MONETERY POLICY JULY 2006

Tight money ahead
One or both of two things will happen in the coming 12 months: the economy will lose steam, and/or interest rates will go through the roof. The only way both negative developments can be avoided is if the Reserve Bank allows more money to flow into the system—but that will not be without other consequences.

Now for the details:
Bank credit has grown by an unusually rapid 30 per cent for two years in a row. And if the April-July period is something to go by, that performance is going to be repeated this year as well. But where is the money to finance this rate of credit expansion? The RBI requires banks to keep a minimum statutory reserve of 25 per cent, and a cash reserve of 5 per cent, so banks cannot lend more than 70 per cent of their deposits. In the last two years, though, fresh credit has been more than 100 per cent of fresh deposits. That didn’t come up against any barriers because banks had headroom for lending, since the credit-deposit ratio two years ago was well below the limits. But if fresh credit matches fresh deposits this year as well, there will be no headroom left. Which can only mean one thing: money will become scarce and interest rates will shoot up.

The RBI sees it differently. It is betting on credit this year growing by no more than 20 per cent—which would be a sharp slowdown from the speed up to now. Since companies are announcing bigger and then still bigger projects, all of which have to be financed, there is no sign of a slowdown. Nor is there any let-up in the general economic tempo. If credit growth is to slow down in such a macro-economic context, interest rates will have to climb more steeply than they have so far, to reflect the scarcity of cash. This is precisely what happened 11 years ago: the economy was growing at 7.5 per cent, there was runaway credit growth, and because inflation had become a worry, the RBI clamped down by jacking up interest rates so sharply that many companies went into a tailspin and the economy as a whole went into a three-year mini-recession. Is history about to be repeated?

Probably not, because everyone remembers what happened last time. Also, inflation today is less of a threat than in 1995—so there is no need to choke growth if fresh money can be pumped into the system to feed the credit machine. The RBI can do this by lowering the cash reserve requirement from 5 per cent to 4.5 per cent or even 4 per cent. The problem with that is it adds a huge amount to the growth of money supply, which is already growing much faster than the RBI would like—and that will certainly add to the risk of higher inflation.

If this is a plausible scenario, it can be argued that rather than waiting and leaving corrective action for too late, the RBI should have been flashing more warning signals by now—and not taking small incremental steps at each quarterly review of the monetary situation. Banks would have picked up the signals and gone in for sharper interest rate hikes. That would not have immediately dried up corporate demand for credit, especially if it is financing investment with attractive returns, but it would certainly have made a difference in the personal credit market—and therefore slowed down the demand for housing and car loans, which have been the fastest-growing segments in recent times. But action delayed till now will have to be accelerated later.

If this reading is correct, the general market expectation that the RBI will not announce any further increase in its short-term rates for lending and borrowing money, and that it will leave the rates unchanged till January if not even later, may be wide off the mark. Anyone running a business, or planning to borrow money for asset buys, should take into account the risk that money is going to become noticeably more expensive before the year is out.
 
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RBI bullish on funding credit

The Reserve Bank of India (RBI) has said banks have over Rs 1,57,000 crore headroom in the form of excess statutory liquidity ratio (SLR) investments to fund the scorching credit growth.

Bankers, however, said the central bank’s intention behind pointing at the excess SLR investments was to ease banks’ liquidity concerns, amid unrelenting growth in credit – particularly loans, despite the recent rise in interest rates.

The RBI, in its first quarter monetary policy review yesterday, stuck to its 20 per cent credit growth forecast for 2006-07, notwithstanding a 32 per cent increase in non-food credit during April 1-July 7, 2006 over a high base a year ago.

The central bank seems to be telling banks that it has not stopped deliberating on slowing down credit growth.

Bankers and analysts said the RBI had refrained from a further tightening of credit market on Tuesday so as to avoid hurting the expected pickup in demand for credit to fund expansion plans.

They expect a further increase in provisionings and risk weights on exposures to certain sensitive sectors, like real estate including home loans and personal loans, in the next review.

The banking system’s SLR investments on July 7, 2006 were 31.5 per cent of net demand and time liabilities (or deposits) or NDTL, which amounted to Rs 1,57,548 crore. The level of SLR holdings is down from 36.4 per cent of NDTL on July 8, 2005.

Excluding liquidity adjustment facility holdings, investments of banks in approved securities in excess of the SLR amounted to Rs 99,273 crore or 4.1 per cent of the system’s NDTL.

“We would not totally rule out further prudential measures on banks in the coming quarters if loan growth rates, in some hot sectors, do not come down. Though the RBI has not increased standard assets provisioning or risk weights further in the current review, there are covert warnings to banks to strengthen their credit appraisal systems,” ICICI Securities said.

IDBI Capital Market said the pricing of housing loans vis-a-vis credit pricing to triple A-rated corporates provides evidence of what could be considered mispricing of credit.

The current yield on 10-year bond of triple A-rated company is 9.25 per cent, while a 15 to 20-year housing loan to individuals is priced at 9 per cent.

It further said, “Banks price their longer-tenure loans to individuals, often with unproven credit history, at interest rates finer than the shorter-tenure loans to blue-chip companies. The issue that emerges is whether the credit spread is adequate to cover the default risk on the bank loans being extended. In our opinion, it is clearly insufficient.”
 
The Reserve Bank of India (RBI) has said banks have over Rs 1,57,000 crore headroom i

India Inc's interest burden is set to go up by about Rs 1,750 crore in this financial year following the two-stage 50 basis point increase in the Reserve Bank of India's reverse repo hike in June and July. One basis point in one hundredth of a percentage point.

This is assuming that commercial banks will hike their lending rates by an identical margin to protect the spread between their cost of funds and earnings on loans. If the banks raise their lending rates by a higher margin, corporate India will end up taking a bigger hit.

Data collected from Capitaline Plus, a corporate database provider, show that India Inc has borrowings of over Rs 400,000 crore in the form of secured and unsecured loans on its books.

Excluding the foreign currency loans of Rs 53,000 crore, domestic borrowings are to the tune of Rs 3,47,000 crore. A 50 basis point rise in the interest cost will translate into close to Rs 1,750 crore as additional interest burden.

The impact of the rising rates is already visible. The interest burden of 571 companies that have so far declared their first-quarter results, has increased by 26 per cent.

These companies had paid Rs 708 crore more interest to Rs 3,479 crore during the April-June quarter against Rs 2,771 crore paid in corresponding quarter of the previous year.

As a percentage of net profit, however, interest cost has not gone up as these companies have put up a better show. Interest cost accounted for 15.6 per cent aggregate net profit in the June 2006 quarter, compared with 16.46 per cent in the June 2005.

These 571 firms have posted a 32 per cent rise in aggregate net profit to Rs 22,287 crore against Rs 16,831 crore in the previous year.

During 2005-06, the interest burden of 3,019 companies increased by 4.81 per cent to Rs 29,771 crore (Rs 28,404 crore). Interest cost accounted for 23.5 per cent of the net profit of these companies in 2005-06 against 25.9 per cent in 2004-05. These 3,019 firms had posted Rs 1, 26,943 crore net profit in 2005-06 against Rs 1, 09,861 crore in the previous year.

The total borrowings of corporate India consist of short-term working capital loans, secured project loans, institutional loans, debentures and fixed deposits.

With the rates rising, along with bank loans, the cost of other financial instruments will also go up. Firms will also have to pay more for new loans.

Private sector petrochemical giant Reliance Industries' borrowing was to the tune of Rs 21,866 crore in March 2006. Pubic sector companies like Indian Oil Corporation, NTPC and ONGC have substantial borrowings on their balance sheets.

The rates started going up from the last quarter of financial year 2004-05 with the Reserve Bank of India (RBI) hiking its reverse repo rate by 25 basis points to 4.75 per cent in the last week of October 2004. That was the first of a series of six rate hikes.

In 2005-06, the RBI policy rate moved up by 75 basis points to 5.5 per cent through three hikes in April and October 2005 and January this year. Since then, there have been two hikes of 25 basis points each on June 8 and July 25, taking the reverse repo rate to 6 per cent.
 
No surprises here

If Mint Road were a human being, it would have smiled on Tuesday hearing the collective sigh of relief from bond dealers after the Reserve Bank of India (RBI) announced its decision to hike the short-term reverse repo rate by 25 basis points to 6 per cent. (One basis point is one hundredth of a percentage point.) Rarely does one see market participants so happy after a rate hike. There was virtually no impact on the government bond prices and the benchmark 10-year bond yield rose by just one basis point to 8.22 per cent. Much more than any thing else, RBI Governor Yaga Venugopal Reddy has restored the confidence of the market and credibility of the central bank by biting the rate hike bullet.

In the annual monetary policy in April, Reddy did not hike the rate against widespread expectations of a rate hike. In June, he hiked the rate in an unexpected inter-meeting move and followed it up by raising the amount of a government bond auction to suck out excess liquidity from the financial system. These actions added to the uncertainties and made the bond market nervous. The 10-year bond yield rose from a level of 7.67 per cent before the June rate hike to as much as 8.42 per cent this month, and left the central bank behind the curve. By hiking the rate, the RBI has caught up with the curve and restored the equilibrium in the market.

This is the sixth hike since the rate hardening cycle began in October 2004, the third since the beginning of calendar year 2006 and the fourth in the past eight months. With this hike, the reverse repo rate and the bank rate — which is RBI’s medium-term signal on interest rates — have converged at 6 per cent. Does this indicate the end of the cycle of rising rates? Possibly not. The RBI has certainly not reached the neutral zone but attained a level from where the rate trajectory can move either way, depending on the external developments (read: what other central banks do) and domestic events (credit growth and inflation rate). With the RBI no more behind the curve, the overwhelming bias in favour of rising rates is not there any more.

However, the bond yields will not remain flat for long. They will rise in tandem with the progress of the government borrowing programme. The government’s gross market borrowings at Rs 69,533 crore in financial year 2006-07 (up to July 17) is only 38.2 per cent of the budget estimate. The net market borrowings at Rs 34,572 crore is 30.4 per cent of the estimate. With more bond auctions taking place, the prices are bound to go down, pushing up the yield gradually.

The immediate action will shift to the loan market now. The cost of money for all borrowers — retail and corporations — will go up once the liquidity in the system starts tightening. The daily reverse repo window of the RBI has been drawing over Rs 30,000 crore worth of liquidity for quite sometime now but this will dry up once the government aggressively pushes for its market borrowing.

Non-food credit of scheduled commercial banks rose by Rs 37,749 crore, or 2.6 per cent, up to July 7. In the corresponding period last year, the rise in credit was Rs 19,948 crore or 1.8 per cent. This is the highest first quarter expansion of credit in the past five years. On a year-on-year basis, the increase in non-food bank credit has been 32.9 per cent (Rs 3,71,993 crore) on top of an increase of 31 per cent (Rs 2,60,164 crore) last year. Retail lending rose by 74 per cent on a y-o-y basis with growth in housing loans being 115.5 per cent and commercial real estates 101.3 per cent. The year-on-year growth in credit to industry was 26 per cent by May 2006. The only way of reining in the phenomenal growth in credit is making money dearer for the consumers of loan.

This has been happening. The public sector banks have been jacking up their loan prices quietly. Even though there have been four reverse repo rate hikes since October last year, most public sector banks have hiked their prime lending rate only once. This is because officially they do not want to be seen making credit expensive when Finance Minister P Chidambaram is keen on maintaining the flow of credit. Instead of hiking their prime lending rates, they have continuously been raising their sub-prime rates. This will increase with the latest reverse repo rate hike.

The scene is quite different for private banks as they are not under the glare of North Block. ICICI Bank has raised its benchmark advance rate (linked to both corporate and home loans) four times since January. The bank’s benchmark rate is now up from 11 per cent on January 2 to 13.25 per cent now. We may soon see another round of hike. Ditto for HDFC, which has hiked its retail prime rate twice since February — from 10.75 per cent to 11.75 per cent. Rates for all loans across sectors will rise now. However, as long as the cost of loans for corporate India in percentage terms is lower than the country’s nominal GDP growth, rising rates are unlikely to derail India’s growth story.
 
Money just got costlier

Reverse repo rate hiked 25 bps; India Inc says expansion plans may take a knock.

The cost of money for India Inc as well as the retail consumer is set to go up by a quarter to half a percentage point, with the Reserve Bank of India raising the key short-term reverse repo rate by 25 basis points today.

The reverse repo rate has now moved up to a four-year high of 6 per cent. Presenting the quarterly review of monetary policy, RBI Governor YV Reddy said the "modest pre-emptive action" had been taken to marry growth with stability.

Reddy has left GDP growth forecast unchanged at 7.5-8 per cent for 2006-07 and inflation rate projection at 5-5.5 per cent.

This is the sixth 25 basis point hike since the rate hardening cycle began in October 2004 and the third hike since the beginning of 2006. However, the cycle of rising rates seems not to be over yet.

"On balance, a modest pre-emptive action in monetary policy is appropriate at this juncture while being ready to respond flexibly and promptly by closely monitoring the related developments," Reddy said.

Bankers maintain that the RBI may keep the rates unchanged at its mid-term review on October 31 but may hike them again in January 2007.

It is a matter of time before banks across the board hike their lending rates. The asset-liability committees of almost all banks will meet over the next few days to take a call on the quantum of hike — between quarter and half percentage points.

However, the bond market gave a thumbs up to the RBI decision as it lifted the uncertainty surrounding the market. The benchmark 10-year gilt yield rose marginally to 8.28 per cent after the rate hike but closed the day at 8.22 per cent against yesterday's closing of 8.21 per cent.

"The market has already priced in the hike," said Nitin Jain, head of fixed income securities at I-Sec, a primary dealer.

Bank stocks cheered the RBI move. The BSE banking index — Bankex — was the largest gainer among the sectoral indices today, rising 4 per cent against the 2 per cent rise in the Sensex.

The Bankex was up by 181 points to close at 4,569.30 today even as the Sensex rose 200 points to close at 10,415. However, the primary reason behind the rise was the RBI's weekend decision to allow banks to raise hybrid capital overseas, analysts said.

Housing Development Finance Corporation (HDFC) Chairman Deepak Parekh said the largest mortgage company in the country might hike its home loan rate now by at least a quarter percentage point.

ICICI Bank, however, would wait a while before raising rates as any rate hike could impact consumer demand, said its retail banking head K Vaidyanathan. It has already hiked its home loan rate thrice in 2006. Its floating rate loans are available at 9.5 per cent while fixed loans cost 10.75 per cent. LIC Housing Finance, too, is bracing for a rate hike.

"We have little choice other than hiking home loan rates," its CEO S K Mitter said.

India Inc is not happy with the rate hike as it will impact corporate expansion plans. A cross-section of senior executives in different sectors said this would slow investment programmes.

Siddhartha Roy, economic advisor with the Tata Group, said it would raise the cost of capital and thereby adversely impact margins of the corporate sector, especially small and mid-size companies. This, in turn, would adversely affect the ability of the companies to invest.

According to him, new projects would be worst hit by the rate hike. "Companies can't stop implementation of a project half-way because of the rate hike. But they will think twice before kicking off new projects," he pointed out.
 
Current conditions are somewhat extraordinary

The Reserve Bank of India (RBI) governor Y V Reddy, for a change, decided not to surprise the markets and went with the general expectations. The 25 basis points reverse repo rate hike eliminated uncertainties that would have lingered otherwise. Here are the extracts from Reddy's interaction with the media:

Reddy: The decision to hike reverse repo rate has been taken keeping in view the current situation and the current objective of trying to maintain inflation within a range of 5.0-5.5 per cent for the current year. In the near to medium term, this would be possible.

But I would like to informally have a self-imposed ceiling of 5 per cent on inflation over the medium to long term long term. This we believe is required to maintain healthy growth momentum consistent with macro balances keeping in view global inflationary situation.

There is perhaps no particular surprise in this measure. However, there is one view that there are certain uncertainties and it is better to wait and then decide. Let me read out two crucial sentences to explain what was on our minds:

* The current situation calls for some stabilising influences while keeping all the options open for the future to maintain a successful and dynamic balance between growth and stability that has been the hallmark of our macroeconomic policies during the reform period.

* A modest pre-emptive action in monetary policy is appropriate at this juncture while being ready to respond flexibly and promptly by closely monitoring the related developments. I would like to submit that while looking at the monetary policy one must recognise monetary policy has lagged effect and it has to be forward looking.


Our stance and steps should be viewed not in response to what is happening today but in the context of a reasonable assessment of the outlook for the next 1-2 years.

Why has the bank rate been kept unchanged?

The current interest rate scenario is related to near and immediate outlook. But medium to long term objective is to keep inflation below 5 per cent and for this the policy rate should be 6 per cent.

Hence, we are not changing the policy rate as we still believe the current conditions are somewhat extraordinary circumstances. But how we have to recast in the near future would deepened on how global imbalances work out and how demand and supply factors within the country work.


Why is he is worried on the high deposit and credit growth in the first quarter?


Banks need to ensure credit quality. Credit has been growing far faster than deposits. A more sustainable balance is required between deposits and credit growth. It would be very difficult to maintain non-food credit growth at around 30 per cent unless deposits increase.


While in the case of credit it is possible to adjust government securities portfolio in the short run, but to mobilise deposits particularly retail is not possible in the short run.


The way forward for banks is to concentrate on deposit mobilisation and ensure credit quality and growth is not too high compared to availability of deposits. This implies that growth cannot be maintained at 30 per cent. It has to decelerate a bit.


Now how far it falls remains to be seen. RBI has said if banks are able to raise deposits successfully, then we would be comfortable with higher credit. A balance is required to ensure credit growth is healthy and sustainable.


What does RBI mean by monetary policy cannot be undirectional for prolonged period of time?


The response of our monetary policy to global developments should be pre-emptive at signs of heightened uncertainties but should also be willing to discern possible trends towards normalcy.


Thus, monetary policy may not be unidirectional for a prolonged period, recognising that the pace of changes in the global economic and financial environment is far more rapid now than ever before.


As far as global developments are concerned, we should be lot more nimble footed to be able to recognise what is happening in globally and be prepared to move in either direction over the longer term. This is more in the context of overall analysis of the global economy.


If anybody thinks this is a signal that very soon we expect a change in the global sentiment or change in direction of the global monetary environment, that is not the intention. But what is intended today is not to be surprised if changes occur swiftly. In such a case we must be ready to move in either direction.


How will the rate hike control or affect money supply?


The 15 per cent M3 growth target is indicative but we have been generally on the higher side compared to what has been anticipated. Money supply may be considered more indicative now while there is greater reliance on the interest rate instrument. Between the two, we would really give greater weight to the interest rate situation.
POLICY SNAPSHOT

Non-food credit growth

Non-food credit of scheduled commercial banks increased by Rs.37,749 crore (2.6 per cent) up to July 7, 2006 compared with an increase of Rs 19,948 crore (1.8 per cent) in the corresponding period a year ago. This is the highest first quarter expansion in the past five years.


Retail lendings

Retail lending rose by 74 per cent on a year-on-year basis with growth in housing loans being 115.5 per cent. Loans to commercial real estate rose by 101.3 per cent.


Corporate lendings

The year-on-year growth in credit to industry was 26.0 per cent by May 2006. Substantial increases were observed in credit flow to industries such as infrastructure (34.7 per cent), metals (37.6 per cent), vehicles (37.9 per cent), gems and jewellery (43.5 per cent) and construction (52.6 per cent).


Deposit growth

Aggregate bank deposits increased by Rs.68,499 crore (3.2 per cent) up to July 7, 2006 against an increase of Rs.19,435 crore (1.1 per cent) in the corresponding period of the previous year. This is the highest deposit accretion any comparable period since 1993-94.


Money supply

Money supply (M3) growth at 18.8 per cent by July 7, 2006 was higher than 13.8 per cent, a year ago and above the projected trajectory of 15 per cent.


Reserve Money

On a year-on-year basis, the expansion in reserve money as on July 14 was of the order of 16.0 per cent, lower than 18.0 per cent a year ago.


WPI Inflation

Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, rose from 4.1 per cent at end-March 2006 to 4.7 per cent as on July 8, 2006. Inflationary pressures are mainly reflecting the pass-through of the hike in administered prices of petrol and diesel effected on June 6, 2006.


CPI Inflation

On a year-on-year basis, inflation based on the consumer price index (CPI) for agricultural labourers and rural labourers increased to 7.2 per cent each in June 2006 from 2.7 per cent each a year ago. The year-on-year CPI inflation for industrial workers and urban non-manual employees was placed at 6.3 per cent and 5.8 per cent in May 2006 as against 3.7 per cent and 4.2 per cent, respectively, a year ago.


Govt market borrowing

Gross market borrowings of the Central Government at Rs.69,533 crore (Rs.60,282 crore a year ago) during 2006-07 so far (up to July 17, 2006) constituted 38.2 per cent of the budget estimate while net market borrowings at Rs.34,572 crore (Rs.39,234 crore a year ago) constituted 30.4 per cent of the budget estimate.


Hike in deposit rates

Banks increased their deposit rates by about 25-100 basis points across various maturities between March 2006 and July 2006.


Hike in lending rates

The benchmark prime lending rates (BPLRs) of PSBs and private sector banks moved to a range of 10.75-11.50 per cent and 11.00-14.50 per cent from 10.25-11.25 per cent and 11.00-14.00 per cent, respectively, in the same period.
 
Buying a dream house may be a tough task

Home loan rates may go up by about 25-50 basis points following the rise in the reverse repos rate of 25 basis points announced by the central bank today.

According to Deepak Parekh, chairman, Housing Development Finance Corporation (HDFC), "Since we did not increase home loan rates last month, we may have to do so now." The hike, Parekh said, would be at least 25 bassi points but capped at 50 basis points.

"We will re-price our loans in line with the market, " said Neeraj Swaroop, CEO, Standard Chartered Bank, adding that "The hike, though on expected lines, will put pressure on banks' cost of funds and how we price to our customers. We will review both retail and wholesale loans and deposits and take a call shortly."

ICICI Bank may, however, take a while to up its rates. Says K Vaidyanathan, Head, Retail Banking, ICICI Bank, "We will be cautious about increasing rates further since it could impact consumer demand."

ICICI Bank has hiked rate three times already in calendar 2006, by 50 basis points each time. Currently, floating rate loans are available at 9.5 per cent, while fixed loans cost 10.75 per cent.

HDFC raised interest rates by 50 bp to 8.5 per cent (for floating rate loans) in February and again by 50 basis points to 9 per cent in May. Fixed rate loans are priced at 10.5 per cent.

Vaidyanathan believes that demand for home loans, which has been growing at around 25 per cent year-on-year last , is slowing down. "We have to assess the demand before we pass on the hike," he said.

During the June quarter, the weighted average cost of funds for the bank has gone up by about 60 basis points, thanks to an increase in deposit rates. On how the bank would manage its margins, Vaidyanathan said it would be a management challenge.
 
Rate blues get the better of India Inc

India Inc is not happy with the rate hike as it will impact corporate expansion plans.

A cross section of the senior executives of different sectors, contacted by Business Standard after the RBI announcement, said the cost of money would go up to a four-year high level and this would slowdown the future investment programmes.

However, with the lowering of debt:equity ratio and creation of huge reserves through internal accruals, a large segment of the corporate India has to some extent been able to insulate itself from the impact of rate hike.

D D Rathi, executive director of Aditya Birla group's flagship Grasim Industries, said the impact would vary depending on the profile of companies and projects.

While the big corporates with huge cash reserves might not feel the pinch, small firms which had no alternative but to borrow from the institutions to implement their growth plans would be hit.

However, the psychological impact of today's rate hike would not be great as it was widely expected. "For the past six months, interest rates have been going up and up. This time, it was also expected that the apex bank would raise the interest rates," he added.

Siddhartha Roy, economic advisor with the Tata Group questioned the basic idea of raising interest rate to curb inflation. "The inflation in our country is a supply-push phenomenon. Therefore, measure like raising interest would have no impact on inflation. On the other hand, it would raise the cost of capital and thereby adversely impact margins of the corporate sector, especially small and mid-size companies. This, in turn, would adversely affect the ability of the companies to invest," he explained.

According to him, new projects would be worst hit by the rate hike."Companies can't stop implementation of a project half-way because of the rate hike. But they would think twice before kicking off new projects," he pointed out.

A senior official of Essar group said the RBI step would have minimal impact on the expansion programme of the corporate sector.

"The bank lending rates have already gone up and the rise in repo rate is only a manifestation of the lending rate. In view of the slowdown in retail lending , there is enough liquidity in the system to meet the requirement of corporate sector," he said.
 
Commercial lending hits 5-year high

Bank lending to the commercial sector in the first quarter of 2006-07 is the highest in the last five years. The quarter has also seen highest deposit accretion since 1993-94.

The pressures emanating from high growth in money supply and credit are seen by the Reserve Bank of India (RBI) as having the potential for "impacting stability and inflation expectations".

In its first quarter monetary policy review, the RBI said the growth in money supply, deposit and credit are running well above indicative projections, warranting caution by all concerned in this regard.

There are also disturbing signs of demand pressures, especially continuing high credit growth, that could exert upward pressure on prices when associated with supply shocks from oil prices, it noted.

Non-food credit of scheduled commercial banks (SCBs) increased by Rs.37,749 crore (2.6 per cent) up to July 7, 2006 as compared with an increase of Rs 19,948 crore (1.8 per cent) in the corresponding period a year ago.

This increase is the highest first quarter expansion in the past five years. On a year-on-year basis, the increase in non-food bank credit was 32.9 per cent (Rs 3,71,993 crore) on top of an increase of 31.0 per cent (Rs 2,60,164 crore) a year ago.

Aggregate deposits of scheduled commercial banks increased by Rs 68,499 crore (3.2 per cent) up to July 7, 2006 as against an increase of Rs 19,435 crore (1.1 per cent) a year earlier.

The accretion to bank deposits during 2006-07 so far is the highest for any comparable period since 1993-94. The year-on-year increase in aggregate deposits at 20.7 per cent (Rs.3,72,977 crore) was significantly higher than 14.9 per cent (Rs 2,34,020 crore) a year ago.

With the year-on-year growth in credit still outpacing deposit growth, the incremental non-food credit-deposit ratio continued to remain high at 99.7 per cent compared with 111.2 per cent a year ago.

The growth in aggregate deposits was projected at around Rs.3,30,000 crore in 2006-07. Non-food bank credit including investments in bonds/debentures/ shares of public sector undertakings and private corporate sector and commercial paper was expected to increase by around 20 per cent.

Developments during the first quarter of 2006-07 indicate that money supply, deposit and credit growth are running well above the indicative projections, warranting caution by all concerned in this regard
 
Nasty surprise round the corner for economy

The Reserve Bank of India (RBI) today cautioned that the possibility of downside risks for the economy materialising in the near-term is more now than before.

Both domestic and global factors are delicately balanced in terms of growth vis-a-vis price stability with a tilt towards the possibility of identified downside risks materialising in the near term being more likely than before, RBI said in its first quarter monetary policy review.

"The unfolding path of the risks, however, is naturally unclear at this stage. On balance, a modest pre-emptive action in monetary policy is appropriate at this juncture while being ready to respond flexibly and promptly by closely monitoring the related developments," RBI said referring to the 25 basis points hike in the reverse repo rate.

The central bank said it is necessary to strike a balance between reinforcing the resilience of our economy against global risks and taking advantage of global expansion.

RBI said the two important questions in assessing the economic outlook are whether the process of re-pricing of risks, in general, is complete with the mid-May correction and whether corrections are incomplete in the economies which benefited from lower-priced risks in the past.

"The overall macroeconomic and geopolitical global environment is admittedly indicative of marked downside risks," the central bank pointed out.

Overall, for policy purposes, the forecast for GDP growth has been retained in the range of 7.5-8.0 per cent during 2006-07.


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Economy will not slow down: FM

Soon after the Reserve Bank hiked overnight interest rates, Finance minister P Chidambaram said the decision was aimed at containing inflationary expectations in the short term and was in line with what other central banks have done across the world.

Speaking to reporters outside Parliament, Chidambaram added that the rate hike would not impact economic growth. "The economy will not slow down. On the contrary, it will continue to grow in a healthy and robust way", he said. Chidambaram said the government broadly recognised the need for the hike.

"I am not surprised at this increase. RBI has reviewed the risks in the short term and has hiked the reverse repo rate by 25 basis points and accordingly the repo rate by 25 basis points. The Governor has said he would ensure that productive sectors would not be denied credit", he said.
 
COMMENTS

The monetary tightening is a pre-emptive measure aimed at checking excessive growth in credit and rising prices. The economy is growing at a healthy pace for a fourth straight year and credit demand is robust, across sectors.

The tightening will also help check the demand-pull part of the price spiral. To the extent a large part of domestic inflation is being fed by the global spiral in commodities, especially of crude, monetary policy can't do much, but some moderation in growth impulses will certainly slow down the India component of the rising global demand for such commodities. Thus, this could lead to much more stable growth impulses in the medium term.
Sanjay Bhandarkar, MD and head,
investment banking, Rothschild

Returns look safe

RBI has acted as referee in the game of interest rates and has blown the whistle. It has certainly its reasons - robust credit offtake, inflation fears, heightened global conflicts, and global rate hikes.

In one sweep, however, the rate hike settles the score in favour of the hawks who would be pleased with the pronouncement of pressure on rate hikes.

It will be interesting to watch what equilibrium gets established between investments in equity instruments and deposits as retail savers juggle returns. Lastly, with greater equalisation of rates, the mandated small saving rates and return on PFs look safe and the battle for reforming those areas may be postponed to another day.
R Ravimohan, MD and chief
executive officer, Crisil

Small firm hit hard

The impact would vary on companies and projects. While big corporates with huge cash reserves might not feel the pinch, smaller corporations, which have no alternative but to borrow from the institutions to implement their growth plans, would be hit badly.

However, the psychological impact of today's rate hike would not be great as it was widely expected. For the past six months or so, interest rates have been going up and up.

This time also, it was expected that the apex bank would raise the interest rates. Therefore, the rate hike was factored in psychologically.
D D Rathi, executive director,
Grasim

Inflation fighter

Major central banks across the globe, too, have been concerned over build-up of inflationary pressures. Domestic economic momentum has been strong and has manifested in higher credit growth and pressure on inflation and interest rates. The RBI's move underlines linkages to an evolving global economy and flags downsides risks to growth.

In this environment, hiking rates will put pressure on the cost of funds of banks and prompt them to look at re-pricing. This could affect credit offtake though the impact is unlikely to be significant.

The rate hike once again establishes the RBI's credentials as an inflation fighter, and is, hence positive for the rupee.
Neeraj swaroop, CEO-India,
Standard Chartered Bank

Rethink on projects

The basic idea of raising interest rate to curb inflation is a bit fuzzy. Inflation is a supply-push phenomenon. Therefore, measures such as raising interest would have no impact on inflation.

On the other hand, it would raise the cost of capital and, thereby, adversely impact margins of the corporate sector, especially small and mid-size companies. This, in turn, would adversely affect the ability of the companies to invest.

New projects would be worst hit by the rate hike. Companies can't stop implementation of a project half-way because of the rate hike. But they would think twice before kicking off new projects
Siddhartha Roy, economic advisor,
Tata Group

No hike for now

The policy review looks to finely balance growth momentum. The gap between PLR and sub-PLR rates is expected to narrow down further following the rate hike.

RBI has rightly emphasised on the need for rationalising deployment of resources. The central bank has also highlighted the point to focus on mobilising retail deposits which have durability (long term). This is necessary to manage asset and liabilities. The market continues to show liquidity overhang.

The daily absorption of excess resources in the system through liquidity adjustment facility has been over Rs 40,000 crore. Hence, we do not see the need to revise deposits rates at this juncture.
M Balachandran, chairman & MD,
Bank of India

Action justified

The modest hike in repo and reverse repo rate is in line with our expectation. The policy action seems to be justified given the strong credit growth through the first quarter, rising crude prices, incomplete pass-through and the need to manage inflationary expectations.

Domestic factors are likely to dominate policy actions over the near future and the RBI has shown the willingness and ability to respond swiftly on policy directions.

Given that we have already seen a significant correction in the long-end of the yield curve over the last few months, further short term rates rises may not translate into equivalent shifts in long-end of yield curve.

Sanjay Nayar, CEO,
Citigroup India
 
awsome man aws0em---------
There could be a few policy changes as well in the course of re-writing the Act. “Although the expert group has been mandated to rewrite the Act in simple langauge without changing the law, a few policy changes may be unavoidable in the course of re-drafting”, said a top government source.
 
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