The Hindu Business Line : A review of hard times

THE Mid-Term Review of Credit Policy comes amid hard times with soaring metals and minerals prices, as reflected in the CRB Futures Price Index trading at a 23-year high, and crude hovering around $55 per barrel. All this exposes India to substantial inflationary pressures, given the dominance of oil in its import bill. As recognised in the Credit Policy, every dollar rise in the price of oil shaves 15 basis points off GDP growth. Against these exceptional conditions, the task of announcing interest rate and credit policy measures for the second half of the year was clearly not easy.

Having said this, it is extremely encouraging to see that the RBI has chosen not to ignore the price pressures building in the economy at the cost of pursuing growth. The focus has clearly shifted to balancing growth with price stability.

The policy is replete with inflationary concerns stemming from supply-side bottlenecks, which are harder to deal with. The policy also warns the markets of uncertainties ahead. The fresh guidance on year-end point-to-point inflation is at 6.5 per cent, a whopping increase of 150 basis points over the previous guidance. Not surprising that GDP growth estimate has, as a result, been trimmed 50 basis points, to 6-6.5 per cent.

As a regulator of the financial markets, the RBI has done well to read early the signs of trouble by raising short-term rates by 25 basis points, while leaving the broader benchmark "Bank Rate" on hold.

While the RBI takes note of the persisting liquidity overhang, we believe that the last policy action to increase CRR that impounded Rs 8,000 crore and a strong credit growth dented the surplus liquidity substantially; thus the reduced overhang requires no additional measures.

Besides, the accretion to forex reserves is likely to be a lot lower this year, which should reduce rupee liquidity pressures. The central bank, however, clearly wants to provide liquidity in the system, as is evident by the inaction on the reverse repo rate. All this is obviously no music to the bond market. The good times of building large bond portfolios to enjoy capital gains arising from a secular decline in yields are clearly over. We are headed for trying times, with so much uncertainty and scepticism on the horizon.

The good news is that rate hike expectations are already somewhat discounted — as is reflected in the steepness of the yield curve which has jumped to 200 basis points over the repo rate from the lows of 50 basis points. In the short term, though, we expect buying to emerge around the 7 per cent levels in the 10-year segment. A few other encouraging announcements include stronger capital adequacy requirements for home loans, risk management paper geared towards meeting Basel II norms and more directed lending to the agricultural and SSI sectors.

Overall, a focussed policy to meet the need of the hour.

(The author is Group President — Financial Markets and Private Banking — Yes Bank.)