BOMBAY, 10 November 2003 — The eagerly awaited Monetary and Credit Policy for 2003-04 was announced last week by the new governor of Reserve Bank of India (RBI), Y. V. Reddy. This was his first credit policy and naturally, there were a lot of expectations. Following the footsteps of his successor Bimal Jalan, Reddy also delivered a pragmatic and practical credit policy.
The most important decision of his was that he left the interest rates unchanged, he did not cut the bank rate and the cash reserve ratio (CRR) and also left the repo rate unchanged.
Reddy did not do anything to infuse any more liquidity into the markets, instead he said that there is a need to ensure adequate credit flows to small businesses and the agricultural sector at the right price. He shifted the focus of the credit policy from the creation and management of liquidity to the delivery of credit. With flows expected to continue for some time, Reddy said there was at the moment no need for a fresh infusion of domestic liquidity. The stock markets were not very happy about the rates remaining unchanged, most of the banking stocks saw selling on their counters after the policy was announced.
Yet, the news which spurred the Bombay Stock Exchange over the 5,000-mark was the upward revision of the economic growth forecast by RBI in the policy. It upped the gross domestic product (GDP) projection from 6 percent to 6.5-7 percent. Inflation was projected lower, from 5-5.5 percent to 4-4.5 percent. Reddy said that money supply (M3) growth at 11.9 percent was within the projected levels. He also reported with a lot of cheer that forex reserves were up $17.2 billion since end-March 2003. Exports in dollar terms, were up 10 percent in the first half of the year and imports grew by 21.4 percent. It is also to be noted that $5.5 billion RIBs were redeemed without any adverse impact which is indeed no small feat.
After the credit policy, bank rates now stand unchanged at 6 percent, CRR is also unchanged at 4.5 percent. However, a large section of the market is unconvinced that the RBI is signaling that interest rates can’t fall further. In their opinion, reducing the bank rate would have signaled that the central bank wanted long-term rates to fall, which is certainly not the case. The central bank’s projection of a lower inflation rate, they believe, leaves the door open for another repo rate cut in the future. So why were the rates left unchanged? Well, economists say that with the RBI projecting a higher growth rate, interest rates can no longer be lowered. Also, RBI will be reviewing the liquidity adjustment facility, and it’s possible that the bank rate, which is a very weak signaling device, will be phased out. Different repo rates will serve two separate functions — one to signal the interest rate stance of the central bank, and another used for sterilization operations.
Reddy reviewed the status of investment fluctuation reserves (IFRs) and asked banks to build up IFRs so that they are in a better position to meet interest rate risks. To align asset classification norms of the financial institutions and banks, with international norms, the RBI has told FIs to adopt the 90-day norm for recognition of loan impairment with effect from March 31, 2006.
Moving further on the development of the inter-bank market, RBI has allowed non-bank participants to lend up to 60 percent of their average daily lending in the call/notice money market during 2000-2001. To develop the repo market further, it has been proposed that with effect from Feb. 7, 2004, primary dealers will be allowed to borrow up to 200 percent of their net own funds. RBI announced that banks could extend foreign currency loans above $10 million provided there was adequate hedging of the corporate exposure. However, exporters would be exempt from this condition.
RBI has also capped call money borrowings of primary dealers to 200 percent of net owned funds on average from Feb. 7, 2004. This is meant to boost repo market. Banks have been asked to build a 5 percent investment fluctuation reserve as a measure of prudence. Financial institutions, however, are told that they can switch to the 90-day loan impairment norm from 2006 while banks would be switching to that norm from the last quarter of FY04.
There has been a mixed kind of response to the credit policy. Some felt that the rates should have been altered while some felt that by keeping the rates unchanged, Reddy had laid emphasis on continuity which is the most important ingredient to ensure a stable economic growth. Some felt that RBI should have taken concrete steps to bring down lending rates to small and medium enterprises (SMEs). There were some who were of the opinion that RBI should have taken some measures to close the gap between the deposit rates in India and major global economies.
Following the credit policy, State Bank of India (SBI) decided to cut interest rates on domestic term deposits by 0.25-0.5 percent across all maturities from Nov. 10, in a bid to align their rates with other banking entities. The country’s largest bank has, however, left the lending rates untouched. The interest rate for deposits of 15-45 days has been reduced by 0.25 percent at four percent.
Well, SBI has set the ball rolling once again, now one has to wait and see whether the other banks toes its line and reduces rates despite RBI keeping it unchanged.