immediately. However, the official central bank perception, based on domestic as well as international developments, is that interest rates will have to go up. The RBI Governor has, on many occasions, pointed out that the interest rate cycle has turned from the low observed during 2003-04. Interest rates in many countries, including the United States, are moving up. In India, inflation continues to be a worry, although it started moderating from October 2004. Global oil prices continue to rule high. The full pass through effect of sticky global oil prices has not been factored in. The credit policy makes the point that "it will be desirable to contain inflationary pressures to stabilise domestic financing conditions both for the government and the private sector."

However, for a number of reasons abandoning the benign interest policy is not going to be easy. Industrial growth has been robust over the past year. Credit disbursement by banks to industry has been at record levels. Banks have also lent more to agriculture. If bank loans become more expensive, both industry and agriculture will suffer. The large government-borrowing programme planned for the year will be costlier in a higher interest rate regime. These are factors arguing for a continuation of a softer interest rate regime. Finance Minister P. Chidambaram has remarked that there is no reason why interest rates should change. However, with most interest rates now determined by the market, there is very little official policy can do except to moderate a steep hike in market-determined rates. Maintaining price stability continues to be a key task of monetary policy. Much will depend on the monsoons and, of course, global oil prices. The official dilemma over the immediate direction of interest rates probably explains why the RBI, while advocating the need to dampen inflationary expectations, has stopped short of sending out an overt signal by, say, hiking the bank rate. The overall message, however, is clear enough: interest rates will go up. Refreshingly, the credit policy has called upon banks to pay attention to depositors and deposit mobilisation. At one level, this is an exhortation to go back to banking basics. At another level, it is a reminder to the banks to price their deposit schemes in line with the market.

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