Date:27/10/2004 URL: http://www.thehindubusinessline.com/2004/10/27/stories/2004102700661100.htm

Back Bracing the economy

R. Ravimohan

THE Credit Policy announced today is significant for the signals it sends out. Inflation and fiscal discipline are highlighted as incipient problems, and the policy braces the economy for these. The review , therefore, is timely and appropriate, despite its lukewarm reception by the markets.

Investment will be funded by both banks and the bond market. While yields in the bond market have shown signs of tightening in recent times, the credit market has remained relatively immune to upward pressures on interest rates. CRISIL expects the benchmark G-Sec yield to be at 7 per cent by end of FY2005.

Given the healthy deposit growth, the liquidity in the banking system, and the high levels of inter-bank competition, the banks are not likely to increase lending rates as yet. Banks will probably feel the impact of lower lending margins in the medium term, as depositors require more interest to counter higher inflation. Pressures on treasury portfolios will also force banks to re-examine lending rates at that time.

Entities looking at capital expenditure should focus on securing full funding for their capital projects, and should estimate interest rates conservatively while calculating project viability, given heightened expectations on the interest rate front. In the light of high levels of capacity utilisation witnessed across sectors, investments are fairly certain, and are not likely to be swayed only by interest rate considerations. CRISIL estimates a GDP growth of 5.6 per cent this fiscal. Measures to shorten the minimum tenor of commercial paper to seven days, and to mandate reporting of CP transactions on the Negotiated Dealing System (NDS) will improve transparency and liquidity at the short end of the money market.

On a different note, higher risk weights for housing loans will slow the healthy growth rates in this sector, as banks increase lending rates to compensate for the increased capital charge. CRISIL estimates that the additional capital allocated for housing loans by the banking system would be about Rs 20 billion. In course of time, the increased risk weight, along with higher interest rates, can be expected to impact some core sector industries.

(The author is Managing Director & CEO, CRISIL Limited.)