The Hindu Business Line : Right emphasis on growth and liquidity

The Credit Policy Statement for 2005-06 handles well the conflicting objectives of growth and price stability with an emphasis on creating an enabling environment of benign interest rates. Summing up macro-economic developments competently and reflective of the substantial improvement in the country's credit climate, the Policy will, it is hoped, provide the appropriate liquidity at reasonable rates says S. Venkitaramanan.

THE Credit Policy Statement for 2005-06 is on expected lines. The RBI Governor, Dr Y. V. Reddy, has not tinkered with either of the crucial interest rate signals — Bank rate and cash reserve ratio. He has deemed discretion to be the better part of wisdom and handled the conflicting objectives of growth and price stability with an emphasis on creating an enabling environment of benign interest rates.

Although he has not stated this in so many words, it is obvious that this is the background of his main policy stance, which, in spite of threats of rising inflationary expectation, has stopped short of raising interest rates.

The Credit Policy includes the usual competent analysis of macro-economic developments. The Governor notes that the latest advance estimate released by the CSO places GDP growth at 6.9 per cent in 2004-05, higher than the expectations of the Mid-Term Review of October 2004.

The Governor also notes that the GDP growth of 6.9 per cent in 2004-05 is on top of a higher increase of 8.5 per cent the previous year.

The Credit Policy notes that the annual inflation rate, as measured by the variations in the wholesale price index (WPI), on a point-to-point basis peaked from 4.6 per cent in March 2004 to 8.7 per cent in August 2004 after which it registered a steady decline. As at the end of March 2005, the annual point-to-point inflation stood at 5 per cent, compared to 4.6 per cent a year ago.

The inflation rates stand out as projected in last year's annual policy statement, but lower than the mid-term review projection of 6.5 per cent. The policy statement notes that these lower inflation rates were possible because of successful intervention, which included fiscal as well as monetary measures. The villain of the piece was the increase in oil prices, which was transmitted to other prices also.

Dr Reddy notes that there has been a substantial insulation of the inflationary pressures from the oil price increase through fiscal action. Whether this is sustainable on a long-term basis is, however, a serious question with fiscal implications. This the Governor has not touched upon.

While the movement in the wholesale price index (WPI) inflation was on the above basis, primarily because of increases in prices of key commodities, the consumer price index (CPI) was significantly lower. The point-to-point inflation rate based on CPI was 4.2 per cent in February 2005 — almost the same as a year ago.

On an average basis, CPI inflation was 3.8 per cent during the year up to February, compared to 3.9 per cent a year earlier. These inflation numbers not only reflect the effect of sustained policy actions by the Government but are also as a consequence of monetary steps taken by the RBI.

The Governor notes that there has been a substantial increase of credit during the year. Scheduled commercial banks' credit registered a strong movement of 26 per cent in 2004-05 as compared to 15.3 per cent the previous year. The net non-food credit alone increased 26.5 per cent. The incremental non-food credit-deposit ratio was as high as 100 per cent, compared with 66 per cent the previous year. Implicit in this ratio is the high pressure on banks for increasing deposits.

The Credit Policy notes that agricultural credit increased 23.1 per cent during the year as compared to 15 per cent in the corresponding previous period. Similarly, the flow of credit to industry increased 12.6 per cent, compared to 3.5 per cent in the corresponding pervious period. More significant is the fact that there is an increase in credit flow to infrastructure industries at 36.6 per cent as compared to 33.2 per cent in the corresponding period the previous year. It also reflects the fact that the Central Government's net market borrowings during the year, at Rs 36,000 crore, was significantly lower than such borrowings in the previous year. This is partly a result of the States' repaying their debt under the Debt Wrap Scheme. But, in addition to normal market borrowings, the Central Government raised a substantial sum under the Market Stabilisation Scheme.

Overall, the resources raised through government securities amounted to Rs 145,000 crore, marginally higher than the amount raised by the Centre and the States together the previous year. One aspect of the situation is that the average cost of Central Government borrowing rose by 40 basis points to 6.11 per cent, compared to 5.71 per cent the previous year.

A significant feature of the year is that the banking system holding government securities as a share of net demand and time liabilities decreased from 41 per cent in March 2004 to 38.5 per cent in March 2005 — higher than the statutory liquidity ratio of 25 per cent.

On the external front, the policy review notes that the situation exhibits very desirable features. It notes that the current account went into a deficit after a long period, perhaps reflecting the pressure of demand for imported goods as a result of growth of manufacturing and investment, in general.

This development is in spite of the fact that India's exports in US dollar terms increased by 27 per cent as compared to 16 per cent in the previous year. Imports, however, show an increase of 36 per cent. The balance of payments was, however, sustained by the receipt of invisibles, primarily due to software receipts, private transfers, such as remittances, as also increased capital flows.

The policy reiterates the stance that the exchange rate policy will continue to be guided by the broad principles of careful monitoring and management of exchange rate flexibility without a fixed target or a pronounced band. The successful management of India's foreign exchange situation over the years has shown that the RBI has been handling it right. Overall, the policy has the right emphasis on growth and provision of appropriate liquidity at reasonable rates. The Governor deserves success in the implementation of the policy, which is a continuation of the good stance he has been adopting over the last few years.

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