Reddy keeps interest rates intact to spur demand

GDP growth pegged at 6.5-7% in 2004-05.

The Reserve Bank of India (RBI), while announcing its annual credit and monetary policy, yesterday left the benchmark bank rate, short-term repo rate and banks' cash reserve ratio (CRR) unchanged and announced a string of incremental measures to improve credit delivery and strengthen the prudential norms of the banking system.

The central bank pegged the gross domestic product (GDP) growth in 2004-2005 at 6.5-7 per cent on the back of a normal monsoon and a sustained growth in industrial activity and exports. The forecast for the rate of inflation is around 5 per cent, below last year's average of 5.4 per cent, but higher than last year's projection of 4-5 per cent.

Unveiling the policy, RBI governor YV Reddy said: "India will continue to be among the top performers globally."

Describing the policy approach as "status quo", Reddy said the overall stand of the policy would continue to be the provision of adequate liquidity to meet credit growth and support investment and export demand while keeping a close watch on price movements. He also said the RBI would pursue an interest rate policy to support the growth momentum and price stability.

Although the policy document took extensive note of rising international rates and called for close watch on the inflation situation, Reddy said a rate hike was not considered because the positive domestic factors like macro economic stability far outweighed external uncertainties. "If you see the level of linkages (of the domestic market with global markets), there is always a lag effect. There could be an alignment later (with global rates)," he said, without making any commitment on the interest rate front.

Setting the agenda for the banking sector, the RBI called for a comprehensive and transparent policy on the ownership and governance of both public sector and private banks. This assumes significance against the backdrop of the RBI's push for limiting foreign ownership in private banks (by those foreign banks which have presence in India) to 10 per cent and capping the voting rights for the foreign owners at that level.

On the credit delivery front, the RBI has fine-tuned norms for priority sector and infrastructure lending to increase the flow of credit to these sectors.

It has also allowed banks to raise long-term funds through infrastructure bonds. This will enable banks to take care of their asset-liability mismatches.

While making changes in the prudential norms, the RBI has followed a carrot and stick policy. It has lifted the cap on banks' exposure in unsecured lendings and allowed them to take an additional 5 per cent exposure to individual borrowers and groups of companies for infrastructure financing without the central bank's permission.

If these are relaxations, some norms have been tightened too. For instance, it has put in place a 100 per cent risk weightage to banks' exposure in public finance institutions. The banks have also been asked to maintain a

capital charge for market risk to ward off any impact on their government securities' portfolio in case interest rates rise.

In due course, the capital charge for market risk will replace the existing system of investment fluctuation reserve (IFR), which the banks need to create to take care of shocks arising out of any adverse movement in interest rates. The RBI has also introduced a graded provisioning requirement for those assets which are "doubtful" for more than three years.