Strengthening fundamentals

ANNUAL POLICY 2005-06/ GUEST WRITERS

Vishwavir Ahuja
MD and Country Head
Bank of America

Given the rising trend in global interest rates and oil prices, an increase in the reverse repo rate was widely expected in the credit policy.

Continuing with its stance of an "upward bias" in interest rates, RBI has hiked the reverse repo rate by 25 bps to 5 per cent, while the bank rate has been left unchanged at 6 percent.

Inflation, largely supply-side driven, has been placed in the 5-5.5 per cent range and continues to be the key factor impacting RBI' s decision on hiking interest rates.

Given the current level of commodity prices, especially crude oil, it is likely that inflation will continue to rise.

The RBI has cautioned that this factor may also impact the GDP growth outlook. In line with the twin objectives of the monetary policy, RBI is targeting an interest rate environment that would be favorable to maintaining, firstly, price stability and then macroeconomic growth.

The continued pick-up in investment activity and broad-based industrial performance is encouraging. The growth in credit off-take and the significantly higher government's borrowing programme for 2005-06 is however likely to impact liquidity.

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

The measures announced to liberalise the FX market such as permitting cancellation and re-booking of FX contracts and extending the working hours are welcome.

RBI's announcement of permitting overseas investments upto 200 per cent of net worth under the automatic route indicates the increasing confidence placed in the global ventures of the Indian industry.

The policy also does not disappoint in respect of structural measures that are required for a healthy development of the financial sector such as moving towards a pure inter-bank money market, reduction in minimum maturity of certificates of deposit, implementation of Basel II norms and evolving a blue print for the future role of Primary dealers.

In summary, the annual policy continues to tread the pro-growth path by concentrating on strengthening the economic fundamentals, financial stabilization and promoting good corporate governance.

Further, pro-active quarterly reviews of the annual policy will facilitate better monetary policy management.