How the credit policy will affect you

The Reserve Bank of India announced the mid-term review of its monetary policy on Tuesday. Though the central Bank kept away from the much expected interest rate hike, the policy contained recommendations that affects the money markets and securities market. With inflation on the up in the country, RBI primarily has aimed the credit at curbing inflation and maintaining price stability. But a proper understanding of the fundas involved in the making and functioning of the monetary policy will help to understand the investment climate in the country. In the world of policies in the financial sector, the Monetary Policy could appear ver alien with terms like M3, CRR, SLR, PLR and OMO. The policy primarily determines the supply of money in the economy and the rate of interest charged by banks. The policy also contains an economic overview and presents future forecasts. What is the Monetary Policy? The Monetary and Credit Policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include - money supply, interest rates and the inflation. In banking and economic terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the economy. Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it. These would be banks, financial institutions, non-banking financial institutions, Nidhis and primary dealers (money markets) and dealers in the foreign exchange (forex) market. How is the Monetary Policy different from the Fiscal Policy? Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. Fiscal policy is a broader tool with the government and in a very common term may be called Tax policy. The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices. The annual Union Budget showcases the government''s Fiscal Policy. What are the objectives of the Monetary Policy? There are 4 main tools implemented by RBI 1. Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates). 2. Interest rate. 3. Exchange rate channel. 4. Asset price. How does the Monetary Policy impact the individual? In recent years, the policy had gained in importance due to announcements in the interest rates. Earlier, depending on the rates announced by the RBI, the interest costs of banks would immediately either increase or decrease. A reduction in interest rates would force banks to lower their lending rates and borrowing rates. So if you want to place a deposit with a bank or take a loan, it would offer it at a lower rate of interest. On the other hand, if there were to be an increase in interest rates, banks would immediately increase their lending and borrowing rates. Since the rates of interest affect the borrowing costs of corporates and as a result, their bottomlines (profits), the monetary policy is very important to them also. Since the financial sector reforms commenced, the RBI has moved towards a market-determined interest rate scenario. This means that banks are free to decide on interest rates on term deposits and loans. Being the central bank, however, the RBI would have a say and determine direction on interest rates as it is an important tool to control inflation. The bank rate is a tool used by RBI for this purpose as it refinances banks at the this rate. In other words, the bank rate is the rate at which banks borrow from the RBI. What are the measures in the Credit Policy 2004 that will directly impact investors? The bank rate has been left unchanged at 6%. The bank rate is a key interest rate signal. Banks use this rate to price their loans. This means that banks won''t be changing the lending rates. You will be able to get loans from banks at the same old rates. But with a liberalised regime in place the banks may change the rates in the long run. The repo rate has been hiked by 25 basis points, to 4.75% with effect from Oct. 27. This is the rate at which the RBI borrows funds from the market. It impacts market interest rates. The reverse repo rate has been left unchanged. The bond market will have direct impact from the repurchase rates. Composite loan limit for SSI up from Rs 50 lakh to Rs 1 crore. A measure taken to boost investment in small industries, which has the potential to increase employment and rural demand. 7 and 14 day Repos will be discontinued from November 1. This was in much expected lines as these were not doing well in the money market. Interest rate ceiling on NRE (Non-Resident External) deposits has been raised by 50 basis points over the dollar LIBOR/swap rates of corresponding maturities. Piority sector limit advances have been enhanced to improve farm credit. What does the credit policy 2004 means to common man? Bank loans will be availabe at the same old rate. More rural jobs with the huge impetus given to small scale sector and the enhancement in farm credit limit. The RBI proposed an increase in the risk weightage assigned to bank lending in the housing finance and consumer credit segments, following a steep rise in loans to these areas. Monetary policy review proposed to raise the housing loan risk weight to 75 per cent from 50 per cent while for consumer credit such as personal loans and credit cards, the risk weight would rise to 125 per cent from 100 per cent. Banks can extend direct finance to housing sector upto Rs 15 lakh under the priority sector. Banks may finance distressed urban poor to repay debt to non-institutional lenders. What''s the policy telling about the economy? The economy is forecast to grow by 6.0-6.5 per cent during the fiscal year to March 2005, below an earlier estimate of 6.5-7.0 per cent, assuming that the combined downside risks of high and uncertain oil prices, and sudden changes in international liquidity environment remain manageable. The RBI projected inflation at around 6.5 per cent by end-March 2005, up from an earlier estimate of 5.0 per cent. Foreign exchange reserves are at present comfortable and consistent with the rate of growth, the share of the external sector in the economy and the size of risk-adjusted capital flows. Money supply (M3) growth in this fiscal year (up to October 1, 2004) lower at 5.4 per cent as compared with 7.8 per cent in the previous year. The Central Government has completed net market borrowings of 29.0 per cent of the budgeted amount up to October 21, 2004. The market borrowing programme in the remaining part of the year needs to be calibrated carefully in view of strong credit demand. Banks advised to prepare themselves to implement the capital charge for market risk as envisaged under Basel II norms in a phased manner by end-March 2006. Which sectors of the economy will benefit the most? The policy has increased credit to petroleum, infrastructure, electricity, construction metals, pharmaceuticals and automobiles industries. Farm sector will get a big boost with directives like: IBA to make suggestions to NCAER on the Kisan Credit Scheme. Banks will increase disbursements to small and marginal farmers under the Special Agricultural Credit Plan, SACP, March 2007. Private banks have been urged to formulate SACPs from 2005-06 targeting annual growth of 20-25%. Non-Food credit is seen rising 19%, upped from the earlier call of a 16 â€“16.5% gain. Piority sector limit advances have been enhanced to improve farm credit. Will the stock markets take a cue from the credit policy? Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity in the system. This is not entirely true. The factor connecting money and stocks is interest rates. People save to get returns on their savings. In true market conditions, this made bank deposits or bonds (whose returns are linked to interest rates) and stocks (whose returns are linked to capital gains), competitors for people''s savings. A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect.

How the credit policy will affect you

Bank loans may not cost more in the short run as the RBI has left bank rate unchanged at 6%.

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