• APRIL 28, 2005

Highlights of Monetary Policy 2005 - 06

Against the background of developments during FY05, the stance of monetary policy FY06 has been dependant on several factors, including macroeconomic prospects, global developments and the balance of risks.

To begin with, there is a possibility that the tight conditions in oil markets may moderate the economic growth in FY06. Besides, the non-food credit during FY05, recorded as the second highest in 55 years, may be subdued due to the Centre's borrowing programme. It should also be noted that the borrowing programme of the Centre was unusually low in FY05, while that for FY06 is significantly higher and in line with the magnitudes in FY02 and FY03, though the credit growth was sluggish in those years. Also, the current account, which was in surplus for three consecutive years, is turning into a deficit while the capital account continues to be in surplus. The apex bank anticipates that these trends will continue in FY06 and consequently, the external sector will exhibit strength and resilience, though unanticipated, globally transmitted shocks cannot be ruled out.

Monetary Measures

  • The Bank Rate was kept unchanged at 6 %.

  • The Reverse Repo Rate has been increased by 25 basis points under the liquidity adjustment facility (LAF) of the RBI w.e.f April 29 2005, from 4.75% to 5%. With the fixed repo rate continuing to remain at 6%, the spread between the repo and reverse repo rates have reduced by 25 basis points.

  • The Cash Reserve Ratio (CRR) has been kept unchanged at 5 %. However, the Reserve Bank of India (RBI) will continue to pursue its medium-term objective of reducing the CRR to the statutory minimum level of 3%.

Besides these, there have been no changes to the priority sector lending norms and the suggestions regarding increasing the scope of lending have been put on hold for further considerations.

Projections for FY06

  • With a normal monsoon, the growth in agriculture is estimated at 3%. Further, it is expected that industry and services sectors would maintain their current growth momentum while absorbing the impact of oil prices. The real GDP growth during FY06 is estimated to be 7%.

  • Consistent with the real growth of GDP and inflation, the projected expansion of money supply (M3) for FY06 is placed at 14.5%. In tune with this, the increase in aggregate deposits of scheduled commercial banks is set at Rs 2,600 bn, which is higher by 15% YoY. Non-food credit of banks is projected to increase by around 19%. This magnitude of credit expansion is expected to adequately meet the credit needs of all the productive sectors of the economy.

  • For FY06, the net borrowing programme is budgeted at Rs 1,103 bn as against Rs 460 bn in FY05 (240% growth YoY).

  • The apex bank has also indicated that there is a possibility of unwinding the Market Stabilisation Scheme (MSS) to provide adequate liquidity for accommodating the continued growth in credit needs as well as the higher borrowing programme.

Our view
The apex bank stand of not tinkering with the CRR and Bank rates despite possibilities of a liquidity crunch are indicative of the fact that it does not wish to send out any preliminary signals of the same and wishes to wait till the necessity to do so arises. Although the current monetary policy seems to be a non-event, going forward changes in the monetary measures cannot be ruled out. It seems that the apex bank has deferred the decision to take bitter pill for some more time. But eventually, economics will prevail.

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