The Hindu Business Line : Maintaining momentum

THE Mid-Term Review of the Monetary Policy for 2004-05 was expected to be a balancing act by the Reserve Bank of India between the need to contain inflationary pressures and the requirement to ensure the continued momentum of economic growth. In many ways, the RBI has lived up to its expectations.

The Review aims to provide appropriate liquidity (as opposed to "adequate liquidity" mentioned in the Annual Policy statement of May) to support credit growth, investment, and exports, while emphasising price stability equally strongly.

Of course, how effectively the monetary controls (as opposed to fiscal measures such as reduction in duties on inputs such as crude oil, coal, and metals) can tackle cost-push inflation of the kind India currently faces, remains to be seen.

Meanwhile, the marginal increase in the repo rate is unlikely to affect bank lending rates to corporates, partly because there exists ample liquidity in the system and because of the inefficiencies of the bilateral loan market.

In fact, the enhancement of limits on advances to the priority sector and the securitisation of SSI loans will only increase the flow of funds to small-scale units, and to agricultural borrowers. This should significantly meet the unfulfilled credit needs of agriculture and small-scale industry.

On the other hand, the increase in risk weightage on housing loans (from 50 per cent to 75 per cent) and on consumer loans (from 100 per cent to 125 per cent) constitutes a minor setback in the growth of retail bank credit (and places pressure on the capital adequacy ratios of several banks). However, a force that is likely to operate in the opposite direction is the raising of the limit for priority-sector classification of housing finance from Rs 10 lakh per unit to Rs 15 lakh.

In all, while this may see a rise in interest rates on housing loans, the deceleration mechanism on home loan growth in the form of higher risk weightage is certainly a prudent step.

In respect of bank deposits, the raising of the interest rate ceiling on NRE deposits by 50 basis points over the base rates will help reverse the lower growth rate in aggregate bank deposits; it will also help to keep the rupee stable. The reduction in the minimum tenor for domestic retail term deposits to seven days should further help deposit growth rates to rise. However, to the extent that such seven-day retail term deposits will represent a shift of funds from current accounts, the deposit cost of banks will probably increase.

As for the forex market, the liberalised issue of guarantees (and standby letters of credit) by banks for trade credit up to $20 million per transaction up to one year not only represents an opportunity for banks to increase their non-fund revenue but also allows corporates to manage their international trade exposures more efficiently.

Similarly, the relaxation in the booking of forward contracts will help corporates better manage their exchange rate risks and provide trading opportunities to those entities that have the required expertise.

Interestingly, in the realm of corporate governance, RBI's intention to publicly disclose penalties imposed on banks means that banks need to be more careful on regulatory matters than ever before — or run significant reputational risks which will henceforth be under close market scrutiny.

(The author is Managing Director, IndusInd Bank Ltd)