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RBI refrains from rate hike rush

Mumbai, April 18: The Reserve Bank of India (RBI) today left key interest rates unchanged in a bid to keep the country’s growth engine chugging, though it sent out a strong signal that higher inflation on account of firm crude oil prices could push them up in the months to come.

The warning came even as the central bank, worried about rising asset prices, asked banks to clamp down on unbridled growth in credit, particularly to non-productive sectors of the economy.

In his annual policy statement for the year 2006-07, Reserve Bank governor Y.V. Reddy did not tinker with key interest rates. He left the reverse repo, an instrument through which the central bank mobilises funds from banks, unchanged at 5.5 per cent and the repo rate at 6.5 per cent.

While the RBI injected funds through repo, it also left the bank rate unchanged at 6 per cent. The bank rate is the rate at which the RBI lends funds to banks. Moreover, the cash reserve ratio (CRR), which is that proportion of a bank’s deposits which has to be maintained with the RBI, was also left unchanged at 5 per cent.

This status quo on interest rates surprised markets that expected Reddy to hike the reverse repo by 25 basis points.

Hawkish tone

Despite the relief, the RBI adopted a hawkish tone and warned that further interest rate increases could not be ruled out as a measure of combating inflation. The central bank is obviously worried about the impact of high global crude prices on the country’s inflation. “Regardless of the manner in which the future scenario for crude oil prices unfolds, there is a need for continuous and close monitoring and appropriate policy responses to contain its inflationary impact,” the RBI said.

It’s not on the inflation or the interest rate front alone where the Reserve Bank raised a red flag. Reddy did not mince words in saying that the rapid growth in credit, which has risen by 30 per cent in the past two years consecutively, was a matter of concern. With asset prices, particularly in housing and real estate, rising in tandem, the major worry is that this growth in demand for credit does not result in any financial instability. “The present rate of high credit growth and increase in asset prices seem to pose a downside risk to overall financial stability,” the RBI warned.

Credit growth

Reddy later told reporters that while he wanted to see the good times witnessed during 2005-06 lasting even in this fiscal, he wanted to bring back the credit growth within a reasonable trajectory of 20 per cent. “We have to bring it back to a reasonable trajectory, but it has to be done in a non-disruptive way,” he added.

In its annual policy, the RBI forecast a GDP growth of 7.5 to 8.0 per cent for 2006-07 compared with an estimated 8.1 per cent in the previous year. Although inflation was well contained during 2005-06, the central bank set an inflation estimate of 5.0 to 5.5 per cent.

Like interest rates, Reddy also did not bite the bullet on yet another score. Bankers who were expecting him to decontrol the interest on savings bank deposits, now at 3.5 per cent, were in for disappointment when the RBI said that it would maintain the status quo now prevailing. It, however, pointed out that deregulation of this interest rate is essential for product innovations and price discovery in the long run.

Bond market

The Reserve Bank today proposed constituting a working group to suggest a roadmap for the implementation of the relevant recommendations of the RH Patil committee on developing corporate bond market.

In this regard, consultations will be held with the Securities and Exchange Board of India (Sebi) and the Insurance Regulatory and Development Authority (Irda), the central bank said.

Pursuant to the announcement made in the Union Budget 2005-06, a high level expert committee on corporate bonds and securitisation was appointed to examine legal, regulatory, tax and market design issues in the development of the corporate bond market.

The committee's recommendations included enhancing the issuer as well as investor base of corporate bonds, simplification of listing and disclosure norms, rationalisation of stamp duty and withholding tax and consolidation of debt.

The committee had also suggested improving trading system through the introduction of an electronic order matching system, efficient clearing and settlement systems, a comprehensive reporting mechanism, developing market conventions and self-regulation and development of the securitised debt market.

Co-op banks

Stepping up efforts to facilitate the development of urban co-operative banks, the RBI today said it would constitute a working group to identify alternative instruments for augmenting the capital funds of such banks.

The working group will comprise representatives of RBI, state governments and the UCB sector, the central bank said in its annual policy statement 2006-07.

The bank said it has also widened the scope of task forces for UCBs and now it will cover the scheduled UCBs registered in the state concerned.

Earlier, the RBI had signed MoUs with four state governments ' Andhra Pradesh, Gujarat, Karnataka and Madhya Pradesh ' to promote the sector.

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