RBI's Reddy: Read my lips

The liquidity pressure has eased a bit and the inflation monster seems to be on a leash for the time being, but the scorching pace of credit growth-both in the retail as well as the corporate sectors-and the trailing bank deposit growth can combine rather awkwardly to put pressure on short- and medium-term interest rates. Industry needs more credit, consumers need easier and more loans; these are sine qua non for a sustained and sustainable 8 per cent-plus growth rate. But there's also the high risk of greater credit flows leading to a higher inflation rate. But that's a tightrope for Reserve Bank of India (RBI) Governor Y.V. Reddy to walk and his short-term response to these issues, in the form of a possible hike in the repo and reverse repo rates in his April 18 Credit Policy, will be known by the time this issue hits the stands.

But regardless of the credit policy, Neeraj Swaroop, CEO, Standard Chartered Bank India, feels interest rates are likely to remain stable at current levels. "At most, there may be a very moderate (25-50 basis points) increase," he predicts.

The inflation rate over the last quarter has been at 4-4.5 per cent against the projected rate of 5-5.5 per cent; but spiralling crude oil prices, which are hovering around the $70 (Rs 3,150) levels, may just ruin this happy picture. There is speculation the government may bite the bullet and raise oil prices after the elections in the five states are over. This will definitely stoke inflation and put further pressure on interest rates.

Abheek Barua, Chief Economist at ABN Amro India, says there are worries on the inflation front over the medium term. "RBI could tinker with the bank rate this time around," he says. In the January policy, RBI kept the Bank Rate untouched, but hiked the reverse repo rate-which is a tool for absorbing surplus liquidity from the banking system-by 25 basis points to 5.5 per cent. It worked. There has been considerable tightening of monetary conditions in a fairly short period of time, says the latest JP Morgan report. It came at a price, though: interest rates began hardening.

Another cause of worry is the rising cost of deposits in the banking system (growth rate: 16 per cent year-on-year, compared to a credit growth of over 32 per cent). Home loan biggies like HDFC, ICICI Bank and State Bank of India have already reacted by raising rates by 25-50 basis points. And there seems little respite in sight, caught as interest rates are between soaring crude oil and commodity prices on the one hand and an expected rise in the rate of inflation on the other. The most likely victims: auto and personal loans. The scorching pace of growth in bank credit, however, is expected to continue, despite the measures RBI has taken to cool down the retail lending boom, especially in the housing sector. "RBI is also having some success in slowing lending to potentially speculative sectors by tightening prudential norms and by the recent revision in securitisation rules," reports JP Morgan.

The central bank is clearly on the ball. But it will have to move with great circumspection in the days following its credit policy announcement fine tuning the system, so that its actions do not spoil the party that the rest of the world so desperately wants to join.