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Reserve Bank of India (RBI) credit policy review

Nirmal Bang presents Indian 1QFY2010 monetary policy preview:

Highlights of RBI Credit Policy
RBI kept all key rate unchanged as expected by market.

GDP
RBI Remained cautious and not increased its yearly expectation of 6% growth in GDP. This was mainly on account of delayed monsoon. But with the improving domestic industrial scenario, governor has indicated that RBI has positive bias for GDP growth of 6%.

Business Confidence
The Industrial Outlook Survey of the Reserve Bank, conducted during April-May 2009, shows a turnaround in the business sentiment. The assessment for Q1 of 2009-10 suggests that the slide in sentiment in the preceding three quarters has been arrested on key indicators such as production, order book position, capacity utilisation, financial situation and availability of finance. The business expectation index (BEI) for the forward July-September 2009 quarter crossed the neutral 100-mark and moved into the growth terrain on the perception of improvement in demand conditions.

Inflation expectation for yearend increased from 4.0% to 5.0%
The headline inflation, as measured by year-on-year variations in the wholesale price index (WPI), decelerated from a peak of 12.91 per cent on August 2, 2008 to 0.84 per cent at end-March 2009 and turned negative in June 2009. Negative WPI inflation is expected to persist for a few more months till the base effect wears off. The currently observed negative WPI inflation largely reflects the statistical effect of the high base of last year and should not be interpreted as structural deflation arising from demand contraction. This is also evident from CPI which is ruling in the range of 8.6-11.5 per cent.

In the Annual Policy Statement of April 2009, WPI inflation at end-March 2010 was projected at around 4.0 per cent. On a financial year basis, WPI inflation has already increased by 3.5 per cent by July 11, 2009. The base effect, which is generating the negative WPI inflation, is projected to completely wear off by October 2009. Thereafter, the year-on-year WPI inflation will creep up even without any major supply shock. Keeping in view the global trend in commodity prices and the domestic demand-supply balance, WPI inflation for end-March 2010 is projected at around 5.0 per cent.

Managing Government Borrowing
The challenge before the Reserve Bank is to manage the Government`s borrowing programme for 2009-10. Despite active liquidity management by the Reserve Bank, yields on government securities firmed up from a low of 5.8 per cent in January 2009 to around 7.0 per cent in July 2009. Private credit demand remains subdued as of now, but is likely to pick up. In order to manage the government borrowing without crowding out present or potential private credit demand, the Reserve Bank will continue with its active liquidity management policy.

Interest Rate
Since mid-September 2008, the Reserve Bank has reduced policy rates significantly. Taking cues from the reduction in the Reserve Bank`s policy rates and the easy liquidity conditions, all public sector banks, most private sector and foreign banks have reduced their deposit and lending rates. The banks have responded to the monetary stance by reducing deposit and lending rates, although there is scope for further reduction. Going forward, the Reserve Bank will meet the challenge of spurring private credit demand by maintaining policy rates and liquidity conditions conducive for revival of private credit demand.

Deposit Growth increased but credit growth kept unchanged
RBI increased FY10 deposit growth forecast to 19% from 18% projected in April but Kept credit growth projection at 20% for FY10.

Policy Stance

- RBI will be observe the following policy to manage the liquidity inflation and growth in the economy.
- Manage liquidity actively so that the credit demand of the Government is met while ensuring the flow of credit to the private sector at viable rates.
- Keep a vigil on the trends and signals of inflation, and be prepared to respond quickly and effectively through policy adjustments.
- Maintain a monetary and interest rate regime consistent with price stability and financial stability supportive of returning the economy to the high growth path.
- Maintain an accommodative monetary stance until there are definite and robust signs of recovery.