Focus on liquidity to fuel growth

MID-TERM REVIEW OF ANNUAL POLICY 2004-05/ GUEST WRITERS: SASHI KRISHNAN

Sashi Krishnan

The overall stance of the mid-term credit policy for 2004-05 is to ensure adequate liquidity to support credit growth and pursue an interest rate approach that maintains the growth momentum and macro economic stability.

The RBI policy however warns that "while the Reserve Bank will continue to give some weight to considerations of stability, the market should be prepared for the uncertainties".

These uncertainties in the interest rate environment will arise out of a combination of factors including the globally transmitted supply shock, less than normal monsoon, liquidity over hang and a pick up of non food credit.

The policy therefore tries to draw a balance between managing the monetary complexities arising out of the above while at the same time maintaining the growth momentum.

According, RBI has marginally revised downward its GDP growth estimates for the year to 6-6.5 per cent from 6.5- 6.75 per cent and revised upwards its inflation expectation from 5 per cent earlier to 6.5 per cent.

Inflation seems to a very big concern for RBI. The policy document suggests that while headline inflation is presently at 7.1 per cent, if the entire increase in international oil prices is passed on to investor, inflation will move up by 2.2 per cent.

RBI is also of the view that though this may not be completely passed on, it will get more difficult in future. The RBI therefore feels that necessary adjustments will need to be made from time to time.

As a first step in the adjustment process, RBI has hiked the repo rate by 25 basis points, from 4.50 per cent to 4.75 per cent. It has also hiked the ceiling on NRE deposit rates by 50 basis points to align the rates with international interest rates.

The outlook therefore is that the uncertain interest rate outlook will continue for some time. The overall stance of RBI seems to point to a further hardening of interest rates, mainly on account of inflation concerns. While the short end of the market will reflect the repo rate hike, this will also get transmitted to the long end in due course.