The Hindu Business Line : Has Dr Reddy been needlessly overcautious?

Are the stringent provisioning requirements and higher risk weights for commercial real-estate justified, though the RBI has to fight inflation, and manage excess liquidity without affecting capital flows that feed the market and fund an ever-growing current account deficit? The RBI is using indirect means to enforce credit allocation or non-allocation to or from specified channels when it ordains "penal" provisioning or capital adequacy norms for select credit categories.

THE RBI Governor, Dr Y. V. Reddy, has a difficult task at hand.

Commentators have been equally divided between those who are surprised at the Reserve Bank of India's moderation and those who endorsed it. The RBI Governor, Dr Y. V. Reddy, himself has explained, in interviews subsequent to the Credit Policy statement, that he had already done a pre-emptive strike in his last policy by raising policy rates.

He also pointed out that it is not necessary or feasible to copy other central banks in their tightening policy moves. Each country has a unique situation and each central bank has to adopt its own country-specific stance, although global factors do influence such stance. Dr Reddy was particularly at his eloquent best in clarifying why he took the decision to increase provisioning requirements and risk weights for commercial real-estate.

In one interview, Dr Reddy was also at pains to point out that loans against housing are not risk-free. He was referring to the transaction costs involved in the documentation and registering the sale of repossessed property.

True, higher provisioning was intended for higher cost housing. He drew comfort from the fact that these stringent provisioning and capital adequacy requirements had the support of the guru of banking reform, Mr M. Narasimham himself.

IS THE CONCERN JUSTIFIED?

It is necessary to review the Governor's caution in the light of the absolute size of loans given by banks for these purposes. One has to concede the legitimate concern of Dr Reddy in a general sense.

Asset bubbles can prove destabilising. But the question I raise is whether the size of the loan portfolio against commercial real-estate or housing itself is so large as to justify concern.

For instance, the booklet on Macroeconomic and Monetary Developments for 2005-06 shows that the size of the real-estate loans in absolute terms as on January 20, 2006, was only Rs 24,527 crore out of a total credit disbursed amounting to Rs 12,56,368 crore.

This seems to be relatively a small proportion, 2 per cent or near-about. The increase during the financial year 2005-06 was Rs 11,225 crore, an increase of 84 per cent, mainly because the base itself was low.

Consider their sizes in comparison to the size of India's economy and the credit needs of the real-estate operators.

Dr Reddy has, of course, not missed this point. I am only restating this to emphasise that the real-estate bubble the Governor is afraid of is not yet on the cards. Much larger commercial credit to real-estate may be needed before it can morph into a boom phenomenon.

Further, the RBI has to initiate a detailed study of how the so-called real-estate boom of 84 per cent increase has arisen. Maybe, it is a legitimate part of infrastructure growth or of corporate forays into SEZs and retail marketing. It is, in my view, an overreaction by a risk-averse central bank to call the present size of real-estate loans a serious danger.

MISPLACED FEARS

Let me turn to housing. Housing accounted for an outstanding loan book of Rs 1,66,000 crore as on January 20, 2006. This again is not too large a proportion of the outstanding loans of nearly Rs 12 lakh crore.

The increase in housing loans during the period April 2005 to January 20, 2006 was Rs 37,000 crore, up 29 per cent, which is not too high considering that the gross total of bank loans disbursed rose by 25.7 per cent in the period. The fears of the RBI in regard to runaway expansion in housing loans seem to be misplaced considering the big housing gap in India.

The experience of most dedicated and other housing finance agencies shows relatively robust ratios of low non-performing loans measured against total loans. The percentage of housing loans needed to be written off also is not too high. Loans against a house are incidentally as safe as the houses themselves.

Especially in a rising housing market, the lender may not have much of a serious problem recovering the principal by sale of the property. Anyway, the mindset of the RBI, which appears biased against housing, seems to need a change.

After all, let us recall that the foundation of the prosperity of the US depended, to a large extent, on the expansion of housing, fed by liberal credit. Housing construction, as is well-known, gives rise to jobs to a wide variety of labour, not merely the skilled. Further, the spill-over effects, such as the increase in demand for steel and cement, are also employment-generating. Above all, increased house-ownership leads to a sense of belonging in society. It is time the RBI sheds its anti-housing bias!

During the post-Policy announcement interviews, the Governor gave expression to concerns about the expansion of personal loans. He was apparently referring to rather ugly practices prevailing among collecting agencies acting on behalf of lenders against credit cards.

It is true that even sophisticated banks tend to go overboard in applying strong-arm tactics to recover credit card loans. But "collectors" of loans are always prone to such tactics, whether they represent MNC banks or plain indigenous moneylenders.

COMPOUNDING THE DIFFICULTIES

While the RBI is right to deprecate such practices, it does not help to make it more difficult for banks to lend against credit cards, such increased provisions only raise costs for the borrower. It is time that the RBI re-examined its policy frame on such loans, credit cards in general.

Credit cards are a natural offshoot of a modern market-based credit system, sustained by improved technology. While much can be done to educate credit card users against living on the "never-never" culture, it does not seem rational to discourage lending against credit cards, especially now that Kisan credit cards are in the picture.

While it is right that the RBI has donned the mantle of inflation fighter, it is perhaps guilty of applying generalised tools, such as increased provisioning or risk weights to implement what amounts to selective credit control.

Earlier studies had shown that selective credit-control measures may not always be successful for the reason that money is fungible. Money borrowed for one purpose may be used for another.

The RBI is using indirect means to enforce credit allocation or non-allocation to or from specified channels when it ordains "penal" provisioning or capital adequacy norms for select credit categories.

WHAT IS THE RIGHT MIX?

No central bank is so omniscient that it can predict the right mix of credit for an economy to stay on a non-inflationary course. The former US Federal Reserve chief, Mr Alan Greenspan, himself is reported to have said that he would not interfere with an asset boom directly lest he lands the economy in a state of deflation.

Dr Reddy is too much of an expert in central banking to let himself be carried away by rigid formulae for slaying the perceived monster of asset inflation.

Dr Reddy has a difficult task on his hands. First, he has to control inflation expectations — a difficult concept to measure. Second, he has at the same time to manage the pressures arising from inflow of excess liquidity, partly led by external capital flows and a stock market boom, which feed on each other.

At the same time, he cannot risk breaking the euphoria linked to a rising stock market, which contributes not only to a feel-good factor, but also to the essential capital flows, which are needed to finance an ever-growing current account deficit.

The Monetary Policy in a political economy like India is an art, not a science. All power to Dr Reddy's elbow as he dons the artist's mantle!

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