RBI keeps key interest rates unchanged

April 24, 2007 12:09 IST

The Reserve Bank of India on Tuesday left all key interests rates unchanged and announced steps that would pave the way for lower interest rates on home loans in its annual Monetary and Credit Policy -- aimed at sustaining growth without fuelling inflation.
Unveiling the Annual Policy Statement for 2007-08, the Reserve Bank also lowered the growth forecast for 2007-08 to 8.5 per cent and promised to keep the inflation close to 5 per cent, bringing comfort to commoners.

Announcing a feel-good policy, the apex bank Governor Y V Reddy took a number of initiatives toward capital account convertibility and encouraging hedging of price risk on global commodity exchanges.

The RBI kept Bank Rate kept unchanged at 6.0 per cent, and also kept the reverse Repo Rate and Repo Rate unchanged at 6.00 per cent and 7.75 per cent, respectively.
Cash reserve ratio (CRR) of scheduled banks at 6.5 per cent with effect from the fortnight beginning April 28, 2007, as announced on March 30, 2007.

The Reserve Bank retained the option to conduct overnight repo or longer term repo under the LAF depending on market conditions and other relevant factors; and the RBI will continue to use this flexibility including the right to accept or reject tender(s) under the LAF, wholly or partially, if deemed fit, so as to make efficient use of the LAF in daily liquidity management.

Highlights of the Credit Policy

Reddy also put in place measures to develop the corporate bond market, futures contract, establishment of credit information companies and a number of steps to help distressed farmers and micro-finance.

Some of the other measures announced include:
GDP growth projection for 2007-08 at around 8.5 per cent.
Inflation to be contained close to 5.0 per cent during 2007-08. Going forward, the resolve is to condition policy and perceptions for inflation in the range of 4.0-4.5 per cent over the medium term.

M3 expansion to be contained at around 17.0-17.5 per cent during 2007-08.
Introduction of a credit guarantee scheme for distressed farmers.
Indian banks permitted to extend credit and non-credit facilities to step-down subsidiaries within the existing prudential limits and some additional safeguards.
Banks and primary dealers permitted to begin transactions in single-entity credit default swaps.
RBI announced that risk weight on the residential housing loans to individuals would be reduced to 50 per cent from 75 per cent as a temporary measure, keeping in view the default experience and other relevant factors. This step would be applicable to loans up to Rs 20 lakh and will be reviewed after one year, the policy said. This measure would leave banks with more money to lend for the housing sector and probably make interest rates attractive for loans up to Rs 20 lakh.

The policy statement said:
"While there is evidence of structural changes underlying the recent Indian growth experience, there are also indications that the upsurge of demand pressures may contain a cyclical component. The structural changes include a step up in the investment rate supported by a sizeable increase in the rate of gross domestic saving, the growing linkages of the Indian economy with the global economy and the indications of improvements in productivity in industry and services.

"Among the cyclical factors, first, robust global GDP growth has been supportive of high growth in India. Second, the persistence of high growth in bank credit and money supply, the pick-up in non-oil import growth and the widening of the trade deficit together indicate pressures on aggregate demand. Third, cyclical forces are also evident in the steady increase in prices of manufactures, resurgence of pricing power among corporates, indications of wage pressures in some sectors, strained capacity utilisation and elevated asset prices.

"A significant worrisome feature of domestic developments in 2006-07 is the firming up of inflation, which represents the key downside risk to the evolving macroeconomic outlook. The recent hardening of international crude prices has heightened the uncertainty surrounding the inflation outlook.

"A careful assessment of the manner in which inflation is evolving in India reveals that primary food articles have contributed significantly to inflation during 2006-07. At the same time, prices of manufactured products account for well above 50 per cent of headline inflation.

"Indian financial markets have experienced some volatility in the fourth quarter of 2006-07 alongside sizeable swings in liquidity and a hardening of interest rates across the spectrum. During episodes of tightness, contrasting conditions were often observed when short-term interest rates had firmed up but long-term rates had declined in the Government securities market.

"While capital flows to emerging market economies and, in particular, to Asia in 2006 have reflected the improvement in macroeconomic performance, they were also driven by a search for yields and a stronger appetite for risk. Consequently, reversals of capital flows can pose challenges to emerging economies, particularly in the context of withdrawal of monetary accommodation in developed economies.

"In the event of demand pressures building up, increases in interest rates may be advocated to preserve and sustain growth in a non-inflationary manner. Such monetary policy responses, however, increase the possibility of further capital inflows, apart from the associated costs for growth and potential risks to financial stability. Thus, foreign exchange inflows can potentially reduce the efficacy of monetary policy tightening by expanding liquidity."
Belying all expectations on monetary tightening, Reddy kept bank rate unchanged at 6 per cent, short term repo rate at 7.75 per cent and cash reserve ratio at 6.5 per cent.
RBI had hiked key short term repo rate five times since June 2006 and Cash Reserve Ratio three times in two tranches since December last in a bid to suck out liquidity to douse inflation, hovering over 6 per cent.

The annual policy, however, expresses confidence to contain inflation close to five per cent in 2007-08 and with a medium term policy objective of keeping it in the range of 4 to 4.5 per cent.
"The objective would be conducive for maintaining self accelerating growth over the medium term," Reddy said.