Close Watch On Inflation

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: The Monetary Policy announcement has been a relatively low-key event, which has focused largely on maintaining status quo. The overall aim of the policy has been provision of adequate liquidity to meet credit, investment, and export demand, even as a close watch is kept on movements in the price level and ensuring an interest rate environment that is conducive to maintaining the present momentum of growth, as well as macro-economic and price stability.

The Interest Rate outlook contained in the Policy Statement - manifested in an unchanged Bank Rate, CRR, and Repo Rate - is indicative of RBI’s view that the downward movement in interest rates has ended, and that it may now need to maintain stable interest rates in the context of upward pressures.

In respect of risk management, banks are to draw a roadmap by December 2004 for migration to Basle-II. Risk-Based Supervision (RBS) will be extended from the present set of eight banks to another 15 - although this list has not been made public. This suggests that RBI’s experience last year with RBS has served to convince it of its benefits. The various measures in respect of Settlement Risk (including the introduction of CBLO and RTGS, settlement of non-SLR investments and OTS derivatives through CCIL, etc) clearly mark RBI’s move towards the reduction of Settlement Risk for the Indian banking system.

Governor Reddy’s intention to increase provisioning on certain categories of NPAs might not result in anything more than a moderate increase in provisions on existing NPAs. However, for new NPAs, the augmented provisioning requirements will have a significant impact.

The modifications announced by Dr Reddy in respect of banks’ Prudential Exposure norms are expected to permit higher exposure to quality borrowers. Finally, RBI’s inflation estimate of around five per cent for 2004-05 as a whole may be somewhat optimistic. With increasing oil and commodity prices, along with a significant upturn in projected GDP growth, there is adequate upward pressure on inflation. Thus, average inflation for the year is more likely to be in the range of 5.5 to six per cent.