Date:19/04/2006 URL: http://www.thehindubusinessline.com/2006/04/19/stories/2006041901501000.htm

Back RBI intrigues to interest

The Credit Policy is remarkable for its critical interventions in banking operations and a leave-well-alone approach.

Perhaps the most significant feature of the Reserve Bank of India's Annual Monetary Policy statement for the new fiscal is that the central bank has not done what it was expected to do. Interest, repo rates and, most surprising, the CRR (cash reserve ratio) have been left unchanged disappointing those who expected a drop in them and surprising the others who anticipated a rise. In short, the RBI's latest policy is an anticlimax. And, yet, it is remarkable for that very reason.

By leaving alone the interest rates, the RBI has transmitted a message of confidence in the financial system and itself, to manage its affairs on business lines and to use market mechanisms, such as the Liquidity Adjustment Facility and the Market Stabilisation Scheme, to iron out any volatility in liquidity. By not lowering the CRR, as suggested in the previous review, the RBI has sent the message that the banking system is stocked with liquidity to fuel projected levels of growth. In 2005-06, the credit-deposit ratio rose to over 70 per cent. In fact, the pace was searing with credit growth outpacing deposits "by a substantial margin". For the first time since 1969, scheduled commercial banks' investments in government securities declined by Rs 11,576 crore in contrast to an increase of Rs 49,373 crore the previous year. That the largest beneficiary was the non-food sector, and within that the retail sector including housing finance, has the RBI worried and this defines the policy's major concern: Credit quality and financial stability. The central bank has responded by: One, raising the risk weight on exposures to commercial real-estate to 150; and, two, raising the provisioning for standard advances for personal loans and residential housing beyond Rs 20 lakh to one per cent.

If so far the policy is remarkable for its critical interventions in banking operations and a leave-well alone approach, it turns remarkable for the wrong reasons. While the concern for the quality of assets and the inflationary risks of such credit is understandable, what is not is the prospect of a "calibrated deceleration" of non-food credit in the new fiscal to 20 per cent from 30 per cent in 2005-06. This is an ominous signal, especially in view of the central bank's observation of the poor participation of banks in government securities last fiscal. There is a real danger of the baby being thrown out with the bathwater and the productive economy being made to feel a credit squeeze in the drive to control inflation, prevent a decline in asset quality and, most dangerously, fund government extravagance. By not raising interest rates so far the RBI has, to its credit, bucked a global trend; barring Britain and China, interest rates are hardening everywhere. But will its desire for decelerated non-food credit growth this year end up spoiling the growth story?