Apr 28, 2006|
Banks: Facing moral suasion?
Three months ago, in its review of monetary policy for 3QFY06, the Reserve Bank of India (RBI) had cited numerous reasons for raising its reverse repo rate by 25 basis points. These included high international crude oil prices, high asset prices, runaway credit growth leading to strain on credit quality and the widening of the current account deficit. The central bank had then pointed out, "The risks to inflation from both domestic and global developments remain high, persisting well into FY07."
The recent annual monetary policy (for FY07), however, seemed to show little consistency. The decision to leave rates unchanged was also at odds with the general tenor of the policy statement. For instance, the policy commented, "The outlook on inflation as well as the choice of the appropriate manner of dealing with the pass-through of oil prices remains clouded at the current juncture. The Indian economy needs to prepare for higher orders of pass-through into consumer prices, in respect of the overhang as well as the possibility of additional increases in crude prices in the future." However, the possibility of such price rises were not factored in while keeping the interest rates unchanged.
More tellingly, the policy noted that the macroeconomic environment was 'fraught with risk' with pressures from aggregate demand embodied in rising bank credit, high crude oil and asset prices and global risks from larger macroeconomic imbalances making it difficult to contain inflation in the medium-term. In short, the central bank is well aware of the risks, which is why it has proposed to rein in money supply growth in the ensuing fiscal at 15% and limit the growth in non-food credit to 20%. It is unclear, however, how it proposes to do so without raising interest rates.
The only measure taken by the central bank to check the rampant growth in credit was hiking the risk weightage on loans to commercial real estate developers, high value housing loans and capital market exposures. Exposure to venture capital funds will also now be treated as part of capital market exposure and assigned a higher risk weight of 150%. The effectiveness of such policy is, however, debatable given the fact the growth in loans disbursed to commercial real estate segment was 84% YoY in FY06, despite the risk weight being increased from 100% to 125%.
What has changed?
Not much has changed since January. Non-food credit growth was 31% YoY (highest in the last two decades), while the money supply expanded by 21% YoY. Asset prices across categories have soared, be it commodity, real estate or stocks. True, inflation as measured by the wholesale price index (WPI), was a mere 4.2%, but the likelihood of the same remaining unchanged is anybody's guess. Infact, crude oil prices have surpassed all previous records and crossed the US$ 70 per barrel mark in the last month. Notwithstanding this, our oil consumption (POL imports) shows no signs of abating. The Fed too, remains unfettered, about keeping its 25 basis point rate hike continuing.
Why the mute stance?
The mute stance taken by the central bank makes one wonder as to why it is refraining from calling a spade a spade. On the face of it, the decision not to raise rates seems to indicate that it is not unduly uncomfortable with the pace of growth in credit and in asset prices - a signal diametrically opposite to the one it made in January. But that interpretation would be contradicted by the RBI's insistence that it would tighten money supply and credit this fiscal. Far more likely, therefore, is that the decision is the result of the 'moral suasion' by the finance ministry - the finance minister having lost no opportunity in opining that banks should 'keep' interest rates unchanged. At the same time, given the fact that the underlying risks and pressures continue to be present, it is also probable that interest rates have merely paused their upward march.
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