The Hindu Business Line : Going towards growth

The `no-rate policy' does not in any way mean that the rate hike cycle is over. The RBI would be ready to act in a timely and prompt manner if inflationary expectations turn adverse. The `no-rate policy' does not in any way mean that the rate hike cycle is over. The RBI would be ready to act in a timely and prompt manner if inflationary expectations turn adverse.

Srinivasan Varadarajan

The RBI Governor, Dr Y. V. Reddy, has clearly given economic growth top priority in announcing the monetary policy for 2006-07.

Inflation expectations have been well-contained over the last year and headline inflation at around 3.5 per cent gives him substantial comfort to be more sanguine on the price stability front. Against this backdrop, growth for the economy is projected at a healthy 7.5-8 per cent for 2006-07 and all benchmark rates have been left unchanged.

In RBI's view, the pre-emptive hike in repo rates done in January 2006 should serve well in anchoring inflationary expectations for now and they would look for more signals in the ensuing months to validate its efficacy.

The `no-rate policy' does not in any way mean that the rate hike cycle is over. The Monetary Policy stance clearly states that the RBI would be ready to act in a timely and prompt manner if inflationary expectations turn adverse.

Merely a pause

As per RBI's assessment, the risks to growth and price stability seem to emanate more from global factors, the more important of them being global imbalances and crude oil prices.

With the major central banks around the world still in tightening mode, the Governor makes it clear that the rate decision in this policy is merely a pause and policy actions of other major central banks would play an important role in shaping further policy action here.

The RBI has cautioned banks on many occasions against large exposure to sensitive sectors such as commercial real estate, capital market exposures, etc.

The large increase in bank credit to these sectors has prompted the RBI to increase provisioning/capital requirements for such advances.

General provisioning has been increased from 0.4 per cent to 1 per cent for such specific sectors, while risk weights for commercial real-estate exposures has been hiked to 150 per cent.

Addressing credit-related risks to sensitive sectors through such measures, rather than through an overall interest rate hike, is surely an efficient way to guard against systemic risks arising from them.

There are a number of other positive announcements in the policy for financial markets. The decision to embark on an active consolidation exercise for Central Government securities is a welcome step and would bring about increased liquidity and better price discovery in these markets.

The introduction of a `when issued' market is another phase in the gradual transition to permitting outright short sales in the bond market.

`Feel-good' policy

Considering that a good section of the bond market expected the RBI Governor to hike rates, bond markets, at last, had something to cheer about. Bond yields rallied by around 10 bps, post-policy, and with liquidity situation comfortable, bonds should be well supported at the current levels.

It is possible for benchmark 10-year bonds to trade below 7.4 per cent in the short term. If credit growth continues to be strong and bank investments in bonds lukewarm, the curve could get steeper and 10-year bond yields can rise to pre-policy levels as auction supply hits the market over the next couple of months. Overall, the policy is a `feel good' policy for bond markets, though caution is advised as further rate hikes seem probable in the next quarterly review.

(The author is Managing Director, Head of Markets, JP Morgan.)