The mid-term review of annual policy for FY2005 is pro-growth and pro-price stability. The RBI is juggling price stability, economic growth and smooth passage of government's borrowing programme in an increasingly difficult environment. While the repo hike is short-term negative for interest rates, the reduction in corridor between reverse repo rate and repo rate from 150 basis points to 125 basis points is long-term positive for interest rates.
The changes in language from "aiming to provide appropriate" instead of "adequate liquidity" and "pursuing price stability conducive rate environment" from "growth conducive interest rate environment" is acceptance of hard reality that inflation needs to be controlled for sustenance of long-term economic growth notwithstanding supply side rhetoric.
The revision in GDP growth and inflation target for FY05 are acceptance of reality and pretty much discounted in the market.
The hike in risk weightage for housing loan and personal loan is an attempt to slow down credit growth and bring some rationality in the pricing of the products. It is unusual to have the borrowing rate of an individual for housing loan and government at similar level.
The increase in risk weightage along with implementation of Basel-II norms will demand higher capital in the banking sector. Deluge of issuances from banks will be detrimental from the equity market point of view.
The RBI has decided to issue a new discussion paper on ownership in banking sector which could provide a respite by attracting direct / strategic investment.
Liberalisation of NRE deposit ceiling probably shows the need to attract foreign inflows as forex reserves have stagnated for the last three months. Introduction of capital index bonds is a positive sign for passage of government borrowing. However, the same could have been introduced earlier.
The RBI has put lot of emphasis on improving credit delivery systems for benefit of agriculture and other neglected sectors in the current political thinking. Expansion of housing loan limit for priority sector inclusion will bring respite to many private banks in meeting priority lending targets.
We think that the RBI has kept options open on interest rates and the borrowing programme by equally weighing price stability and growth in the policy language.
The future trend of inflation, which is going to be impacted in the short term by hike in oil prices, will determine further responses from the RBI. We think interest rate market will be volatile in the near term as inflation and the borrowing programme threat will keep interest rates under pressure.
However, there is a silver lining for interest rate market in the form of return of liquidity and slowing down of inflation towards second quarter of next year.
We also firmly believe that the RBI will revert back to soft monetary policy stance as and when inflation numbers provide an opportunity.
