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Reserve Bank of India not for upsetting growth effort

Mid-term policy review, however, calls for caution in credit expansion at earlier rates

THE GOVERNOR of the Reserve Bank of India, Y. V Reddy, and the Union Finance Minister, P. Chidambaram, are keen that credit expansion should be mainly for constructive purposes and there should not be any jerk in the interest rate structure, which will have a dampening effect on the economy.

Both Dr. Reddy and Mr. Chidambaram have, of course, agreed that the economy is overheated in some segments and there will have to be circumspection when expanding credit to the housing sector, particularly the real estate segment and granting personal loans.

In fact it is emphasised that there should be a balanced credit portfolio and a vigorous effort for mobilising fresh deposits. If this approach was not adopted, the emergence of a credit squeeze cannot be obviated. No difficulty has so far been experienced in expanding credit in a big way, as deposit growth also has been heartening.

It should not, however, be overlooked that the managements of banks have not had any difficulty in finding the required resources as they could utilise the `excess' investments in Government and approved securities for meeting fresh obligations relating to the statutory liquidity ratio (SLR). But this process of minimising fresh investment in Government and approved securities by taking advantage of the excess investments cannot be continued for long.

There will thus have to be caution when expanding credit on ambitious lines. The objective should be to ensure quality of fresh advances so that there is no undue rise in NPAs.

The deposit and lending rates will tend to rise in the absence of a proper match between fresh credit and fresh deposits while observing also SLR. The unprecedented increase in bank credit in three years has obviously been responsible for the growth in demand for various products exceeding supply to some extent.

The pumping of large funds into agriculture and other sectors has perhaps been responsible for the demand exceeding supply of related products, even though major industries have been raising their output, sales and profits. In spite of the rapid progress in the past three years and more, the growth in industrial production has been quite impressive at 10.6 per cent in April-August against 8.7 per cent in the corresponding period in 2005, even with the lag in mining and infrastructure sectors.

Watch on inflation

The outlook for 2006-07 and subsequent years is therefore viewed with optimism. But there is a need to keep a watch on the emergence of new inflationary pressures. It is because the rise in the inflation rate is due more to costlier essential commodities. In fact, the movement in the fuel index indicates that future inflationary pressures will come mainly from sectors where supply constraints prevent meeting the surging demand.

Luckily, the banking system has been able to meet the demand of the manufacturing and other sectors, despite the intention of the Government to lend more to the agriculture sector and allied industries. A liquidity squeeze in the money market has not been experienced.

What is surprising is that banks have been in a position to extend modest support to the borrowing programme of the Central and State governments. These privileged borrowers may not be compelled to exceed the targets for borrowing for the current year as there has been a distinct improvement in the finances of the State governments thanks to buoyancy in revenues and the impact of VAT.

The Centre also may be adhering to the lower targets for revenue and fiscal deficits. The target for net borrowing for 2006-07 may not therefore be exceeded, though interest charges may be higher because of a further rise in yields of various types of securities.

The heady inflow of FII funds due to confidence in the ability of the economy to register sustained growth has also been responsible for the boom in the bourses and the BSE index has soared to new high levels, the finish being quite firm on Friday at 13297.93.

With a surge in inflows of FIIs and others and buoyancy in stock markets, forex reserves have been registering a significant net rise even with freer use of funds abroad for remittance, investment and other purposes on capital account.

The immediate outlook for the economy is therefore viewed with optimism as the efforts to attract foreign direct investment in a big way and the development of SEZs on ambitious lines may place the economy on a new growth path as visualised by the Prime Minister.

P.A. SESHAN

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