The Hindu Business Line : RBI pitches for growth with stability

Even while expressing concern over inflationary expectations, the RBI's Mid-term Review of Annual Policy Statement for 2005-06 has refrained from tinkering with either the Bank Rate or the Cash Reserve Ratio (CRR) so as not to disturb the robust growth momentum of the economy.

CLEAR that the ongoing growth momentum of the economy needs support, the Reserve Bank of India, at least for now, appears keen on continuing with an interest rate environment that is conducive to macroeconomic and price stability.

Indeed the RBI's Mid-term Review of Annual Policy Statement for 2005-06 has tried to achieve a fine balance between growth and price stability. Even while expressing legitimate concerns relating to inflationary expectations, it has refrained from tinkering with either the Bank Rate or the Cash Reserve Ratio (CRR) so as not to disturb the robust growth momentum of the economy.

However, in line with market expectations and to indicate its growing concern over possible upward pressure on prices in the face of a relentless rise in international oil prices, the RBI hiked the reverse repo rate (the rate at which banks park their excess liquidity with the RBI) by 25 basis points to 5.25 per cent. Similarly, the repo rate (the rate at which RBI infuses liquidity into the system) has been hiked from 6.0 per cent to 6.25 per cent so as to keep the spread between reverse repo rate and the repo rate unchanged at 100 basis points.

In the developing situation on the price front, there was some speculation in the market that the RBI will hike the benchmark Bank Rate by 25 basis points. This rate has remained unchanged at 6.0 per cent since April 2003 even as the US Federal Reserve hiked the rates by quarter percentage point 11 times to 3.75 per cent from 1.0 per cent in June last year. However, the RBI decided to leave the Bank Rate unchanged for now.

Domestic developments

Referring to the domestic developments, the RBI Review states that the prospects for sustained growth in industrial output have improved in an environment of rising investment and export demand, strong corporate profitability and buoyant business confidence. There are signs of sustained growth in the production of basic goods, capital goods and consumer goods. Despite some deceleration, export growth remained robust during April-September 2005.

Domestic production and imports of capital goods have risen strongly in tandem, indicative of ongoing capacity expansion. The investment demand in the economy has been booming in recent times. With continued business expansion and lower interest costs, corporate profitability is high and there is an expansion in internal resources available for investment. Also non-food bank credit has witnessed a significant growth at 31.5 per cent, net of conversion, as on September 30, 2005 on top of a growth of 24.9 per cent a year ago.

The NCAER Business Confidence Index rose for the fourth successive quarter and is now at its highest level since December 1995. The CII-ASCON survey for April-June 2005-06 also suggests a continuance of buoyant manufacturing industrial performance. According to the RBI's latest Industrial Outlook Survey, the Business Expectations Index for the October-December 2005 quarter increased by 2.6 per cent over the previous quarter level. The survey results indicate that the overall business situation, financial situation, availability of finance, production, order books, capacity utilisation, employment, exports and profit margins are expected to improve during the quarter compared with the July-September period.

The RBI, however, cautions that there could be some risks from the sharp increases in oil prices, plateauing of growth rates in some key industries and infrastructure constraints. Furthermore, with manufacturing sector operating at high capacity utilisation levels, significant growth over the medium-to-long term will call for fresh investments that could also involve higher borrowings, and consequent exposure to associated risks and possible deterioration of gearing risks.

Price situation

The RBI Review has expressed growing concern over the price situation. It says that inflationary pressures have increased in a number of economies during 2005-06 so far. True, the global consume price inflation has been relatively muted so far despite large increases in oil prices. This is partly because the pass-through from international prices to domestic prices of oil has been less than complete due to sharing of the burden by governments, especially in a number of emerging economies, including India.

The RBI has indicated that the inflation rate may exceed the earlier projected 5-5.5 per cent level, largely because of the pressure of rising international oil prices and the continuing high growth in demand for credit. The caution is all the more relevant because global oil prices continue to be high and volatile and an overwhelming part of the increase in recent years is now increasingly being regarded as permanent. Hence, the RBI says that the upside inflationary pressures from oil prices can be expected to continue with attendant direct and indirect effects. Hence, it is necessary to be ready to take further measures as warranted to meet the challenges posed by the evolving situation.

Prudential measures

The RBI has announced some prudential measures and guidelines aimed at strengthening the banking system with particular emphasis on improving the quality of credit and its delivery. These include:

Raising of provisioning requirements from 0.25 per cent to 0.40 per cent for "standard advances" (except for special categories such as agriculture and small and medium enterprises, or SMEs). This may translate into Rs 800-900 crore additional provisioning by the banking system.

Raising the capital market exposure of banks to 40 per cent of their net worth, while retaining the existing limit of 5 per cent of total advances.

Allowing infrastructure special purpose vehicles (SPVs) to borrow abroad.

Permitting banks to issue guarantees for textile companies wishing to raise ECBs. More important, the RBI has called for a review of the benchmark prime lending rates (BPLR) currently at 10.25-11.25 per cent in public sector banks since many of them have been lending to corporates at rates far below this level. For instance, in its Annual Report for 2004-05, the RBI had noted with concern: "Sub-BPLR lending of the banking system (excluding exports, the bulk of which is at sub-BPLR) constituted over 65 per cent of outstanding advances above Rs 2 lakh."

Again, while the expansion in non-food credit has been high, the share of credit to infrastructure remains low relative to the size and state of the economy. There is also a continued reluctance to provide credit to SMEs. Besides, the rate at which loans are advanced to agriculture and the SSI sector is much higher than for bigger corporates and the housing sector.

To improve the credit flow to the SMEs, banks have been advised to formulate liberal and comprehensive policies for extending loans to the SME sector and rationalise the cost of loans to this sector with cost linked to credit ratings.

Outlook and challenges

Encouraged by the real GDP growth of 8.1 per cent during the first quarter of 2005-06, the robust industrial andn services sector growth and buoyant exports, the RBI has revised its GDP growth forecast for the current fiscal from the earlier 7.0 per cent to 7-7.5 per cent. It says the acceleration of the industry, the buoyancy in services and the positive business confidence and expectations have improved growth prospects for 2005-06.

However, the Review points to the major challenges ahead. These include the management of subsidies, financing of food-for-work and employment guarantee programmes and neutralising the impact of lower loan recoveries from States. Hence, the efforts to improve tax collections in the presence of all round buoyant growth will need to be intensified.

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