Tilting towards growth

Having faced something of a liquidity crisis a few weeks ago, the Reserve Bank of India (RBI) was expected by some observers to infuse additional resources into the system. However, in the days that followed, the crisis appeared to blow over and mainstream opinion converged towards a neutral policy position. That is how it turned out eventually, with no change in the four basic parameters of monetary policy""the repo rate, the bank rate (the rates at which the RBI lends money to the banking system), the reverse repo rate (the rate at which it borrows from the system) and the cash reserve ratio. While this may be something of a departure from the relatively strong anti-inflationary positions taken in the policy announcements last January and October, it was entirely warranted by the circumstances. Having tilted the scales towards inflation control on the previous two occasions, growth seems to have got the nod this time round. There was little question that the rise in interest rates as a consequence of the rapid increase in credit demand, reinforced by the RBI's position over the last two quarters, would begin to bite sooner rather than later. The major housing finance companies had already announced a 50 basis point hike in their prime lending rates a couple of weeks ago, an indication of pressure across the board. With the stock market and real estate sector on a binge, banks are finding it ever more difficult to raise resources without providing substantially higher returns to depositors in whatever form they are willing to part with their money. A sharp contraction of lending activity by the banking system through retail or wholesale channels, or both, could well have been the party pooper. Better to wait and see how market forces deal with this pressure; in fact, if inflation continues on its moderate path and interest rates show signs of surging, the RBI must keep open a credible avenue for supplementing rather than tightening liquidity within the banking system. Its neutral stance suggests that, while it hasn't entirely dismissed the threat of inflation yet, it is sensitive to the trade-offs involved.

The macroeconomics apart, the policy announcement dwelt quite a lot on managing public finances and systemic risks more efficiently. A number of streamlining measures to manage the finances of state governments will help them take better advantage of the Twelfth Finance Commission's push to direct access to markets. Recognising the banking system's increasing exposure to real estate, both residential and commercial, there has been some tightening of the provisioning requirements against large loans to this activity. The RBI has also initiated several measures to improve the flow of credit to rural borrowers in ways that are consistent with the rather rigorous prudential norms being put into place. Admittedly, these are mainly in the exploratory stage, but given the government's emphasis on expanding rural credit, it is incumbent on the RBI to ensure that this does not happen at the cost of the banking system. For some time now, the RBI has been pre-occupied with the macroeconomic canvas. It was time for it to take a breather and pay some attention to bread-and-butter banking issues. The window may not be open for long and should be taken full advantage of.