The lack of surprise in RBIs mid-term review of monetary and credit policy should bring comfort to market participants whose growth and other predictions have been endorsed by the central bank even though the decision to leave interest rates untouched might have disappointed some. The policys focus is on a more even transmission of monetary policy changes across the economy and stability of the financial sector. The central bank is rightfully anxious about the overall rigidity in the downward movement of lending rates and this concern is reflected in its urging of financial intermediaries into immediate action in credit pricing and delivery to socially critical sectors. The problem simply is that banks are not lending to high-risk borrowers (small and agricultural borrowers) in order to limit further damage to their balance sheets. As asset classification and provisioning norms have strengthened in the 1990s, banks have been under increasing pressure to improve their balance sheets; this, however, has induced the distortion of plenty of liquidity combined with unwillingness to lend (except with inordinate mark-ups reflecting borrower risk) and investments in government securities. In this scenario, RBIs solutions of ensuring credit flows to SSIs through enhancing loan limits and setting up more committees to examine the issue are unlikely to remove the post-reform credit market segmentation. For the time being though, the banks will continue to prefer AAA borrowers, who can raise money more cheaply elsewhere, leaving banks flush with cash. Maybe the change in movement of interest rates might force banks to look at borrowers in the second tier, thus correcting the distortion.
The second thrust of the policy financial stability is reflected in making it mandatory for banks to ensure hedging of foreign currency borrowings by corporates on loans exceeding $10 million, in urging banks to build up their investment fluctuation reserves and in the harmonisation of regulatory bodies in monitoring the systemically important financial institutions. These are welcome as they anticipate future risks and seek to guard against widespread asset impairment of banks and limit balance sheet effects of sudden exchange and interest rate changes as well as signify a holistic approach towards financial intermediaries that have diversified across the financial spectrum in the past few years. Could one detect in this anxiety of the central bank any future direction of exchange rate and interest rate policy Will the rupee halt or reverse its upward trend Does the unchanged bank rate signal an inflection point in the movement of interest rates Regardless of the answers, the RBI would want to mitigate their adverse effects upon corporate and banks balance sheets and is warning them to be prepared.