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Monetary Policy: Our view

Apr 18, 2006

Amidst much hype (as usual), the Annual Monetary Policy 2006-07 was announced today. While interest rates and cash reserve ratio (CRR) were maintained at the same level, the Reserve Bank of India (RBI) has advised caution on some aspects like commodity prices and credit quality. Here is our view on the Annual Policy. Current Annual Monetary Policy stance - April 2006

  • To ensure a monetary and interest rate environment that enables continuation of the growth momentum consistent with price stability while being in readiness to act in a timely and prompt manner on any signs of evolving circumstances impinging on inflation expectations.

  • To focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic, in particular, financial stability.

  • To respond swiftly to evolving global developments.

Stance in the Third-quarter review of the Annual Monetary Policy - January 2006

  • To maintain the emphasis on price stability with a view to anchoring inflationary expectations.

  • To continue to support export and investment demand in the economy for maintaining the growth momentum by ensuring a conducive interest rate environment for macroeconomic, price and financial stability.

  • To provide appropriate liquidity to meet genuine credit needs of the economy with due emphasis on quality.

  • To consider responses as appropriate to evolving circumstances.

What is different?

  • To focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic, in particular, financial stability.

  • To respond swiftly to evolving global developments.

Unlike January 2006, there is a greater emphasis on the need to focus on credit quality in general for the banking sector in the recent Annual Monetary Policy statement.

Some of the measures like the hike in general provisioning requirement on personal loans, loans and advances qualifying as capital market exposures and residential housing loans beyond Rs 2 m are aimed at slowing credit disbursals. The provisioning requirement as far as commercial real estate loans from the present level of 0.4% to 1.0% signals the fact that the RBI is worried about the increase in real estate prices in India (risk weight on exposures to commercial real estate raised from 125% to 150%). Higher provisioning impacts banks and consumers alike. For instance, banks have to set aside Rs 150 as provision for every Rs 100 advanced towards commercial real estate developers. Either the bank absorbs the same in its books or adjusts the lending rate to reflect this higher provisioning requirement. If the bank absorbs the same, the return on equity will be affected.

Another interesting aspect, which we subscribe to whole-heartedly, is the emphasis on global developments. Globally, interest rates have been on the rise in the since the last two years. Commodity prices (including crude oil) are governed by global demand and supply. Indian corporate sector is also expanding rapidly in the global markets (both organically and through acquisitions). Given this, it is riskier to assume that India is 'insulated' by global factors. In the analyst meet of UTI Bank yesterday, Mr. P. J. Nayak emphasized the need for caution as far as global expansion by Indian corporates is concerned. He also highlighted the fact that in the case of any adverse movement in exchange rate, the impact on Indian companies will be immediate (at the consolidated level).

Our view...
In short, the Annual Monetary Policy is on expected lines i.e. without any interest rate hikes. The GDP growth prospects of 7.5% to 8% in FY07 with inflation at 5% to 5.5% are positives for the economy as a whole. But for some caution on the quality of credit disbursals, investors have nothing significant to worry about at the macro level.

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