Reserve Bank Is Shifting To Neutral

Updated: Apr 30 2002, 05:30am hrs
The stance of the Credit Policy is definitely neutral, given RBI’s statement that domestic interest rates are at reasonable levels. While RBI has refrained from reducing bank rate further from the current 6.5 per cent, it has stated that it might do a 50 bps cut if the situation permits.

Critical to that possibility is whether the economy picks up during the course of the year and the inflationary situation remains benign. RBI has estimated GDP growth at 6.0-6.5 per cent along with sub-4 per cent inflation rate for FY03. That projection looks optimistic at the moment, but if those are achievable then clearly there will be no need to reduce bank rate any more.

On the direction of the Credit Policy, we believe that while RBI has the intention to pursue softening interest rate bias a little further, the current situation is not conducive for another rate cut. The statement that interest rates are at reasonable levels is a marked departure from the widely held stance that real rates in India are high. This can be interpreted as RBI signaling bottoming out of market yields. But notwithstanding the current constraints arising from political uncertainty and partial roll back of Budgetary provisions, RBI has maintained that large Government borrowings will be manageable and that liquidity conditions will remain comfortable.

The Credit Policy is significant more from the structural viewpoint. RBI has announced critical changes for the money market including reduction of CRR by 50 bps to 5 per cent, initiating phasing out of non-bank participants from lending in the call market, streamlining call money transactions of banks, and announcing phasing out of collateralised lending facility for banks. Banks lending in call market has been capped at 25 per cent of NOF and borrowing is fixed at 2 per cent of aggregate deposit at the end of the previous year or 100 per cent of NOF, whichever is lower. Additionally, the CLF will also be phased out from the fortnight beginning October 5th.

Overall, the measures relating to money markets will reflect in banks relying more on term money market rather than overnight market. This will force development of the term money yield curve up to one year. Given that banks will not be able to fund their Gsec investments through call market borrowings beyond a limit and that recourse to collateralised refinance will be discontinued, both sovereign and corporate investment, hence will have to be repriced on the emerging money market yields. The realignment of bond prices with term money market rates will imply revision of prices with a downside risk.

Allowing banks to access overseas capital markets for borrowing up to 25 per cent of unimpaired Tier-I capital and increasing investment limits for banks to 25 per cent of unimpaired Tier-I capital from 15 per cent are further modest moves towards capital account convertibility.