The Hindu Business Line : Punch bowl still on the table

It is said that the job of a central banker is to take away the punch bowl just when the party gets going. This is a restatement of the principle that prevention is better than cure.

By all indications there is an ongoing party — whether it is asset markets or credit growth. The difficulty is in determining whether this is sustainable or not.

Non-farm credit has grown at 30 per cent for two consecutive years now, as never before. There is an apprehension that some of this credit is going to commercial real estate and the stock market and could lead to a phenomenon of asset price bubbles.

Booming asset markets

The asset markets are experiencing heady times, and this may be creating a "wealth effect" on consumers. The stock market index scaled another all-time peak.

The Sensex rose by 71 per cent during the last fiscal year, and during this calendar year it is already up by 26 per cent, after rising 41 per cent during calendar 2005. Real estate prices across towns in India continue to rise at double-digit rates.

Gold prices have risen by close to 38 per cent since March 2005. Due to a combination of rising credit, asset price rally, as also liquidity tightening, and a global tendency for rates to rise, there was an expectation that the reverse repo rate would be hiked by the Reserve Bank. But the RBI Governor, Dr Y. V. Reddy, chose to retain rates, and instead delivered some hawkish talk, cautioning about credit quality and global imbalances. He also emphasised that the RBI could act swiftly anytime, and that he had already acted pre-emptively by the prior rate hike. To regulate credit quality, the provisioning norms for personal loans, loans against shares, commercial real estate loans and residential housing loans beyond Rs 20 lakh have been increased from 0.4 per cent to 1 per cent.

This measure will make loans costlier in these respective categories. Additionally, risk weight on exposures to commercial real estate has been increased to 150 per cent.

The backdrop to this year's Annual Policy of the Reserve Bank of India was quite unprecedented. If we take a moving three-year average of growth rates of GDP, we are currently in the midst of the highest-ever recorded growth phase.

Commercial credit from banks has grown in an unprecedented manner, leading to an incremental credit deposit ratio of more than 100 per cent. The growth in exports of goods has been more than 20 per cent for four years now, and has surpassed the targets set by the Trade Policy of the Commerce Ministry.

If we count services exports, the numbers are even more impressive. Next year's outlook on growth is also strongly positive.

Surprisingly inflation was below forecast, even though crude oil has risen by 50 and 25 per cent in the past two years.

This incomplete pass through of oil prices as also prices of various commodities is another risk that the RBI has flagged.

Temporary pause

But going ahead it is clear that the current pause in rate hike is a temporary one. The numbers projected by the RBI on deposits, credit and government borrowing for next year point to tightening liquidity ahead.

Further, the global trends of rates, including even countries like Japan, point to rate hardening.

Hence the rejoicing of today will have to be tempered by higher rates and a somewhat slower growth in credit in the coming months.

(The author is chief economist, Aditya Birla Group.)

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