The Hindu Business Line : RBI's mid-term review of credit policy

The RBI Governor, Dr Y. V. Reddy, has negotiated carefully between controlling inflationary expectations and disturbing the behaviour of economic agents. While the Policy has made significant relaxations on the external funds front, Mint Street and North Block will have to work closer together at home, if India is to maintain its robust rate of growth with price stability, says S.VENKITARAMANAN.

The Reserve Bank of India's Credit Policy has lost much of its mystique in recent years. RBI Governors have been more transparent about their intentions in their pronouncements. This is helped by the fact that the central bank has to march in step with its global peers. The contrarian speculation that the RBI Governor, Dr Y. V. Reddy, will be ready with a hike has to come to an end today with Governor's clear policy statements, which include just a raise in repo rate by 0.25 per cent (25 basis points).

Pragmatic approach

In his Credit Policy review statement, closely following the mid-term review of the macroeconomic situation, as is to be expected, Dr Reddy has walked carefully and skilfully between various options on controlling inflationary expectations. One of his options was to tighten the credit flow, including raising interest rates for fear of inflation. The other was to restrict credit flows through raising cash reserve ratio and increasing provisioning requirements. The fact that he has refrained from doing any of these, but contented himself with raising the repo rate by 25 basis points is a reflection of his pragmatism as also of the generally robust situation in the economy. After all, this is the busy season and the Governor is right to warn the banks about managing their liquidity. They should find it costlier to borrow through repo operations from the RBI.

The policy recognises that there are inflationary threats reflecting the growing demand from an ascendant industry and increasing consumption. The fact that this has to be contended through reducing bank credit is obvious. At the same time, the flow of credit to the industrial sector has to increase year-on-year due to increasing production. While Dr Reddy has taken care not to restrict the credit flows to productive sectors, he has struck a cautionary note on some sectors.

Asset bubble worries

He has sent sufficient signals to inform bankers that the Governor will be watching developments carefully, particularly on housing front as well as on consumer credit. This concern is legitimate, but I must enter a caveat here.

Housing is key to the revolution of rising expectations that is sweeping the country. The Governor has to look on it as an essential part of the feeder of growth rather than as an asset bubble. The Governor is particularly concerned that the development of an asset bubble, which is characteristic of most emerging economies, and has also cautioned against expansion of retail credit, and against issuing credit against cards without adequate safeguards.

A generally routine Monetary Policy announcement, it does not rock the boat so far as the costs of government borrowings are concerned. In particular, as part of the policy, Governor has opened the window for FII (foreign institutional investor) participation in government securities, which should ultimately reduce the cost of borrowing ceteris paribus.

The Policy also opens the window for external commercial borrowing through a significant relaxation on the automatic limits. Whether the Governor will follow up further the recommendations of Tarapore Committee-II on external commercial borrowing remains to be seen. The fullness of the capital account convertibility can be realised by corporates only if external commercial borrowing becomes automatic in all cases, leaving the external lender to decide on the creditworthiness of the borrower. There is also a significant relaxation on banks' access to external sources. This will particularly help foreign banks.

On exchange rate policy and the external front, Dr Reddy has nothing special to add to his earlier statements. A good situation on the whole, which does not require any mending! It is to be hoped that Dr Reddy will continue the policy in exchange rate management, which will help the exporters of goods and services.

Inflation management

On the whole, the policy is pragmatic and recognises the limit of a central banker's action in managing inflation in a globalised economy where supplies are globally accessible and prices are exogenously determined. In particular, the inflation is easing, thanks to a drop in crude oil prices.

There is also the expectation that with the rabi prospects, farmgate prices may not rise as fast as before. The Governor is right in having refrained from raising policy rates by more than 25 basis points. Whether he will return to interest rate hike come the next review is to be seen.

One final observation: To what extent will the rise in policy rates by the RBI control inflation in an economy which is basically governed by crude oil prices, which are decided in Saudi Arabia, and food prices, which are determined by monsoon prospects, is a question that central bankers of developing countries, such as India, will need to address. They have to overcome the ideological fixation on raising or reducing credit flows and interest rates, as the device of choice to control inflationary expectations.

There is also the conflict that higher interest rates do not necessarily control consumption in an economy, which is living hand-to-mouth. A minimum level of consumption is almost preordained irrespective of the central bank's rates of interest.

All in all, the latest Credit Policy review has lived up the expectation that the Governor would not do anything to rock the economy or disturb the economic agents' behaviour. Much, however, depends on the positive actions that need to be taken by the North Block in arranging for supply of residential commodities and in addition controlling runaway expenditures, which tend to restrict fiscal expansion and M-3 growth.

Mint Street and North Block have to work closer together in these challenging days if India is to maintain its robust rate of growth with price stability.

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