Credit policy comments

A perfect balancing act

Vishwavir Ahuja,
MD and Country Head, Bank of America

Overall the policy should meet the dual objectives of price stability and maintaining the growth momentum. The Reserve Bank of India's decision to hike reverse repo rate by 25 bps to 5.25 per cent and the decision to keep the margin between repo and reverse repo at 100 points is a clear indication that the central bank is keen to keep inflation rates under manageable levels.

While the bank rate has been left unchanged , the Reserve Bank of India clearly sees the pass-through effect of global hike in crude prices would be felt by Indian economy in the second-half of the fiscal year. The repo rate hike obviously is to ensure that the growth momentum and the potential for higher growth is realised without getting caught in an upward price spiral.

Given the current level of commodity prices, especially crude oil, it is likely that inflation will continue to rise. The upward revision in the GDP growth to 7.5 per cent is mainly owing to the improved resilience of the agriculture sector and sustained uptrend in some manufacturing sectors.

The focus of the monetary policy is achieve the twin objectives of creating an interest rate environment that would be favourable to maintaining, firstly, price stability and then macroeconomic growth. Even as there are indications of all-round firming up of prices, the mid-term monetary policy tries to tread a fine balance by reining in inflation and at the same time encouraging growth.

The decision to allow banks to issue guarantees or standby letters of credit in respect of ECBs raised by textiles companies for either modernisation or expanding capacity would further encourage textile industry in India to compete at the global level in the post multi-fibre agreement period.

The policy yet again has not addressed the need felt for deepening and broadening the market for financial derivatives to initiate pro-active measures for the development of markets for long-term interest rates, foreign exchange benchmarks and other risk management products.

Overall the policy should meet the dual objectives of price stability and maintaining growth momentum.

Rate status quo a good move

A K Khandelwal,
Chairman & MD, Bank of Baroda

RBI policy review reflects the most optimum "policy response" to the present concerns of increasing inflationary expectations and weakening of rupee. By raising the repo and reverse repo rates, the RBI has reasserted its prime objective of "inflation targeting". By not raising the "bank rate", it has prevented the possibility of sharp hikes in lending rates.

This augurs well for the ongoing economic recovery. In the banking arena, the noteworthy measures are - permission for intra-day short selling in government securities that will boost the volumes in this market via better price discovery; and a hike in those banks' exposure to capital markets, which have sound risk management capabilities.

By asking the IBA to issue transparent guidelines for appropriate pricing of credit, the RBI has expressed its due concern over the present mis-pricing of loans in certain segments. By taking forward the process of "financial inclusion" through a proposal to revive co-operative credit system and introduction of no-frill accounts, the RBI has shown its continued commitment.

A hawkish stance indeed

D K Mehrotra,
MD, LIC of India

The Reserve Bank of India in its mid-term review of the monetary policy for 2005-06, has hiked reverse repo rate by 25 bps to 5.25 per cent and repor rate by 25 bps to 6.25 per cent, thus, maintaining the corridor at 100 bps. This clearly signals a shift from the central bank's neutral stance towards a slightly more hawkish stance.

With this, the spread between the US Fed rate and our short-term rate would widen to 150 bps. We have to wait until the first week of November, 2005 to see if the Fed would continue its stance of hiking its policy rate.

With all the sectors of the economy expecting to register an impressive growth in the current fiscal, the Central Bank has for the time being, preferred not to hike the bank rate in order to sustain the growth momentum attained. The basis for this could have been that the inflation is still under control and the current account deficit is perceived to be manageable.

The challenge before the RBI would be to contain inflationary pressures emanating from supply side as well as demand side. We feel that the continued uncertainty of oil prices, the inadequate pass through of oil price rise, the developments on the currency front and the rising US yields shall continue to have bearing on the bond market.

Focus on retaining equilibrium

Nilesh Shah,
CIO, Prudential ICICI AMC

The Reserve Bank of India has come out with a flexible policy that seeks to do justice to its objective of encouraging growth, maintaining price stability, managing exchange rate and ensuring a smooth passage of the government borrowing programme. The focus of the monetary policy is clearly on prompt and calibrated action to maintain an equilibrium among all these conflicting factors.

While the present emphasis seems to be on inflation management and price stability, the hike in repo and reverse repo rates seem to suggest that RBI is watching inflation carefully. While the monetary policy announced today has been largely in line with the market expectations, the central bank's move to increase repo rates by 25 basis points was slightly unexpected.

In a progressive move, the central bank has proposed that the NDS-OM module be extended to insurance companies. We believe that it would be appropriate if the same is allowed for mutual funds, given that fund houses offer various schemes exclusively dedicated to investing in government securities.

This move would also be inline with RBI's intent of getting all the market participants onto a single trading platform.

The central bank has proposed intra-day short-selling of government securities "� a move that will result in better price discovery. Consolidation of government securities as proposed by the RBI will help generate better volumes.

The RBI has also changed the capital market exposure limit for banks linked from advances to percentage of net worth. As per our calculation, this could result in reduction in capital market exposure limit for a few of the private sector banks. We however believe that this will not lead to a significant change in overall numbers.

In another favourable move that will help banks better meet contingencies, the RBI has also raised provisioning requirement from the present level of 0.25 per cent to 0.4 per cent for standard advances.

The RBI has expressed concern on the exposure of banks to real estate, venture capital funds, capital markets and highly leveraged non-banking financial institutions (NBFCs). The supervisory review process, which will be initiated for monitoring these exposures, will ensure effective control for the banking system.

All-in-all, the reserve bank, though its monetary policy seeks to attain price stability and maintain focus on credit quality and keep window open for calibrated and prompt actions in managing growth, liquidity and inflation.

Emphasis on price stability

V P Shetty,
chairman, IDBI Ltd

The overall stance of the policy remains unchanged, that is, to provide appropriate liquidity to meet credit growth while placing equal emphasis on price stability. The upward revision of reverse repo rate is expected to increase the short-term interest rates and narrow the gap between sub-PLR and PLR rates.

To avoid the pro-cyclical adverse selection during the credit expansionary phase, general provisioning requirement towards standard assets has been increased to 0.40 per cent. Banks would thus need to make higher provisioning requirement.

The proposal to allow banks to issue standby letters of credit in respect of ECBs raised by textile companies would enable the industry to be competitive and give banks increased opportunities. The proposal to consider SPVs established to finance infrastructure under the approval route would facilitate increased growth requirement.

Playing it safe

Sunil Mehta,
Country Head & CEO, AIG - India

The policy was in line with market expectations. The key monetary measures taken by the RBI have been to increase the reverse repo rate by 25 bps to 5.25 per cent and the repo rate from 6 per cent to 6.25 percent. We believe that this hardening is an appropriate response to current macro-economic conditions.

Overall, the policy stance is cautious and RBI is concerned about inflationary impact driven by rising oil prices and asset prices. It has taken cognisance of changing balance of payments dynamics and global monetary tightening.

While CRR has been kept unchanged at 5 per cent, RBI has stressed on its medium-term objective of reducing CRR to 3 per cent. Capital market exposure limits have been increased and banks with good risk management controls and systems will be considered for this increase. RBI has sounded a note of caution on the rising bank exposure to real estate sector due to "spiraling prices". Provisioning requirements have been increased for 'standard advances' from 0.25 per cent to 0.4 per cent.

Clearly, emphasis is on ensuring credit quality provided by banks and higher credit discipline. The RBI has also instituted various structural changes to financial markets. Intra-day short-selling in Gsecs is a welcome measure for the debt markets. An electronic trading platform for market repo transactions is being developed by CCIL.

This and NDS-OM module extension to insurance companies bodes well for private insurers and indicates rising significance of insurance sector in deepening Indian debt markets.The RBI has once again managed to walk the tightrope between 'price stability' and 'growth momentum'. The Central bank has indicated it will take dynamic and prompt measures based on prevailing macroeconomic conditions.

Such, prudent RBI policies are a must if India has to continue on a high growth trajectory while managing macro-economic risks.

Calibrated approach to risks

Sanjay Nayar,
CEO, Citigroup India

The mid-term review comes against the backdrop of hardening of interest rates in the US, rate hikes in most emerging markets and flattening of capital flows. The monetary policy statement has reiterated the focus on price stability while ensuring that adequate liquidity will be maintained to meet the "legitimate requirements of credit".

The stronger than expected credit growth in the economy has not necessarily found its way to the infrastructure and SME sectors where as asset prices have gone up significantly. Consequently , the RBI has laid down measures to channelise credit to the SME and agriculture sectors.

The governor has noted the renewal of inflationary fears globally and has appropriately highlighted the concerns of global imbalances. Hardening interest rates globally can also potentially slow down capital flows into India. In this backdrop, the increase in the repo and reverse repo rates by 25 bp recognises and addresses the balance between growth and inflation and the increasing influence of global factors on the economy.

The proposal to introduce intra-day short selling in government securities, the new provisioning norms and the rationalisation of capital market exposures are prudent and welcome. The new measures on capital market exposures are unlikely to have any immediate impact on the equity markets. In sum, the policy is a welcome one recognising and articulating all the known risks to the economy and addressing them in a calibrated manner.

The general tenor of the policy implies that the RBI would be monitoring the global and domestic factors closely and further measures to manage inflation expectations cannot be ruled out, if the situation warrants.

Bias towards stability

Vallabh Bhansali
chairman, Enam Financial

The credit policy presented by the RBI Governor today is a well thought out prescription to maintain price stability in the wake of a structural acceleration in growth estimates and inflationary pressures. In a tight ropewalk of fostering growth and maintaining price stability, a slight tilt towards the latter is clearly discernible. The hike of 25 bps in the repo rate (along with the expected 25 bps hike in reverse repo rate) was indeed a surprise.

By raising the Repo rate the RBI has definitely hinted at a further hardening in the medium term. This policy also comes in the backdrop of INR having lost heavy ground to the USD. The Governor's assessment of the inflation threat is in contrast to the assertion of the Finance Ministry that all is well on that front.

By raising the GDP growth estimate to 7 to 7.5 per cent, the RBI has confirmed a structural acceleration in it. However, it has also rightly pointed out the need to increase investments in infrastructure. The policy has raised the aggregate capital market exposure of banks to 40 per cent and direct exposure to 20 per cent of net worth of banks on a solo as well as aggregate basis.

This is positive news for the markets. The markets have been expecting the rate hike and taken the increase in GDP growth estimates positively. Equity investors have cheered the policy announcement by taking up the Sensex by over 70 points.

Emphasis on prudent risk mgmt

Ashok Wadhwa,
Partner & CEO, Ambit Corporate Finance

The credit policy is broadly in line with expectations. It tries to strike a balance between containing inflation and keeping interest rates stable for maintaining the growth momentum. Having said that, there could be inflationary pressures in the coming months on account of oil price hikes, which may be required to align domestic prices with increases in international crude price.

An increase in the reverse repo and repo rate by 25 bps has created a distinction between the repo rate and the bank rate, a policy statement which will become clear in the days to come. The RBI has continued to emphasise on prudent risk management. The increase in provisioning on standard assets is a step in this direction.

The proposal to restrict banks aggregate capital market exposure to 40 per cent of the net worth of the bank is also in line with RBI's overall policies on risk management. These are positive steps in improving the overall governance of banks. The streamlining of credit delivery to SMEs is a welcome step as their credit currently seems to be overpriced.

Overall, while the central bank has cautioned on inflation, rising oil prices, increasing asset prices and global imbalances, the policy stance is towards having appropriate liquidity for credit and having interest rates conducive for price stability, maintaining GDP growth momentum and supporting industry expansion.