The Hindu Business Line : Lull before the storm

The Policy can be viewed as a form of consolidation before tightening measures are re-introduced in case the rigorous new inflation target is not met.

Possibly because it had taken several strong measures on the interest rates front in the recent past, the Reserve Bank of India has chosen at this juncture to wait and assess the impact of its earlier measures (which are yet to materialise fully) before exercising further options to reduce the demand "push" factors, by nudging interest rates higher or reduce liquidity in the system via sterilisation methods such as CRR/SLR hikes and issue of MSS bonds.

Hitting the pause button

Thus, the RBI has opted to "pause" in its on-going agenda of reducing systemic liquidity and making bank borrowings more expensive (particularly for certain sectors), and to act instead on the third point in its three-point agenda, that is, reducing foreign currency inflows into the system and increasing the outflows.

Towards this end, the RBI has announced a number of measures, both direct and indirect (reduction in FCNR and NRE interest rates, increase in overseas investment limits for individuals/corporates/mutual funds, prepayment of ECBs, etc.) aimed at reversing the net inflow of foreign exchange funds and, thus, restricting the appreciation of the rupee. These measures are also intended to check growth in money supply.

However, it is doubtful whether these will be effective in addressing the RBI's concerns over rupee appreciation.

Even at the current permitted levels (far less than the enhanced levels announced in the Policy), investment outflows have been modest, whether by resident individuals, corporates or mutual funds.

When yields on domestic investments are more attractive than yields on investments in global markets, it is unrealistic to expect Indian entities to remit funds overseas and, in the process, take the related exchange risk as well.

Also, the demand for External Commercial Borrowings (ECBs) remains high.

Thus, immediately after the Policy announcement, it was not surprising to find that the rupee had appreciated further, from 41.65 (to the dollar) to 41.35.

A breather?

By leaving interest rates unchanged, both money and capital markets have been granted a "breather".

However, any gains will remain limited on the expectation of tightening measures to come, given the aggressive money supply target of 15-17 per cent and inflation target of 4.5-5 per cent.

In fact, the RBI's inflation target is seen as ambitious and tough, particularly in the prevailing context.

The Credit Policy can, therefore, be viewed as a lull before the storm — a form of consolidation before tightening measures are re-introduced in case the rigorous new inflation target is not met.

Financial inclusion

On the softer side, the Credit Policy takes several steps towards the attainment of RBI's goal of "financial inclusion".

Thus, the reduction of risk weight on low-value residential housing loans (keeping interest rates on such loans low so as to benefit the lower-middle and middle-income groups of borrowers), and on low-value loans against gold and silver ornaments (typically taken by the needier sections of society), encouragement for credit to distressed farmers, the establishment of financial literacy-cum-counselling centres, upgraded IT initiatives to keep transaction costs low (an area in which new private sector banks can play a dominant role) and the reduction/waiver of charges on electronic payment systems, are all measures towards the encouragement of "financial inclusion" in the system.

(The author is Managing Director and CEO, IndusInd Bank Ltd, Mumbai.)

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