Banks Guarded From External Uncertainties, Says Reddy

The Indian banking sector is not vulnerable in anyway to the fallout of the September 11 events in the US as the domestic economy's exposure to the international markets is limited and the exposure of banks to the equity markets and real estate is also limited, Y V Reddy, deputy governor of Reserve Bank of India, said here today.

Amidst the general feeling of uncertainty and slowdown enveloping the economy, stability has been restored in most of the economic sectors, he said at a function orgainsed by the Fixed Income Money Markets and Derivatives Association of India (FIMMDA) here today.

The current developments in the world economy will have little direct impact on the real economy.

The possible risks faced by the Indian economy could arise from a possible delay in the global economic recovery, regional spill-over in terms of linkages on account of capital and current account, which is limited to a certain extent, Reddy said.

The enthusiasm of central banks for further rate cuts is less now than it was six months ago. He pointed out that the US Fed had been able to cut rates nine times since September 11 to inject liquidity into the markets there as the benchmark rates had been substantially increased prior to this date.

Public policy will be effective only if public institutions are respected. In this context, he pointed out that, whenever the markets are in trouble it is only public policy and public institutions that intervene and restore a semblance of order, the deputy governor explained.

Fiscal dominance is a fact of life due to which operational autonomy of the Reserve Bank of India (RBI) is constrained. "Due to fiscal activism the scope of a counter-regulatory monetary policy is less," Reddy said.

Once a fiscal stance is taken, it is the responsibility of the RBI that the fiscal is managed as per to the macroeconomic indicators, he said.

He explained that the on the one hand interest rate rigidity arose due to the system being accustomed to a fixed rate regime, which was psychological, while on the other it was due to institutional rigidity that takes into account that atleast a positive return for the savers, cost of intermediation and premium on credit risk. Administered interest rates were also adding to the overall interest rate rigidity.

In the absence of proper risk management system at the bank level, they were not equipped to handle rapid fluctuations in interest rates and the RBI had to smoothen out the movements in the rates.

He explained that the paring of the Gross Domestic Product (GDP) growth from 6 to 6.5 per cent in the April policy to between 5 to 6 per cent was directionally down but magnitudinally was not as steep as it obtains in the rest of the world.

Reddy hoped that the capital inflows in the remaining part of the fiscal would be enough to keep the current account deficit at 2 per cent of GDP.

On the debt markets front, he said, there had been slippages on putting in place the negotiated dealing system (NDS) in view of the complexities involved on the technical, procedural and adminstrative fronts.