The mid-term review of the annual credit policy for 2004-05 announced by the Reserve Bank of India (RBI) lends a whiff of optimism to the view that economic growth is likely to continue. Supporting the prognosis are the good corporate results, buoyant non-food credit growth, and higher private corporate investments, among other positive indicators.
Additionally, the confidence of investors, both domestic and international, in the Indian story appears to be increasing.
Thus, for instance, the risk premium on private sector bonds as measured by the yield spread between AAA-rated corporate bonds and government securities declined significantly during April to October 2004.
However, as widely anticipated, the RBI has now scaled down the 2004-05 growth rate for the gross domestic product (GDP) to 6-6.5 per cent from the 6.5-7 per cent projected earlier, given the prevailing inflation rate of around 6.5 per cent (5 per cent assumed previously).
But the apex bank has kept the M3 growth rate unchanged at 14 per cent, may be to douse a possible flare-up in inflationary expectations.
Interestingly, the RBI has also pushed up the fixed repo rate to 4.75 per cent from the earlier 4.5 per cent, perhaps for the same purpose. This increase in the repo rate is a signal to the market that the current fundamentals of inflation "" global crude oil prices and interest rate dynamics "" may not allow a softening of bond yields.
Signals apart, the policy has proposed several concrete steps to facilitate credit delivery to the productive sectors of the economy. Thus, it has suggested a host of measures under the priority sector lending norms.
These include extension of the special agricultural credit plan to private sector banks, enhancement of the composite credit limit for small scale industries from the existing Rs 5 million to Rs 10 million, and enhancement of the credit limit for housing loans from Rs 10 lakh to Rs 15 lakh.
Interestingly, the policy has also sought to introduce a counter cyclical measure by increasing the risk weight on housing loans and consumer credit.
On the issue of regulation and supervision, the policy has stated that it will soon put in place a set of draft guidelines for the Indian banking system to make a smooth transition to Basel II.
While this is a welcome step, the proposed strengthening of prudential norms for the classification of doubtful assets by financial institutions also marks a move in the right direction.
A notable feature of the current policy is the suggestion on "vision documents" for urban co-operative banks and the payment and settlement systems.
Moreover, it has suggested the setting up of "working groups" for the establishment of a regulatory mechanism for credit cards, for the avoidance of conflict of interests in the financial services sector, and such other issues.
These measures, in my view, will impart additional transparency to the financial system and improve regulatory monitoring.
The RBI has decided to be cautious in not reducing benchmark rates. The status quo has disappointed the markets but the prudence shown by RBI, given the recent bond market rally and also the prevailing macro-environment, is understandable.
