'Monetary policy alone can't tackle inflation beyond a point' - Aditya Puri, HDFC Bank

Aditya Puri, managing director of the country’s second largest private sector lender, HDFC Bank, believes raising of rates would not suffice to control inflation; instead, it may slow the growth of the economy. He tells Somasroy Chakraborty how HDFC Bank plans to sustain its growth in this period of elevated interest rates.

Continue reading.....................

High inflation posing risks to growth: Subbarao

Reserve Bank of India (RBI) Governor D Subbarao on Friday said the current high level of inflation was posing significant risks to future growth and it was imperative to bring it down even if that meant sacrificing some growth in the short term.  In a presentation to the Inter Ministerial Group (IMG) on inflation, Subbarao said the monetary policy measures, announced in the bank’s Annual Statement for 2011-12, were based on the premise that bringing inflation down, even at the cost of some growth in the short term, should take precedence.  The RBI, in its credit policy statement on May 3, reduced growth estimates to eight per cent, as it increased the policy rates for the ninth time in over a year. It decided to go for a sharper-than-expected 50 basis points rise in the policy rates to rein in inflation. “We said everything we needed to say in the policy document. The RBI’s understanding of short-term and long-term inflation situation was explained to the IMG,” Subbarao told reporters after emerging from the third meeting of the IMG that lasted about two hours.  He explained that experience in India as well as globally suggested that in the long run, there was no trade-off between growth and inflation. He said any attempt to push growth above the potential level would only lead to higher inflation, but no durable growth or employment gain. He, however, emphasised that containing inflation was imperative to sustain growth over the medium term.  “This is a critical attribute of a favourable investment climate, on which growth sustainability depends. Fiscal consolidation will also contribute to improving the investment climate,” he said.  Chief Economic Advisor Kaushik Basu, who heads the IMG, agreed there was no conflict between the objectives of high growth and low inflation in the long run. In the short run, lowering inflation can have a dampening effect on growth, as the traditional Philips curve analysis suggests. But this is desirable, according to him, if the aim is to achieve high, sustainable growth.  Basu said all emerging economies were troubled by the resurgence of inflationary pressures and there was a concern that the very nature of global inflation might be changing.  The Wholesale Price Index-based inflation for March was 8.98 per cent. Although food inflation came down to 8.53 per cent for the week ending April 23, from 20 per cent in February last year, actual prices of food items continue to remain high.  The IMG was set up at the suggestion of Prime Minister Manmohan Singh in February ‘to review inflation situation and suggest corrective measures’. The meeting was also attended by secretaries from finance, commerce, Planning Commission, food and agriculture ministries, who are part of the IMG.

Getting policy act together

The Finance Ministry, while revising the growth estimates, must find ways to use its vast and varied armoury to fight sticky prices.  Recently, the Economic Advisor to the Finance Ministry, Mr Kaushik Basu, told presspersons that the Ministry might just revisit the forecast for GDP in the current year and lower it a notch. Global commodity and fuel prices are rising, putting pressure on growth worldwide, and India, he said, will have to take stock of that. In a break from past practice, the Finance Ministry will undertake an interim review of the economy that will analyse current developments and, accordingly, fix a new and more modest GDP forecast. As Mr Basu added, India will be following a trend prevalent all over the world, with several economies pegging their growth for the current year at lower levels. That should not become an excuse for not exploring policy options on revitalising the engine of growth. The downside risk is real. The RBI's annual statement, released a few days ago, has already sounded the cautionary note in its analysis of the year gone by and its prognosis of the one we are in now. According to the central bank, it is the inflationary pressure brought about by global commodity prices that is now adding to the “downside risk” of subdued growth. In fact, the RBI has found evidence of “moderating growth” with a sluggish capital goods industry and slackening investment spending. What spending there is, a good chunk of it is flowing to overseas suppliers, especially the Chinese, starving domestic producers, in the process, of much needed incremental demand. Take a look at external commercial borrowings and it is evident that a number of firms in power and telecommunication sectors are importing capital equipment; and no prizes for guessing what they regard as the most attractive source of such imports. China has built up a sizable capital goods industry and now is considered a major exporter of even alternative energy equipment. What the Ministry will have to remember is that the review will be gauged against the sombre mood that permeates the RBI report. What it essentially points to is slowing growth coupled with rising inflation and, as a central bank, it has done what it can do. Now, North Block, while revising its growth estimates, will have to find out just how its vaster and more varied armoury can be utilised to fight sticky prices. So far, New Delhi has simply waxed eloquent on the prospects of high growth without a thought to inflation, treating it as a problem for the RBI to handle. Restoring the past momentum of growth, combating inflation on multiple fronts and easing regulatory bottlenecks must top the Finance Ministry's policy agenda.

The wrong war? - T N Ninan

No one should cavil at the new repo rate of 7.25 per cent (up from 6.75 per cent earlier), since inflation is at 9 per cent. Still, in a week when the Reserve Bank of India (RBI) has said that combating inflation is now its primary focus, it is important to ask: is RBI fighting yesterday’s war, instead of peering into the future to glean what might be coming — as monetary policy is supposed to do? Rewind to where the inflation debate started. From the middle of 2009-10, sundry government spokesmen predicted that the year would end with 5 per cent inflation. It wasn’t to be. Then they switched to making the same forecast for 2010-11. Several reasons were given for the expected drop in inflation: a high base effect would kick in, a good harvest was coming, and so on. None of it made a difference. Last year, wholesale price inflation was 9 per cent, and the year before 10.2 per cent. Retail price inflation was comparable, if not worse (8.8 per cent and 14.9 per cent).  Forecasting is a hazardous business, especially about the future, as a rueful Dr Subbarao wisecracked the other day. So if you were to ask why RBI and the government got their inflation numbers way off track, the truth is that no one could have seen that international oil prices would treble in the last two years, from $40 per barrel to $120. Or that global commodity prices as a whole (including oil) would see an 80 per cent price surge. The domestic backwash was clear too: primary articles went up 22.4 per cent, and fuel and power 13.8 per cent in 2009-10; both went up a further 13 per cent in 2010-11. How could any governor achieve 5 per cent wholesale price inflation in such a context?  Having got it wrong twice, the RBI wants to be third time lucky —except that global commodity prices have just taken a tumble. Oil has dropped below $100, and silver is down 30 per cent. Copper, tin, coffee, cocoa … they have all dropped. From the country demand perspective, China is slowing down and US indicators look shaky. As for the domestic signals, from January 2010 till now, consumer price inflation has virtually halved (from over 16 per cent). There is more room to fall, but in the most recent months, between November and March, the consumer price index went up from 182 to just 185. So, has the inflation beast already been tamed — especially if global commodity prices are falling? And if so, is the anti-inflation thrust in danger of curbing growth?  Note that the index of industrial production for the latest four months (till February) has shown average annual growth of less than 3 per cent. Despite the surge in commodity prices last year, import growth was just 17 per cent. Discounting for the price surge (think oil and commodities), import growth would have been in the low single-digit region — pointing to a lack of domestic demand. If you look at sectors, the demand for capital goods has already slowed. With higher interest rates, the demand for consumer goods should slow too. And the government has become less of a spendthrift; with lower deficit numbers, it is no longer pumping up demand as it was doing through 2008-11 (a period in which 43 per cent of the increase in money supply was accounted for by fresh credit to the government!). Finally, agricultural growth this year is likely to be modest, since it comes on top of a good harvest last year. In short, you might be lucky to get even the lower 8 per cent GDP growth that is now forecast.

RBI makes first move in savings account rate change

The Reserve Bank of India (RBI) has said in a draft paper that the savings account interest rate should be deregulated. This rate is currently 3.5% and is the only interest rate offered by banks that is enforced across all banks. Even though knowledgeable investors do not keep a significant proportion of their money in savings accounts, this is a useful move.  On Tuesday, the RBI announced a hike of 0.5 percentage point in the savings deposit rate — the first increase in 19 years — taking it to 4% with immediate effect.  Savings bank accounts are the primary savings vehicle, almost by definition, of the least well-informed class of savers. As such, the only way these people have of maximising their returns is if the RBI creates conditions that facilitate that. A few months ago, RBI had forced banks to change the method of calculating the savings bank interest on the daily average balance instead of the minimum balance. This made the calculation fair and enhanced returns for customers. Interestingly, after the RBI's draft on rates was released, some bankers seemed to suggest that rates may actually come down because they claim that small accounts are uneconomic at even the current levels. My guess is that the banks will end up giving different interest rates to different categories of customers. Whether that achieves the RBI's goal remains to be seen. Savings bank returns apart, banks products are the default 'investment' that a majority of Indians use, and it's a fact that bank's rules and regulations are not setup to maximise your returns. This means that if you are using fixed deposits as an investment vehicle—and a lot or people are—then you need to track their expiry carefully because lapsed fixed deposits are major source of leakage of returns. The ideal would be if the RBI would fix the underlying rules, but failing that, investors need to take care of their interest themselves.

Opening up the last spoon-fed rate

The Reserve Bank of India (RBI) has published a discussion paper on deregulation of the interest rate on savings bank deposits, seeking feedback. The RBI, in its latest monetary policy review, did decide to increase the savings bank deposit interest rate from 3.5% to 4% with immediate effect, pending a final decision on doing away with the administered rate and leaving it up to banks. The paper seems cautiously optimistic that deregulated, market-determined interest rates on savings bank deposits would bring about better allocation of resources, boost savings and lead to better transmission of monetary policy. The interest rate on savings bank deposits is the last remaining administered rate in the domestic banking system. Now, in the days of pre-reform , what was essayed was a conscious policy of financial repression so as to coagulate funds at fine rates for investment. Back then, most deposit and lending rates were controlled by the finance ministry, including for entire segments of consumers. With thoroughly suboptimal results, it needs to be said. The paper mentions that financial sector reforms here were initiated in the path-breaking 1990s, as part of structural economic reforms begun during the period. There were missteps and wrong moves along the way, notes the paper. For instance, in April 1985, there was a tentative move to deregulate deposit interest rates with banks allowed to decide interest rates for maturities between 15 days and one year, subject to a ceiling of 8%. But the end-result was a race to the bottom with banks offering the highest possible rate for the shortest period and a general shift of deposits from current accounts and even from savings accounts to 15-day deposits! The freedom to decide on interest rates was withdrawn in May 1985. The paper adds that the process of deregulation restarted in the early 1990s, and was largely completed by October 1997. When it comes to bank lending, a few categories of interest rates continued to be regulated: for small loans up to . 2 lakh and rupee export credit. These two rates were deregulated in July 2010, when the RBI replaced the benchmark prime lending rate (BPLR) system with the base rate system. It meant curtains for all administered rupee lending rates. So, the only interest rate that continues to be regulated today is the savings deposit interest rate. The paper enunciates that deregulation of the deposit rate, with interest rates decided by individual banks as per liquidity conditions, would be favourable to savers. It cites empirical evidence to suggest that widening interest rate differential between term deposits - long deregulated - and savings deposits leads to reduction in the share of savings bank deposits in total deposits. Apart from reducing relative attractiveness, administered interest rate policy on savings deposits also adversely affect the transmission of monetary policy , avers the paper. And the fact that the savings deposit interest rate has not been changed since March 1, 2003, does imply that changes in RBI's policy rates - for example, the dearer cost of funds indicated by the central bank of late - have not been transmitted to savings bank deposits. The study hastens to add that if the overall cost of deposits moves in tandem with the policy rates, then monetary transmission is not so adversely affected. Be that as it may, savings deposits are about 13% of financial savings of households, and the interest rates on such funds do need to be market determined and not by administrators at RBI. International experience also corroborates such deregulation. For instance, well into the 1970s, commercial banks in the US faced a panoply of restrictions on interest rates, both on deposits and extending credit. And subsequent deregulation did allow banks to offer better services at lower prices. However, for banks, savings deposits are a low-cost source of funds, and could deregulation mean unhealthy competition and asset-liability mismatches? If deregulation of interest rate for term deposits , which constituted more than 60% of deposits, did not have a destabilising impact, deregulation of interest rate for savings deposits, which constitute about 22% of total deposits, may not have a significant adverse impact on the system, concludes the paper. It makes sense to begin deregulation of the savings deposit rate in a phased manner, subject to a minimum floor initially, and with builtin flexibility on cheque issuance and withdrawals. (Deregulation of Savings Bank Deposit Interest Rate: A Discussion Paper, RBI, April 2011).

Pushing growth beyond potential to boost inflation: RBI

Click to read.............

RBI asks Tamilnad Mercantile Bank to list shares through an IPO

TUTICORIN , TAMIL NADU: The Reserve Bank of India has asked the Tamilnad Mercantile Bank (TMB) to list its shares through an IPO, a top official of the bank said on Friday. "We are one of few unlisted banks in the country and the Reserve Bank of India wants us to get listed as soon as possible .... We would be considering this proposal provided a couple of pending cases are resolved," A K Jagannathan, managing director and chief executive officer of the Nadar-dominated , Tuticorin, Tamil Nadu-based bank, said. He was speaking after the release of the bank's results.
The RBI suggestion is important as a few weeks ago the banking regulator had declined to acknowledge the sale of a 33.54% stake by well-known serial entrepreneur C Sivasankaran to a group of investors. The group's members included Rajat Gupta, former McKinsey chief, and Ramesh Vangal , the former Asia Pacific president for PepsiCo Foods . The investors were acting as a group, the banking regulator said and asked them to cut their stake to about 5%. TMB was one of the many community banks that were set up in the 20century in many parts of the country to finance local entrepreneurship and take care of community needs. Over the years, it became successful and started attracting attention from corporate and takeover artists like Sivasankaran. The Essar Group tried to get a foothold but were rebuffed. Siva, who belongs to the Nadar community, also could not get full control and decided to sell to the
Vangal-led group a few years ago. The issue has got more complicated now due to a shareholder's suit in the Madras High Court challenging the RBI's order. The shareholder alleged that the central bank's order is vague since it did not include B Ramachandra Adityan and his family members as part of the Vangal-led group. Asked whether the IPO would be the way for these investors to cut their stake to 5%, Jagganthan said the bank can go for IPO on its own and it is up to the investors to decide what they want to do. "After the Reserve Bank of India order , the bank's hands have been freed to make key operational decisions . Now the annual general meeting holds the key, where the proposals for IPOs, bonus and rights issue can be made. However , there are a few lawsuits in courts which have to be settled to go ahead with the annual general meeting," he added. After the Reserve Bank of India order, the bank had planned to conduct its annual general meeting on June 15. On a thin equity of Rs 28.45 lakh, Tamilnad Mercantile Bank has reserves of Rs 1,366.02 crore and the book value of the Rs 10 share is at Rs 48,022 a share as of March 31. The bank has been roiled by ownership tussles for two decades but the latest round does not seem to have affected its performance in the past year. In fiscal 2011, the bank's net profit rose 35.97% to Rs 250.90 crore, while business grew 23.17% to Rs 24,679 crore. The net interest margin was at 4.25%, while gross NPA was 1.30%. The bank has declared a dividend of Rs 1,000 per share for fiscal 2011, up from Rs 800 a share last year, pending shareholders' approval.

RBI to interview all 7 EDs for Dy Guv job

Deputy Governor Shyamala Gopinath retires on June 20.

The government has started the process to identify a replacement for Shyamala Gopinath, Deputy Governor of the Reserve Bank of India (RBI) who retires on June 20. A search committee headed by Governor D Subbarao has called all seven Executive Directors of the central bank for interviews on May 13. To be eligible, a candidate should have two years of residual service.  Among the seven executive directors, V K Sharma is the seniormost, followed by V S Das. The other executive directors are G Gopalakrishna, H R Khan, D K Mohanty, S Karuppasamy and R Gandhi. The central bank, which has created two more ED posts, will also conduct the interview for the selection of EDs on May 13. With Gopinath retiring, there will be three vacancies for the ED’s job. Among the eligible candidates, Chief General Manager P Vijay Bhaskar, currently the Regional Director of Bangalore, is the seniormost. Bhaskar is followed by B Mahapatra and G Padmanabhan in terms of seniority. In the last couple of years, RBI followed the seniority criteria to appoint an ED. While the appointment of Deputy Governor is made by the government, RBI takes care of the ED appointment. Traditionally, of the four Deputy Governors of RBI, one is a commercial banker, one an economist and two are promoted from within the central bank. Shyamala Gopinath and Anand Sinha were promoted to the Deputy Governor’s post from the ranks of RBI. Deputy Governor K C Chakrabarty represents the commercial banking fraternity, while the other Deputy Governor, Subir Gokarn, is an economist. Gopinath, who holds charge of nine departments, including foreign exchange, was appointed Deputy Governor in September 2004 for five years. A Deputy Governor in RBI can be appointed for a maximum of five years or till the age of 62, whichever is earlier. In September 2009, Gopinath was reappointed by the government for a little less than two years. The government made an exception during the reappointment and relaxed the two-year residual service criterion. The retirement age for RBI Deputy Governor is 62, while for all other RBI employees, it is 60.

Banks witness negative loan growth so far FY12

Banks have witnessed a negative growth in loans so far in the current financial year, as is typical at the beginning of a financial year. The outstanding loans fell by Rs 19,660 crore or 0.5% to Rs 39,20,000 crore as of April 22 from Rs 39,40,000 crore as of March 25, according to the Reserve Bank of India data released on Thursday. Deposits, on the other hand, rose Rs 1,15,000 crore or 2.2% to Rs Rs 53,20,000 crore in the same period. Typically, banks take large number of short-term loans at end of a quarter to shore up their balance sheet. These loans mature at beginning of the next quarter, leading to lower credit growth numbers. On-year bank loans grew 22% and deposits 18%. Banks' loan demand usually remains muted in the first half of a financial year.The Reserve Bank of India has projected loan growth of 19% and deposit growth of 17% in 2011/12 at the annual policy statement.

Soon, RBI will decide salaries of foreign banks' honchos

Salaries of top management executives at private and foreign banks will have to be as per RBI's guidelines from next fiscal, central bank said today, while asking the lenders to start preparing for the new wage rules."The implementation of the Reserve Bank guidelines on compensation policy has been deferred till 2012-13. This will also give sufficient time to banks to formulate their policies," RBI said in its annual monetary policy statement.  It was proposed in the second quarter review of Monetary Policy for 2010-11 to issue final guidelines on compensation practices by end-December 2010. However, RBI said that in October 2010, the Basel Committee on Banking Supervision (BCBS) brought out a consultative paper for public comments. "As the paper provides guidance on important methodological issues, it has been decided to await the final version of this paper for formulating our guidelines," it said. The apex bank further said that banks in the meantime should refer to the BCBS consultative paper and begin the preparatory work. It was indicated in the quarterly policy of October 2009 that in line with the steps taken by the global community, particularly the initiatives taken by G20 nations, the Reserve Bank would issue guidelines to private sector banks and foreign banks with regard to sound compensation policy. It was proposed to issue guidelines based on the FSB principles on sound compensation practices, which would cover, among others, effective governance of compensation, alignment of compensation with prudent risk-taking and disclosures for whole time directors and chief executive officers as well as risk takers of banks. Accordingly, draft guidelines on sound compensation policy were framed and unveiled in July 2010 by the central bank for public comments.

Currency verification, processing machine at RBI

PATNA: With the installation of a modern currency verification and processing machine at the Patna office of Reserve Bank of India (RBI), the city is now one of the five centres across the country to have the mechanized facility to process soiled notes. The machine was inaugurated by RBI Regional Director M K Singh. RBI Deputy General Manager Aditya Kishwar said the bank has adopted a 'clean note policy' to promote circulation of quality currency notes. For this, constant withdrawal of soiled notes from circulation is necessary; he said and added the mechanized system can process one lakh notes in an hour.

RBI to open more offices in northeast

Agartala, May 5 (IANS) The Reserve Bank of India (RBI) will set up offices in all northeastern states for better monitoring of banking services in the region, a senior official said here Thursday. Currently, RBI only has a regional office in Assam's main city Guwahati.  'After Guwahati, the first sub-office would start functioning in the Tripura capital Agartala May 18. Subsequently, sub-offices would be opened in other northeastern states in a phased manner,' a senior RBI official told reporters. RBI Governor D. Subbarao will inaugurate the sub-office in Agartala May 18. The central board meeting of the country's apex bank would also be held in Agartala next day (May 19), the RBI's first board meeting in the region.  'After the opening of RBI offices in the northeast region, the monitoring and functioning of nationalised, regional rural banks and private banks would be further improved,' Tripura Finance and Public Works Development Minister Badal Choudhury told reporters. 'We have been demanding more RBI offices in the region for the past 12 years to improve the credit deposit ratio, providing advances and financial support to the people of the region,' said the minister, who recently held a meeting with the RBI Governor in Mumbai. He complained that the credit flow to the northeastern region from nationalised banks was meagre. 'It is unfortunate that despite intervention from the union finance ministry, the credit-deposit ratio for commercial banks in the region has remained at a level of around 30 percent over the past many years. This should be raised to at least 50 percent by 2010-11,' Chowdhury said. The minister urged nationalised banks to open more branches in rural areas to curb the illegal collection of deposits by non-banking financial companies (NBFC). Quoting RBI guidelines, Choudhury said the central bank had asked all nationalised banks to open banking services, in any form, in every village in the country with a population of over 2,000.

RBI move may leash micro finance industry

NAGPUR: Micro Finance Institutions (MFIs) which have earned the disrepute of being worse than the unscrupulous village moneylenders may finally be reined in. In an oblique move, the RBI has not only capped the interest rate to be charged by these agencies, but MFIs have also been barred from charging any penalty on delay by its borrowers. The rule does not directly apply to the MFIs but is certainly expected to impact their business in a big way.  MFIs have been a cause of concern in Vidarbha too. There were apprehensions that their proliferation may put farmers in the region into a debt trap. RBI has now allowed banks to classify loans given to MFIs as priority sector lending. However, that would be if the loans are given to only those MFIs that meet a whole gamut of conditions including the cap on interest rates and no penalty on delay.  The qualifying MFIs will also have to cut down on consumer loans as RBI conditions want at least 75% of loans be given for income generating purposes only. No borrower can be indebted for an amount more than Rs 50,000 in at least 85% of the loans. The conditions also restrict the choice of borrowers for an MFI. In 85% loans the borrower's household income should not exceed Rs 60,000 a year in rural areas and Rs 1,20,000 in urban areas. Loans have to be without a collateral security and borrower will have the choice over repayment schedule.  If the banks want the loans to be classified under priority sector, they have to ensure that the MFIs comply. Currently the lending rates by MFIs go as high as 36% per annum. MFIs source their funds from bank loans at 13%-14% thus ensuring a huge spread for themselves. The banks will have to ensure that MFIs to whom they lend do not further disburse loans at a margin more than 12% while an overall cap of 26% has to be maintained. Which means the rate charged by a MFI cannot be more than 12% of what it pays to the bank and it has to be under 26% all the time. MFIs can also not take any security deposit or margin money from the borrowers.  Sources said the move will go a long way as banks are always under pressure to meet priority sector lending targets which have to be 40% of its total advances. As a result it would be ensured that the MFIs adhere to the conditions laid down by the RBI as the latter are always in need of bank funds.  "A cap of 26% is reasonable. The RBI plan will work as a big majority of MFIs would starve without bank loans. The latter in turn are under pressure to meet the priority sector lending targets," said Moin Qazi, vice-president of Swarana Pragati, a non-banking finance company having a major stake in micro finance and also a presence in the region.  Loans meeting RBI conditions would be categorized under the priority sector from April 1, 2011, onwards. RBI has also placed certain conditions on the size of the loans by MFIs.

Malaysia: Asia’s interest rate hawk

India has raised official interest rates nine times in a year, and China four times in six months, but little Malaysia’s 25 basis point rise may be a better guide to how serious Asia’s inflation problem really is.  Zeti Akhtar Aziz, the long-serving governor of Bank Negara, celebrated her reappointment for a further five years by announcing on Thursday that interest rates would go up to 3 per cent, backed up by an increase in the reserve requirement for commercial from 2 per cent to 3 per cent.  The governor, who has been in office since May 2000, surprised global markets by hiking interest rates in March 2010 ahead of other Asian central banks, effectively firing the starting gun for the tightening cycle that has dominated regional monetary policy ever since.

Finally, RBI cracks the whip: S.S.Tarapore

The 50-basis-point increase in repo and reverse repo rates is entirely justified in the current monetary and economic environment. The government, too, has accepted the reality that growth may have to be sacrificed for inflation control. From a stance where its loud bark was accompanied by baby bites, the Reserve Bank of India (RBI) is now concerned that inflation is strongly embedded in the system and that price pressures are spilling over into generalised inflation.  The RBI accepts that inflation in the first half of 2011-12 could remain at around 9 per cent and it is hoped that it will fall to 6 per cent by March 2012, which would still be above the RBI's comfort zone of 4.0-4.5 per cent.  A slowdown in growth in 2011-12 is inevitable. The RBI's baseline real growth is put at 8 per cent and, in view of the uncertainties, the growth rate could range between 7.4-8.5 per cent. It is now recognised by the government that some slowdown in growth is inevitable if inflation is to be brought down to acceptable levels. Consistent with the growth and inflation outlook for 2011-12, RBI has projected M3 expansion for 2011-12 at 16 per cent, deposit growth at 17 per cent and non-food credit expansion at 19 per cent. These projections would imply that the incremental credit–deposit ratio would come down from an unsustainable 95 per cent in 2010-11 to 83 per cent in 2011-12, and even this would be unsustainable given reserve requirements. It is against this backdrop that the measures of May 3 should be assessed. The market was conditioned to baby steps and only in this context does the 50 basis point increase in the repo rate appear high. But this increase is clearly justified in view of the overall monetary situation and the need to reduce the inflation rate. The RBI has done well to follow the sagacious advice of the Mohanty Working Group on Operating Procedures of Monetary Policy and moved over to a single independently varying policy rate to signal the stance of monetary policy. The reverse repo rate will be fixed at one percentage point below the repo rate and as such this would no longer be an independent rate.  Under the new Marginal Standby Facility (MSF), banks will be allowed to borrow overnight up to 1 per cent of their net demand and time liabilities at one percentage point above the repo rate.  Thus, with the repo rate in the middle, which would be independently set as the policy rate, the MSF would be one percentage point above the repo rate and the reverse repo rate would be one percentage point below the repo rate and thus the corridor would be 2 percentage points. Predictably, the RBI may have found it too drastic to implement the recommendation on the Bank Rate. It would be best that RBI expeditiously implements the Mohanty Working Group's recommendations on the Bank Rate and other recommendations in 2011-12. More recently, the RBI has come out with an excellent discussion paper on deregulation of the savings bank deposit rate -- this paper reflects the RBI at its best. Pending a decision on the issues raised, the RBI has done well, as an interim measure, to raise the savings bank deposit rate from 3.5 per cent (fixed) to 4.0 per cent (fixed).  On the issues raised in the discussion paper, the RBI has sought feedback from the general public on a number of crucial issues. In this connection some responses are set out seriatim: (i) The time is apposite to further the deregulation process. (ii) Initially, the savings bank deposit rate could be prescribed as a range, say 4.0-5.0 per cent. Banks should be strongly counselled to use the discretion with finesse so that their net interest margins are protected. Once banks show maturity and judgement, the ceiling could be dispensed with, but the floor rate should be retained. (iii) The process of deregulation suggested above would ensure that small savers are not affected. (iv) As the experience of deregulation of term deposit rates in the late 1990s showed, a well modulated process of deregulation would ensure against any adverse effects. (v) Each bank should be required to ensure that their savings bank deposit rate is uniform for all depositors of the bank. The institutional memory of the 1977-78 experiment would advise against separate interest rates for deposits with cheque book facilities -- in 1977-78, all depositors with cheque book facilities opened two accounts.  In the proposal now under examination cheque book facilities should be subject to increased charges, and there should be charges for excessive credit/debit entries. Moreover, interest should not be paid on any daily amount in the savings bank account above, say, Rs 2 lakh. There is a crying need to reform the present savings bank deposit rate and the phased deregulation should be completed in 2011-12. The development and regulatory policies have been well constructed and deserve separate treatment.

The message is the aim - Ila Patnaik

In the monetary policy statement this week, the Reserve Bank changed its policy stance to a strong anti-inflationary one. However, though this step was much needed and is in the right direction, it will not be enough to bring inflation down. Hiking rates and contracting demand is only one part, the painful part, of the story. An equally important element is public perception about the central bank. To build credibility on its anti-inflationary stance, the RBI will need to improve its research capacity and communication strategy, get rid of conflicting objectives and be consistent in its pursuit of inflation control. This part, fortunately, does not hurt anyone. It needs a change in the framework, functions and objectives of the RBI. Not only are there long lags in the weak monetary policy transmission mechanism in India, the bigger problem for the effectiveness of the tighter monetary policy is that the RBI is yet to build credibility as a central bank that puts inflation control above all objectives. To control inflation it will need to build this credibility with a consistent pursuit of inflation control as its primary function. To consistently pursue inflation control as its objective, it will have to get rid of conflicting objectives like maintaining the competitiveness of exports and being the government’s debt manager. Given its poor record on projecting inflation in the last two years, it will have to visibly create new research capacity to ably forecast future inflation and measure inflationary expectations better.  Considering its exchange rate pegging in the past, it is not enough that the RBI has stopped intervening in the foreign exchange market — it has to communicate its new framework and make a clean break from the framework of exchange rate pegging and multiple objectives. In the past, the RBI has prevented liberalisation of financial markets for both domestic and foreign participants for fear of bringing in capital flows and making it difficult to prevent volatility in the foreign exchange market. Preventing financial markets from developing has not allowed the monetary policy transmission mechanism to strengthen. As a consequence, even when the RBI has been tightening policy over many months, the tightening has not yielded results.  The RBI has to become a central bank that actively seeks to improve the transmission mechanism of monetary policy through developing the bond-currency-derivatives nexus. Once public perception about the RBI changes, the effectiveness of monetary policy in India will improve. What should the RBI’s next step be, even before the rate hike? First, if inflation control has to be its dharma, the central bank must attempt to get rid of all those functions that might conflict with this objective. In the past, some of these conflicting objectives have come in the way of inflation control. For example, if keeping Indian exports competitive by manipulating the exchange rate had not been an important object of RBI policy, the 2004-2008 period would not have witnessed the build-up of reserves and the consequent increase in liquidity, and inflation might arguably have been quite different. Indeed, the RBI would have preferred an appreciating rupee to keep prices under control.  Similarly, if the RBI did not have the responsibility of being the debt manager of the government and keeping its interest expenditure low, it might have raised interest rates more sharply last year. Even though the RBI has moved to a floating rupee, it has shied away from making a commitment that it will not go back to intervening in the foreign exchange market. The market does not believe that if the rupee hits Rs 40 to a dollar, the RBI will still be wedded to inflation control. It is because of such conflicts with the objective of inflation control that most central banks in advanced economies no longer intervene in foreign exchange markets or act as the government’s debt manager. The RBI cannot build credibility as a central bank focused on inflation if it continues its present stance of arguing that it will continue to have multiple objectives and will somehow manage these objectives when a conflict arises. Second, the RBI’s communication on inflation needs to change. On the trade-off between growth and inflation, it has often been argued that inflation targeting means that a central bank must ignore all other objectives such as growth in employment. The present policy statement has seen a break from this framework. The RBI has acknowledged that the objective of high growth does not conflict with that of inflation control. Indeed, high and volatile inflation reduces investment by introducing uncertainty and hurts medium- and long-term growth. This analytical framework needs to become the RBI’s main message. Next, to build credibility, the RBI should state its inflation measure and target. In the present policy it says: “Accordingly, the conduct of monetary policy will continue to condition and contain perceptions of inflation in the range of 4.0-4.5 per cent, with particular focus on the behaviour of the non-food manufacturing component. This will be in line with the medium-term objective of 3.0 per cent inflation consistent with  India’s broader integration into the global economy.” This is not enough. The RBI needs to state which measure of inflation, such as the one based on the Consumer Price Index, underlies this target. More, few people would find this objective credible. The RBI can gain credibility by presenting how it is faring against this objective in the next policy announcement. A report similar to the Bank of England report and a framework where the governor is questioned by Parliament if he fails to meet his targets would help in bringing credibility to the RBI’s commitment. Third, better conduct of monetary policy would also require creating a much stronger research capability for measuring inflationary expectations. For example, the present policy statement asserts: “Significantly, the stability of long-term yields, despite the current high rates of inflation, suggests that inflationary expectations remain anchored.” The RBI’s own data on inflationary expectations strongly contradicts this. Fourth, a short, concise policy statement would be more effective than the present statement which also includes other policy initiatives. The above are some of the steps that can be taken relatively painlessly in the fight against inflation that could last many quarters. If the RBI is serious about this fight, it needs to start on these urgently.  

The writer is a professor at the National Institute of Public Finance and Policy, Delhi

FM takes cue from RBI, says GDP may slip to 8%

Finance Minister Pranab Mukherjee today projected India’s economic growth at 8 per cent for the current fiscal, lower than the budgetary estimate of 9 per cent, due to measures taken to rein in high inflation. “If oil prices continue to rise, it would be difficult to achieve higher GDP. GDP may come down to 8 per cent from (the projected) 9 per cent,” Mukherjee told reporters on the sidelines of ADB annual meeting here. The government’s (India) primary concern now is to manage inflation while sustaining high growth rate. Hardening of global commodity prices, particularly oil prices has accelerated inflation, he said adding “our projection is 7.5-8 per cent inflation during the year”. Earlier this week, Reserve Bank of India too had lowered economic growth projection to 8 per cent due to measures taken to tackle high inflation especially food prices. India’s economy is estimated to have clocked 8.6 per cent growth in 2010-11. Mukherjee said Inflation, particularly the increase in food prices, is a major concern for India as well as other developing countries. “We are trying to reduce it through supply and demand side management. “On supply side we are trying to remove bottlenecks and on demand side RBI has adjusted interest rates to mop up excess liquidity in a manner so that it may not affect the economic activity,” he said. With adequate buffer stock and hopefully a good monsoon, “we are looking at easing of the price situation in India”, he said. Overall inflation was 8.98 per cent in March and has been above the 8 per cent mark since January, 2010. Asked whether the government is planning to increase diesel prices in the near future, Mukherjee said “We will announce it as and when the decision is taken”. In its annual monetary policy, the RBI had advocated hike in prices of petroleum products. The government has not allowed state oil firms to revise diesel prices since June last year when crude oil was ruling at $72-73 per barrel. Crude oil is today trading at around $110 a barrel in international markets.

RBI hike: Home buyers to pay 'penalty'

Housing prices could go up, as the borrowing cost for developers is set to increase following the hike in short-term lending rates by the RBI, industry body CREDAI said today.  The RBI's decision to hike key rates - lending (repo) and borrowing (reverse repo) rates by 50 basis points to 7.25 per cent and 6.25 per cent respectively - will raise the cost of home, auto and other loans.  It was reacting to the news that the reserve Bank of India (RBI) in its credit policy meet had hiked key rates by 50 bps to India's largest realty firm DLF said that banks should not increase the interest rates and felt that prices, whether of food or housing, can only be controlled by improving supplies. Reacting to the RBI's decision to raise the repo and reverse repo rates, Confederation of Real Estate Developers Association of India (CREDAI) Chairman Pradeep Jain said: "This is going to increase the cost of funds for both developers and home buyers."

INTERVIEW - D. SUBBARAO/RBI - Govt should have a say in new bank licence norms

Click to read............