The Hindu Business Line : A fine balancing act

SIX months into the current fiscal, optimism prevails about the robust growth of the economy in spite of the skyrocketing oil prices and widening trade deficits.

The RBI's Mid-Year Review records an impressive performance during the first quarter of 2005-06 with the GDP growth accelerating to 8.1 per cent.

The Review also indicates improvement in Central Government finances, benefiting from higher tax collections and expenditure management through control over non-Plan expenditure.

Monetary conditions have, however, remained comfortable during 2005-06 so far despite a sustained pick-up in credit demand from the commercial sector.

Banks were able to finance the higher demand for commercial credit by curtailing their incremental investments in government securities.

The logic of balance between the issues warranting rate hike and issues supporting status quo were in favour of hike in interest rates.

The cycle of stronger local currency, from which the country benefited immensely for the past three years, seems to be playing in reverse now.

If the weakness in the rupee continues, it may in turn cause more money to be pulled out.

A hike of 25 bps in the repo/reverse repo rates will attempt to contain the domestic interest rate and currency environment amidst growing global uncertainty and expectation of inflationary pressures.

The RBI has maintained the interest rate corridor between repo and reverse repo rates in line with global levels at 100 bps. The Bank Rate, which has a longer-term structural impact on interest rates, remains untouched

The RBI has attempted structural reforms in the financial sector by addressing the demands of the banking industry to review the benchmark prime lending rate system and issue transparent guidelines for appropriate pricing of credit.

Special Purpose Vehicles which are set up to finance infrastructure companies would now be given the status of financial institutions and ECBs raised by such entities will be considered under the automatic approval route.

The RBI attempts to direct bank credit to the SME sector by rationalising the cost of loans with cost linked to credit ratings.

A debt restructuring mechanism in line with the corporate debt restructuring mechanism has been formulated.

The central bank has made a serious attempt to provide basic banking facilities to all the sections of the population by making available a `no frills' account with nil or very low minimum balances.

General permission has been given to banks for issue of debit cards in tie-up with non-bank entities. The long-pending issue of developing a vibrant debt market has been addressed.

Intra-day short-selling in government securities is proposed to be introduced and NDS-OM module has been extended to insurance entities.

But the issue of interest rate futures and options has still not been addressed. The RBI cited `balance of convenience' when it left rates unchanged in July.

The current situation warranted the RBI to manage liquidity to meet the increasing credit requirements and, at the same time, ensure an interest rate environment conducive to price stability.

The central bank has successfully managed this in the current credit policy.

(The author is CFO, Larsen & Toubro Ltd.)

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