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Beyond interest rate signals

In its annual credit policy statement for 2006-07, the Reserve Bank of India has announced a two-pronged approach to emphasise its traditional commitment to price stability and to maintaining the flow of credit to the real economy. Without altering any of the traditional interest rate signals — the bank rate, repo rates, and the cash reserve ratio — the central bank has sought to rein in the explosive growth in certain categories of retail loans, especially mortgage loans and advances against shares. Banks have been asked to provide more for their capital market exposures, personal loans, and residential housing loans (above Rs.20 lakh). The risk weight on commercial real estate has been sharply increased. The net result would be to make these loans dearer immediately. Whether that can check the widely perceived asset price inflation in India remains to be seen. An abundance of liquidity for most parts of last year caused a sharp increase in property prices across the country. The surge in domestic stock prices continues. Foreign institutional investors (FIIs) have invested a record $4 billion in just three months of the year. Domestic mutual funds have become big players. While non-food credit has been growing at over 30 per cent recently, the RBI has projected an increase of only 20 per cent during this year. Presumably, much of the calibrated decline will occur in their retail loan portfolio. The RBI has more than once in the past warned banks against recklessness in lending to these sectors.

The RBI has managed to convey its specific economic concerns without having to signal interest rate hikes. The latter course would have been politically unpopular, although justified in the current upward interest rate cycle. The U.S. Federal Reserve and many other leading central banks have been marking up their benchmark rates. Besides, in India there is a specific need to keep inflation expectations under check. The full impact of persistently high international crude oil prices — now in the vicinity of $70 a barrel — has not yet been passed on to the retail level. The inflation target for this year has been set at 5 to 5.5 per cent, compared with the current 4 per cent. Economic performance during 2005-06 has been robust. The advance estimates of the Central Statistical Organisation place last year's GDP growth above 8 per cent. For the current year, the RBI forecasts it to be in the region of 7.5 to 8 per cent, assuming normal monsoons. The Indian economy has been altogether resilient. There are signs of improvement in the fiscal situation and the Government has signalled its return to the path of fiscal responsibility as set out in the Fiscal Responsibility and Budget Management Act. However, high oil prices, elevated asset prices, and the existence of major macro imbalances in the global economy are major threats. Ensuring credit quality and increasing support for infrastructure are the key tasks.

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