RBI responds to inflation threat

Repo rate raised; Growth forecast down; Home loan rates may go up.

The Reserve Bank of India (RBI) today signalled a balance between its growth stance and inflationary concerns by raising the short-term repo rate by 25 basis points to 4.75 per cent.

But to foster investment, it left the bank rate (6 per cent) and banks' cash reserve ratio (4.75 per cent) unchanged in its mid-year review of the credit policy.

However, some banks may hike housing loan rates because of the increase in the risk weightage on housing and consumer loans.

Despite the repo rate hike, no bank is contemplating an immediate lending rate hike. RBI Governor Y V Reddy said commercial banks might not hike their rates as credit growth had been very good and they were making money.

The central bank raised its inflation forecast by 150 basis points to 6.5 per cent and cut its GDP growth estimate for the current fiscal year to 6-6.5 per cent from 6.5-7 per cent, citing uncertain oil prices and deficient monsoon. It, however, raised its estimate for non-food credit growth from 16-16.5 per cent to 19 per cent for the year.

Unveiling the policy, Reddy said the stance of the policy was to provide "appropriate" liquidity. "Earlier, our approach was to provide ample liquidity, which was then modified to provide 'adequate liquidity', and now the move is to provide 'appropriate liquidity', which signals a balance," Reddy added.

He said the RBI would pursue an interest rate environment that was conducive to price stability and to maintaining the growth momentum. At the same time, the central bank will consider measures in a calibrated manner to respond to evolving circumstances to stabilise inflationary expectations. This is a hint that further tightening of the policy cannot be ruled out if inflation is not contained.

The biggest challenge the RBI faced was in the assessment of growth in view of the erratic monsoon and the impact of oil prices, Reddy said. Even the revised growth projection of 6.5 per cent, according to him, is creditable and shows the resilience of the economy and the growth impulses of the manufacturing sector.

Referring to the phenomenal credit offtake, Reddy said the incremental credit-deposit ratio reached 96 per cent on October 1, 2004, which "indicated the potential increase in economic activity".

The governor, however, expressed concern over the rapid growth in housing and consumer credit.

The RBI has put in risk containment measures by increasing the risk weight from 50 per cent to 75 per cent in the case of housing loans, and from 100 per cent to 125 per cent in the case of consumer credit, inclusive of personal loans and credit cards.

Fearing a retail asset bubble, Reddy cautioned bankers to restrain growth in these areas and asked them to concentrate more on loans to manufacturing, agriculture, and small and medium enterprises.

He was quick to add that the current risk containment measures were temporary and subject to review. While most bankers have not hiked interest rates, many could face pressure in terms of raising home loan rates following the hike in the risk weight.

Reddy expects the government's borrowing programme to go through "as we see a lot of non-banking entities picking up a lot of government paper, so the market is not dependent on the banking sector". Banks have reduced their investment in government securities.

Click here for PDF and WORD versions of RBI release.