Credit policy seems bullish, but conditions tighter

The Annual Credit Policy is bullish about India's growth prospects, but that growth will now have to contend with tighter credit conditions. The interest rate cycle turned around in FY05 after a multiyear downward ride. But FY05 also saw the second highest growth in non-food credit in 55 years. There is still enough evidence to believe that industrial growth will continue to be investment-led this year. RBI's growth forecast of 7% for next year, would constitute a three-year trend, and confirm that India's growth has shifted to a higher trajectory. But this year, the RBI's focus has shifted to tempering inflationary expectations. In the wake of an 8+ inflation rate in August last year, the RBI had responded swiftly with tight monetary measures, and the mild tightening of the (reverse) repo rate is a continuation of that stance. Of course, there won't be too much hardening beyond 50 or 100 basis points, given that the RBI also has to manage the government's huge borrowing. The RBI's lower inflation outlook for FY06 might appear puzzling. Firstly the liquidity overhang is still huge. Secondly, petrol price hikes are imminent and their impact on the wholesale price index is yet to be factored in. Thirdly the room for fiscal relief through duty cuts on imported oil is limited. Fourthly, the threat of imported inflation through commodities is still not gone. And lastly, the industrial sector has begun to show some pricing power. All of this might point to rising inflation. However, there are signs that the global commodity cycle is losing steam. Also the Indian economy still has unexploited productivity gains, which coupled with cost control can keep inflation within the 5-5.5% range. Another weapon in the RBI's armoury to combat inflationary trends is intervention in currency markets. But given that the rupee is considerably overvalued in REER terms, there isn't much room to strengthen further. Global phenomena are increasingly important to domestic monetary policy making. To some extent, the turnaround in interest rates reflects a global phenomenon. But global signals are currently somewhat incoherent. Just a day before the RBI's policy announcement, the Bank of Japan admitted that the country will continue to experience deflation — declining consumer prices till '07, despite the fact that Japan imports a lot of commodity inflation. In the Eurozone, their main growth engine Germany may be on the brink of a recession — that is, contraction in GDP. Germany has the highest ever post war unemployment. At the same time, there are fears of a housing bubble in the US which may necessitate an aggressive monetary tightening by the Federal Reserve. The global imbalance of the record American trade deficits coupled with runway Chinese growth and forex accumulation continues to confound many economists. No wonder, the RBI has announced that it will review its credit policy not once, but three times this year — implying a need for greater vigilance.

Credit policy seems bullish, but conditions tighter

The Annual Credit Policy is bullish about India's growth prospects, but that growth will now have to contend with tighter credit conditions.

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