The thrust of the Monetary and Credit Policy for the new fiscal year 2010-11, unveiled on April 20, focusses on anchoring inflation expectations, actively managing liquidity to meet growth in demand for credit from both public (borrowing) and private sector “ in a non-disruptive way”, and maintaining an interest rate regime consistent with price, output and financial stability.

The benchmark Bank Rate continues to be held at 6 per cent. The repo rate (under which the central bank lends) is increased by 25 basis points from 5.0 to 5.25 per cent, and the reserve repo rate from 3.5 to 3.75 per cent with immediate effect. The Cash Reserve Ratio (CRR) of banks will be increased similarly from 5.75 to 6 per cent of their net demand and time liabilities effective the fortnight beginning April 24, 2010.

Announcing the Policy, Governor Dr D Subbarao said in the emerging scenario, lower policy rates can complicate the inflation outlook and impair inflationary expectations, particularly given the recent escalation in the prices of non-food manufactured items. Despite the increase of 25 basis points each in the repo rate and the reverse repo rate recently, “our real policy rates are still negative. With the recovery now firmly in place, we need to move in a calibrated manner in the direction of normalising our policy instruments”.

RBI has projected GDP growth at 8 per cent with an upward bias”, holding of inflation at 5.5 per cent and monetary expansion at 17 per cent, keeping in view the resource demand by Government and private sectors”, consistent with growth and inflation outlook. Accordingly, aggregate deposits of scheduled commercial banks are projected to grow by 18.0 per cent. Growth in non-food credit is placed at 20.0 per cent. These numbers, it is pointed out, are provided as indicative projections and not as targets.

The growth projection of 8 per cent is on assumption of normal monsoon and sustained good performance in industrial and service sectors on the back of the rising domestic and external demand. The uptrend in industrial performance (April-Feb). increase in non-oil imports, revival in exports and increased activity in services sector are indicative of the growth momentum despite “worrisome developments on the inflation front”. Apart from continuing double digit food inflation, WPI in manufacturing and fuel groups had risen by 4.7 and 12.7 per cent respectively in March 2010. In the context of such inflationary pressures, RBI notes that managing government borrowings in 2010-11 AT Rs. 3,42,300 crores would be a “bigger challenge” than it was last year.

Monetary policy management in the current year has also to reckon with risks such as the negative impact on recovery of waning of public spending (stimulus) as also a sluggish and uncertain global environment. As the Policy points out, sustaining domestic recovery hinges on the revival of private consumption and investment. In the event of global recovery gaining momentum, commodity and energy prices, already on rise for the last year, may harden further and add to inflationary pressures in India. Above all, the critical factor is a normal monsoon which, if unfavorable could exacerbate food prices and impose a fiscal burden and dampen consumer and investment demand.

The increase in CRR is expected to absorb about Rs.12,500 crore of excess liquidity from the banking system.

The Governor said the monetary measures announced would likely contain and anchor inflation expectations and sustain the recovery process while Govcrnment borrowing requirements and private credit demand would be met. At the same time, he said, macroeconomic conditions particularly the price situation would be monitored to take further action as warranted.

On large capital flows, on which the RBI survey of macro-economic and financial developments released on April 19 had words of caution, the policy Statement did not spell out any new line of intended action, even as the rupee appreciation has been sizeable over the last several months. The Policy Statement of the Governor merely noted that global liquidity conditions coupled with favourable growth prospects in emerging economies including India were expected to trigger large capital flows which pose a challenge for exchange rate and monetary management. Both exporters and producers, who compete with imports in domestic markets, are getting increasingly concerned about the external sector dynamics.” There is, therefore, a need to be vigilant against the build-up of sharp and volatile exchange rate movements and its potentially harmful impact on the real economy”.

On developmental and regulatory issues, the Policy Statement has firmed up the switch-over by banks to the Base Rate system (in place of the current benchmark primary lending rates) from July 1. Guidelines have been issued to banks on the formulation of the Base Rate which, according to RBI, is expected to facilitate 'better pricing of loans, enhance transparency in lending rates and improve the assessment of transmission of monetary policy”.

On credit delivery and financial inclusion, RBI has proposed a series of measures to step up the flow of credit to units of micro and small enterprise sector and also to promote financial inclusion through grassroot cooperatives while banks are largely left to develop their own models and these financial inclusion plans would be discussed by RBI with banks individually. For the MSE sector, banks dhave been asked not to insist on collateral security for loans upto rs.10 lakhs as against the present limit of rs.five lakhs.

On foreign banks, the Finance Minister had announced in the budget speech that RBI would consider giving some additional banking licences to private sector players. NBFCs could also be considered, if they meet the Reserve Bank's eligibility criteria. RBI now proposes to prepare a discussion paper “marshalling the international practices, the Indian experience as also the extant ownership and governance guidelines“. The paper would be placed on RBI website by end-July for wider comments.

RBI would thereafter hold detailed discussions with all stakeholders and finalise guidelines and all applications received would be referred to an external expert group for examination and recommendations for granting licences.

On the presence of foreign banks, especially those with cross-border presence, the policy Statement has taken note of international discussions on the larger issue of financial regulations. Some of the lessons from the global financial crisis are to avoid organisational structures which become “too big or too complex to fail”. The resolution mechanism for internationally active banks is not likely to be reached in the near future. (IPA Service)