ECONOMIC HIGHLIGHTS

New Delhi, 20 April 2006

Credit Policy Support

MAINTAINING ECONOMIC MOMENTUM

By Dr. Vinod Mehta

The Reserve Bank of India in its Credit Policy for the year 2006-07 has attempted to provide support to the growth rate of around eight per cent without in any way unduly restricting the growth of credit.  Last time the changes that were made in the Credit Policy were during the mid-term Appraisal of the Annual Policy for the year 2005-06, which endeavoured to encourage the high growth rate and at the same time tried to control the rate of inflation.

The Economic Survey has already projected a growth rate of around 8.1% during the current fiscal.  The RBI’s Credit Policy is again geared to achieve this goal.  As in the last mid-term review, the RBI while announcing its policy has been guided by two concerns – growth and inflation – and measures announced by it are  designed to allow the economy to sustain this growth rate and at the same time contain the rate of inflation at around 5%. 

In the mid-term Appraisal in October last the RBI did not change the CRR ratio but it  raised the reverse repo-rate – the rate at which Central Bank borrows from the banks – by 25 basis point from 5% to 5.5%. The implication of this measure was that the interest rates both on lending and deposit will rise. The interest-rates both for lending and borrowing did rise marginally. But in the Credit Policy for 2006-07 there has been no change in bank rate, cash reserve ratio, Repo-rate and reverse repo-rate                                     

During the mid-term Appraisal, the RBI had expressed its concern over the housing loans which have been growing at a very fast pace in the past few years. With the hardening of the interest rates the interest rates on new housing loans also went up marginally.  In the Credit Policy also the RBI is concerned about the growth of housing loans which is a worrying factor. 

This is also true of other consumer loans.  Therefore, it has increased general provisioning requirements on standard advances like personal loans, housing loans etc. beyond Rs.20 lakhs and commercial real estate loans from present level of 0.4 per cent to one per cent. Because of this provisioning that rate of interests on personal loans will go up by ½ per cent to one per cent.

However, those who have been waiting for a hike in the interest rates in bank fixed deposits may can now be sure of an increase in the interest rates in the coming months.  The nationalized banks have marginally raised their interest rates on term deposits, while one foreign bank has raised the interest rate on term deposit of one year to eight per cent, which is equal to the interest rate being offered by PPF and Post Office. At the moment the interest rate on savings bank deposit, which was deregulated last year, is 3.5%.

The RBI’s reading is that with the competition hotting up among the banks, the rate on interest on savings bank account will not go below 3.5%.   It will be recalled that the interest rates on the savings bank two years ago was fixed at 5%. De-regulation means that every bank can offer any rate of interest on savings bank account depending upon its financial health.  As of today there is no change in the savings bank interest rate in the past six months when it was deregulated.

In this mid-term Appraisal, the RBI had also taken a step to bring more people to keep their money in the banks. It had suggested that the banks may introduce “no-frills” account where the minimum balance would be either zero or very low but the account holders will have to pay for the services like issuance of cheque books, ATM cards and also statement of account.

Some of the new Indian private sector banks have already offered zero balance facility to many depositors. Now this measure will also be applicable to foreign banks operating in India.  Though there is no mention of this in the Credit Policy, many banks including foreign bank have already introduced no frill accounts without fanfare. But it is not known if more clients have taken advantage of this.         .

The Credit Policy for 2006-07 will not raise interest rates for investment in the economy but will curb inflation. The reason for the optimism is that there is adequate liquidity available in the economy, that is to say, the funds which are available for lending are available in large quantity.

The funds to be made available to small and medium industries have already been doubled since October last.  Moreover, it may be added that the interest rates on loans to stronger companies are always flexible and negotiable so it is unlikely that the interest rates on loans to bigger companies will rise to any significant extent. The loan offtake is unlikely to go down.

The RBI is still cautious about India’s current account deficit but feels it is manageable. India’s import to GDP ratio is on the rise and it has risen to 17.2% in the first quarter of last fiscal year from 13% five years ago which is mainly due to increases in both oil and non-oil imports. This trend will continue. Surplus in the capital account has, however, helped in easing the overall balance of payment situation.  This trend the RBI feels will continue.

The Deputy Chairman of the Planning Commission has already stated that the economy is ready to transit from a phase of moderate growth to a new high growth stage where it may achieve an average growth rate of about 8% over the next 15 years. But this calls for supportive action to make this growth rate attainable. He was particularly hinting at the increase in the FDI which at the moment is 1% of the GDP and could be increased further through appropriate measures.

He further observed that with population growth slowing down to about 1.5% over the next 15 years, an 8% growth in GDP means that per capita income will grow at about 6.5% per year instead of around 4% or so in the past fifteen years. The faster growth in per capita income means that per capita income which increased by 80% over the past fifteen years will increase by 160% over the next fifteen years. This in other words means higher living standards for the people of India.

The RBI is doing its bit to push up the growth rate and curb inflation by way of monetary policy.  It is supplementing the efforts of the Finance Ministry.  The Annual Credit Policy including the mid-term Appraisal for the past two years have been quite consistent in their approach.                                                                                                              

 (Copyright, India News and Feature Alliance)