The steps taken by the Reserve Bank of India in the Credit Policy insofar as the financial markets are concerned are comforting, though it is not clear what the apex bank's efforts to rein in inflationary expectations will add up to, given trends in global inflation-exacerbating factors oil prices, for instance.

P. K. Choudhury

THE Monetary and Credit Policy for 2005-06 first half is a continuing reflection of the Reserve Bank of India's attempt to promote orderly development of the financial markets, ensure reasonable liquidity, and lend stability to inflation rates.

Although the steps taken by the RBI insofar as the financial markets are concerned are comforting, I am not very sure of how much the apex bank's efforts to rein in inflationary expectations will add up to, given the trends in global inflation-exacerbating factors (oil prices, for instance).

To contain inflationary expectations, the RBI has pushed up the fixed reverse repo rate to 5 per cent from the 4.75 per cent earlier.

However, simultaneously, the apex bank has also raised the M3 growth rate target from 14 per cent to 14.5 per cent for 2005-06.

The increase in the M3 growth rate target thus appears to be in contrast to the RBI's desire to support expectations of low inflation (an increase in M3 target is perhaps an implicit acknowledgement of a higher inflation rate) and keep long-term interest rates within reasonable limits.

In the context of debt management policies, it may be mentioned that with effect from April 1, 2006 the RBI will not be participating in primary issuance of government securities.

In fact, the October 2004 Mid-Term Review of Monetary Policy had emphasised that Open Market Operations (OMO) would become a more active policy instrument for debt management.

For this, the RBI has now suggested that the number of actively traded securities be increased and the scope of business of the existing market participants be enhanced.

These steps are likely to make the government securities market more liquid and broad-based in the days to come.

Monetary targets apart, there are several innovative measures in the latest Policy document that merit special attention. For instance, to promote Indian investments abroad, the Policy proposes to raise the ceiling on investment by Indian entities in overseas joint ventures and/or wholly-owned subsidiaries from 100 per cent to 200 per cent of their net worth under the automatic route.

This step, I suppose, would enable corporates diversify into new geographies, thereby lowering their vulnerability to cyclical downturns in the domestic market.

Further, the Policy has stated that it will consider allowing corporates to write covered options and hedge the economic risks arising from substitution by imports.

In case the measure is implemented, it would provide corporates the much-needed operating flexibility in foreign exchange management.

Another positive about the current Policy is the concern it has articulated on the fact that banking practices in India sometimes tend to exclude rather than attract large sections of the population, particularly pensioners, self-employed persons, and those working in the unorganised sector.

As for the Policy measures directed at the financial markets, there are several that seek to widen the market base.

For instance, the apex bank has now allowed the participation of non-scheduled urban co-operative banks and listed companies in the repo market.

The policy has also stated that an electronic trading platform for the conduct of repo transactions will be put in place. These measures are likely to add depth and transparency (in pricing) to the repo markets.

In this context, it may be mentioned that the RBI has now allowed same-day sales of government securities (picked up in primary auctions) by banks and primary dealers to non-banking entities.

This measure is also a positive insofar as adding depth to the government securities market is concerned.

Further, the current Policy proposes to make call money market transactions purely an inter-bank activity by phasing out non-bank participants from this segment with effect from August 2005.

A screen-based negotiated quote-driven system for all dealings in call and term money market transactions is also proposed. Simultaneously, the minimum maturity period of certificates of deposit (CDs) has been reduced from 15 days to 7 with immediate effect.

The Monetary and Credit Policy for the First Half of 2005-06 proposes several concrete steps to facilitate credit delivery to the productive sectors.

Some of the measures are enabling non-governmental organisations (engaged in micro-finance) access external commercial borrowings of up to $5 million during a financial year for permitted end-uses, and reviewing all existing guidelines (by the apex bank) on the financing needs of the small-scale sector.

The proposed move to continue with the restructuring of the Regional Rural Banks (RRBs) is also likely to facilitate credit flow to the rural sector.

On the issue of credit delivery, I have a point or two to make. First, there is this problem of multiplicity of regulations governing micro-finance a key credit assistance tool for the `poor' in India.

These include the Societies Registration Act, 1860, the Companies Act, 1956, and the Co-operative Societies Act, 1912. Further, there is the RBI Act, 1934, the Banking Regulation Act, 1949, and the Nabard Act, 1981, among others, that also cover micro-finance.

There is thus need to have greater policy coherence, and may be, a comprehensive legislation so that micro-finance actually serves as a key credit assistance tool in practice.

The second point is, although Basel II norms would now apply to the banking sector, State co-operative banks (SCBs), district co-operative banks (DCCBs) and the RRBs would remain largely out of their ambit.

While it may be too ambitious to expect the SCBs, the DCCBs and the RRBs to comply with Basel norms, there is still a strong case for the RBI to put in place an effective system of prudential measures so that these institutions emerge as more effective vehicles for credit delivery.

The need for such measures can hardly be overemphasised, given that there is no compulsion now for additional disclosures, MIS reporting, and efficient asset-liability management by the SCBs, the DCCBs and the RRBs.

And, not surprisingly, as of March 31, 2004, a significant number of the SCBs, the DCCBs and the RRBs reported negative net worth.

(The author is MD and CEO, ICRA.)

(This article was published in the Business Line print edition dated May 5, 2005)
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