A tightrope walk for the Guv

CREDIT POLICY: ISSUES & INSIGHTS

The mid-term review of the annual credit policy could not have come at a more crucial time than this. Most macro-economic parameters, domestic as well as overseas, have dramatically changed over the last one year.

A quick overview will put things in perspective and help one to analyse the monetary changes expected in the ensuing policy, irrespective of the real outcome.

In the domestic market, outstanding liquidity stands at Rs 35,000-38,000 crore, including the absorption in the market stabilisation scheme.

The daily surplus with banks, which they park with the Reserve Bank of India, stands reduced at Rs 5000-6000 crore against Rs 70,000-80,000 crore in the year-ago period.

Aggregate deposits is currently is at around Rs 16,01,014 crore against Rs 13,85,842 crore. Foreign exchange reserves stood at $119.30 billion now, as against $91.89 last year.

However, the weekly growth in forex has reduced from $500 million-$1 bn last year to a mere $50 million-$100 million this year.

Bank credit, measured primarily in terms of non-food credit, is at Rs 9,35,905 crore, almost Rs 1,77,762 crore higher than Rs 7,52,411 crore.

On the other hand, banks' investments in government securities have gone down to Rs 6,78,535 crore, which is Rs 77,844 crore higher than last year's investment of Rs 6,08, 159 crore.

However, the year-on-year growth is lower as this variation in 2003 over 2002 was Rs 1,19, 664 crore. Consequently, the credit-deposit ratio has gone up from 54.29 per cent to 58.46 per cent, while the investment-deposit ratio has fallen from 45.84 to 44.04.

Credit demand has increased and, therefore, even if liquidity inflow stays constant, the requirement is channelised towards credit demand, both retail and corporate.

Liquidity is not only affected by credit demand, but also from measures taken by the central bank to curtail the impact of liquidity on rising inflation.

In fact, inflation has been the most happening phenomenon in the global economy over the last one year. Geopolitical disturbances in the Middle East, Africa and Latin American countries and its effect on oil production and, consequently, the rise in oil prices are pushing up inflation.

The price of brent crude in the International Petroleum Exchange has gone up from $28 a barrel to $54.47 a barrel now. Being a net oil importing country, rising oil prices has pushed up the year-on-year rate of inflation from 5 per cent last October to 7.10 per cent at present.

To contain inflationary situation in the economy, the RBI hiked the cash reserve ratio by 50 basis points in two stages effective from mid-September 2004.

This was one of the reasons for a further reduction in liquidity by over Rs 8,500 crore. Consequently, money supply, which was growing at 15 per cent few months back, is at 14 per cent.

Economic recovery is perceived to be on a full swing both in India and overseas. Taking a cue from the bullish economy, both the US and UK have raised interest rates. Since May 2004, the US Federal Reserve has effected three rounds of rate hikes, raising the base rate from 1 per cent to 1.75 per cent.

The Bank of England, on the other hand, has increased the repo rate from 3.5 per cent in August 2003 to 4.75 per cent in five tranches. However, there is a fear that rising oil prices might slowdown the nascent recovery seen in many parts of the globe.

In fact, China has been taking a deliberate decision to slowdown its growth to ward off the demand for oil. Coupled with a huge current account deficit, US' economy recovery is a big question among global analysts and, thus, is the strength of dollar.

Going by the resilience of the domestic economy and apprehensions on the dollar's strength globally, India is bullish on forex inflows, both portfolio and direct. Thus, liquidity will continue to remain abundant and the spot rupee is already ranging between 45.72 and 45.75 to a dollar against 46-plus few weeks back.

Domestic credit demand, pressure from globally rising interest rate and inflation scenario have set the stage for a interest rate hike in India as well. Gilt prices have already factored it in as the yield on 10-year benchmark security has gone up to 6.74 per cent from a low of 5.10-11 per cent last year same period.

It's a tightrope walk for the central bank. A rate hike should not be deterrent to the warming-up economy as it is already fighting hard to cope with rising oil prices.

More importantly, government borrowing, which is left to be completed by more than 40-45 per cent, need not fall prey to the high interest rates in its race with private investment in the second half of the fiscal.