Growth without side-effects
MONETARY POLICY MID-TERM REVIEW 2006-07
| The central bank has attempted to achieve balance between continuing growth and reigning in excessive credit expansion. It has opted for increasing the short-term repo rate (the rate at which it lends to banks) without changing the reverse repo and the more medium-term bank rate. |
| The increased inflationary pressures on account of the growth in domestic credit, the increased liquidity in the form of growth in M3 of 19 per cent, which is well above the central bank's tolerance levels of 16-17 per cent, would have warranted an interest hike in the normal course. |
| However the global scenario of a slowing US economy and the apparent Fed's reluctance to increase interest rates over the next couple of months at least must have influenced the governor's decision. |
| The rupee is already facing appreciation pressures and further increase at this juncture was not a comfortable proposition considering the country's robust export growth and the central bank's continued concerns over the oil prices. At the same time, the central bank is perhaps waiting for lagged effects of earlier policy actions to have their necessary cooling off impact. |
| It has acknowledged that recent tracking up of inflation has some supply-side issues for primary commodities (other than the normal demand pressures from a fast growing economy). |
| The increase in repo rate may not immediately impact the banking system with the current liquidity scenario being more or less comfortable. It will start affecting, if and when, the liquidity in the system tightens. And, this can lead to an overall tracking up of deposit rates and consequently, lending rates. |
| The policy announcement has had a few positives for the banking sector. The extension of the deadline for implementation of Basel II to 2008 (in case of banks having overseas operations) and 2009 for others gives elbowroom to many of the banks to continue with current growth momentum, given the strong investment and consumption demand in the economy. |
| Some banks will defer their capital raising plans (especially, high cost hybrid capital) in light of the relaxation. |
| The average GDP growth for the year has been still pegged at an average of 8 per cent. With the growth for the first half pegged at 8.5 per cent means there is a sequential slowdown in the second half of the fiscal (given the base effect of strong 4Q FY06 of 9.1 per cent). |
| But this is not exactly worrisome since the average GDP growth of 8 per cent would still mean a fourth straight year of GDP growth of 8 per cent. Overall, corporate earnings growth outlook for rest of the year remains positive. |