Credit Policy: Will Reddy spring a surprise?

MUMBAI NOV. 1. The Reserve Bank of India Governor, Y. V. Reddy, in his maiden Mid-term Review of Monetary and Credit Policy for 2003-04 could address the pressing need for structural changes in the Indian monetary and banking system.

A cut in the Bank Rate with a pronounced bias towards softer rates could be the cornerstone of the policy.

"Dr. Reddy has a five year term and must aim at setting up a road map for the banking system to see that Indian banking emerges as a globally competitive entity falling in line with all international standards including the proposed Basle II norms,'' said Cherian Varghese, Chairman and Managing Director, Corporation Bank.

"The busy season policy could see more of structural changes in the Indian financial architecture driving home the point of importance of technology oriented systems and the need to keep abreast with the global economy,'' said Kapil Bagla, Senior Vice President, Centrum Finance.

The RBI would lay down, felt Mr. Bagla, a road map for the phased implementation of the real time gross settlement (RTGS) — trading on a continuous basis throughout the day rather than the present system of settling at the end of the day. There could also be a move towards Delivery Verses Payment - III, wherein the traders settle on a net basis.

As of now the Government security deals are being done on gross basis and the amount transfer is done on net basis at the end of the day.

The last time the central bank cut the repo rate was on August 25 and the inflation at that time was 3.7 per cent. The repo has been cut twice in the last one year and it now stands at 4.50 per cent. The repo rate, the benchmark for short term rates in the economy, felt Mr. Bagla, would be left untouched in the current policy.

His reasoning being that the current inflation rate at 5.01 per cent — increased from 4.95 per cent last week — and there is a need to have a pronounced yield curve across maturities. The cut in the repo last time fired the debt segment and led to a flattening of the yield curve which, in technical terms, portends a weak economy and an anomaly.

The economy is indeed on the run, growing at 5.8 per cent (National Council for Applied Economic Research predicted a 7 per cent growth) and Mr. Bagla anticipates that the central bank may revise the growth rate to 6.5 per cent in its policy statement. The Bank Rate, the basis for pricing loans by banks, may be cut by 50 basis points from the present 6 per cent. The last time a similar cut was made on October 30, 2002 and corrected by 25 basis points. "Our hope is that the soft interest rate bias may continue,'' said Mr. Varghese. Agreeing to this, P. G. R. Prasad, Managing Director, SBI Mutual Fund said, "I feel that the Bank Rate may be cut by 25 to 50 basis points.''

Despite inflation inching upwards (lower base phenomenon), the medium term goal of taking the Cash Reserve Ratio (CRR — amount of liquid cash that the banks maintain in its vaults), to 3 per cent — now at 4.5 per cent — is tempting and the same may be cut by about 25 basis points in the current policy. This step would aid the system as "it would release funds into the system that faced a crunch situation in the last ten days,'' said Mr. Bagla, adding, "there may also be a move to pay interest on the CRR maintenance in the policy.'' However, Mr. Prasad, maintains the view that, "CRR may be unaffected for the time being.''

On the foreign exchange front where India has had an unprecedented accumulation in the forex reserves, the RBI may further liberalise the borrowings of the banks overseas.

At present the limit to the banks' borrowing overseas is at 25 per cent of their unimpaired capital or $10 million whichever is higher. This ceiling may be raised. The steps towards global integration by announcing some measures in central bank's efforts to full convertibility of the rupee may be expedited.

It would not be surprising, however, if Dr. Reddy brings to the fore his experience at the International Monetary Fund (IMF) and ushers in holistic structural changes that could have implications in the longer term rather than settle for short term measures.

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