The interest rate policy, a reaction to the "inflationary expectations," could switch growth to the slow lane.

The first quarter review of the Indian economy by the Reserve Bank of India can be taken as an exemplar of a dear money stance aiding economic growth. The RBI Governor, Dr Yaga Venugopal Reddy, may not appreciate the suggestion while the message is embedded in the 33-page report from the central bank. If one sets aside the impact of crude oil prices, the RBI sees no blip on its computer screen while sticking to its earlier growth forecast of 7.5-8 per cent for the current fiscal. The first lot of corporate results for 2006-07 is an improvement over the trends in 2005-06. Business expectations for July-September 2006 are "significantly higher" than in the first quarter.

Non-food credit of banks grew by Rs 37,749 crore (2.6 per cent) as of July 7, 2006 against a rise of Rs 19,948 crore (1.8 per cent) in the corresponding period a year ago and the RBI styles it as the highest contra-seasonal first quarter expansion in the last five years. The year-on-year growth in total flow of banking funds to the commercial sector was 29.6 per cent over the 27.7 per cent a year ago. Bank deposits moved up by Rs 68,499 crore (3.2 per cent) up to July 7 against Rs 19,435 crore in the corresponding period last year making it the steepest rise in any comparable timeframe since 1993-94. The incremental non-food credit-deposit ratio stands at 99.7 per cent against 111.2 per cent a year ago. Yet, there is a cash surplus of Rs 91,231 crore as of July 20 while the cost of funds continues to track the upper ends of the interest rate graph. Inflation measured by the Wholesale Price Index is at 4.3 per cent against 6.3 per cent a year ago despite consumer prices speeding ahead owing to a sharp escalation in food prices. That has to be read with the RBI confession that inflation has stabilised since mid-June and "price stability has created conducive conditions for growth to continue undisrupted." Crude prices, which had a direct effect of 45 basis points on prices after the Government marked up retail quotes in June, are the only source of genuine worry.

Rounding up its stance, the RBI thinks GDP growth can be strong while inflationary pressures have "by and large been contained." Then why lift the interest rates on bank funds held by the RBI from 5.75 per cent to 6 per cent along with that on funds lent by the central bank to 7 per cent? Banks now have a legitimate excuse to mark up lending rates and earn more by parking funds with the RBI. This could drive more corporates abroad leaving government borrowings and farm funds costlier. The RBI is loath to admit that its interest rate policy, a reaction to the "inflationary expectations," could switch growth to the slow lane. Going by the proffered evidence, a Hercule Poirot may exclaim that the case for costly bank funds looks fragile.

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(This article was published in the Business Line print edition dated July 26, 2006)
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