The Hindu Business Line : Rate rise: Easy call for the RBI

It was widely expected. The increase in the repo and reverse repo rates to 6 per cent and 7 per cent respectively in the RBI's first quarter review of monetary policy came as no surprise. Central banks, the world over, are in a tightening mood if not mode and with our economy and markets becoming ever more closely integrated with the global system, there is little scope for running an independent ship.

Not that it was hard for the RBI to justify what it did. Growth has exceeded forecasts. And the near-normal monsoon heralds another good year for the economy. Demand for consumer and capital goods is on a strong upswing.

The sharp rise in energy, commodity, steel and cement prices is yet to dent spending. Business and consumer confidence continues to be high. No wonder, bank credit is soaring — so much so that record deposit growth is matched by an incremental credit-deposit ratio of almost 100 per cent.

For the RBI, global imbalances (read the US trade deficit) are a source of worry. With markets ever more interlocked, a sudden Wall Street, US dollar or bond collapse spells danger and risk to our financial system. It is to meet such contingencies that it attaches the utmost priority and importance to the capital adequacy and provisioning of Indian banks.

Of course, a great source of comfort is the predominant government ownership of the banking system. It may not enthuse reformers, but the biggest beneficiary of completely privatised banks will be the State Bank of India (if it is allowed to exist in its present form) to which there will be a flight of deposits. It is no coincidence that the most successful new-generation banks are those started by former government-owned or public financial institutions like ICICI, HDFC, UTI, etc.

Another reason to be sanguine is that the market risk exposures of Indian banks as a whole are small. Credit risk, although significant, tends to play out over time, giving room for balance sheet adjustments and strengthening, unlike market risk. Thus, the RBI need not fear an LTCM situation in which the highly leveraged US hedge fund threatened to bring several large banks down with it when its market bets went wrong.

When and how far further will the RBI go? If inflation stays in the 4-5 per cent range, there will be no compulsion for the central bank to be aggressive.

Clearly, however, oil prices are key and if they move towards $100, there will be considerable strain on the economy and the BoP. Inflation could very well be accompanied by a slowdown and the monetary policy answers will not be as obvious as they are today.

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