ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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A New Orientation to Directed Credit

The policies for directed credit that were introduced in the 1970s accorded significant priority to agriculture, exports and micro, small and medium enterprises. However, the present framework for directing and targeting credit under the priority sector lending policy has lost much of its original thrust because of the demand of the banking system to sustain its profitability and meet tighter prudential standards. The current priority sector guidelines suffer from multiple and complex categorisations incorporating several objectives. A strategic reprioritisation of directed credit to agriculture, exports and micro, small and medium enterprise sectors can moderate the costs of correcting the adverse redistributive effects of inflation. It is also imperative that the priority sector be redefined more from the objectives of growth and employment while the equity angle be left to be best served through the policy of financial inclusion.

Corporate Bond Market Activity: An Overview

The corporate bond market activity has picked up in recent years both in the primary and secondary market segments. However, this market is yet to acquire depth, vibrancy and integration comparable to other segments of the fi nancial market. The secondary market trends support the view that over the counter trades are the most favoured route by investors. Data on primary and secondary market activity are from diversifi ed sources and lack completeness and uniformity, making it diffi cult to draw meaningful conclusions. Apart from introducing various measures for the development of the market, the regulators should focus on the dissemination of comprehensive data on the corporate debt market in a transparent manner.

Cyclical Responses to Monetary Policy

Monetary policy is effected through changes in the repo rate, reverse repo rate and the cash reserve ratio. The response to changes in policy rates since 2001 in three different respects - the inflation rate, interest rates and the benchmark rates - is examined here. The transition from the benchmark prime lending rate to the base rate has brought about better transmission of policy rate signals to the lending rates of banks. Suggestions to enhance transparency and improve the transmission channels of policy rates include setting a sunset date for the BPLR, disclosing the methodologies in computing the BR, and resuming the practice of disseminating the actual lending rate structure of banks.

Yield Spread and Industrial Activity

Two explanations are usually offered for the empirical relationship between yield spread and economic activity. One, yield spread may reflect the monetary policy stance, and two, it mirrors market expectations of a pickup in economic activity in the future. Using growth in the index of industrial production as a proxy for economic activity, it is seen that the gilt yield spread is able to predict the growth in IIP with a six-month lag. The data on recent movement in bond spreads for different maturities and issuer groups reveals that bonds of non-banking financial companies have the highest spread in all maturities, reflecting a higher risk perception of investors. Public sector units and banks enjoy the lowest spread, signalling a higher level of investor confidence.

The Problem of Inflation

Given the lack of consensus within the government on the factors behind the current surge in inflation and the relevant tools to deal with it, an analysis of the trends in the food and non-food groups in the Wholesale Price Index and the Consumer Price Index for Industrial Workers for 2009-10 and 2010-11 could help bring clarity to the ongoing debate. Contrary to the view on food inflation as the major contributory factor, the analysis here reveals that the weighted contribution of non-food inflation to overall WPI and CPI inflation has increased in the current fiscal year. Moreover, the impact of food inflation on the overall inflation rates is easing. Non-food inflation, the rising prices of manufactured products and the global upswing in fuel and commodity prices warrant an increasingly important role for monetary policy.

Crunching the Liquidity Crunch

There has been an extreme tightening of liquidity in the money market since June, the result of both structural (a rapid growth in credit and a slower growth in deposits) and frictional (higher than anticipated receipts from the broadband auctions and large tax receipts) factors. The frictional factors could have been handled with better cash management practices by both central and state governments that are in harmony with debt management operations. In the absence of such an approach, merely separating the debt management function of the central government from the Reserve Bank of India may result in further complexities to both debt and monetary management functions. An alternative solution would be the creation of a "Debt Management Corporation" as a subsidiary of the RBI with shareholding by both central and state governments to handle debt management.

India's Growth Story: Pre- and Post-Crisis

The earlier than expected recovery of the Indian economy from the effects of the global crisis has led to predictions of a return to the 9% growth rate witnessed in the 2003-08 period. But some awareness of the downside risks is necessary, for the Indian economy does not currently enjoy the benefi ts of low infl ation, low interest rates and favourable debt indicators. It is also a cause for concern that between 2006-07 and 2010-11 some macroeconomic indicators such as the current account defi cit have shown a trend similar to that between 1986-87 and 1990-91, when India faced an acute balance of payments crisis. A cross-country comparison also shows that post-crisis India is poorly placed in respect of these parameters when compared to its counterparts.

Coming to Terms with Inflation

Given the widespread public and government concerns about inflation, now is an appropriate time to address some issues pertaining to its measurement, inflationary expectations, outcomes and the priorities for action. The central government must attempt to construct an internationally acceptable and comparable price index series, the goal of monetary policy on inflation should be made benchmarkable in definite terms, the weights in the available price indices need to be readjusted in the light of recent changes in consumption patterns and the existing surveys on expectations should be put to practical use for developing appropriate policy perspectives.

Hands-off Policy on the Exchange Rate

Since the late 1990s, India's exchange rate policy has been one of minimising the volatility and at the same time maintaining a healthy level of foreign exchange reserves to guard against risks. The Reserve Bank of India's interventions in the market have been by and large guided by these twin concerns. Since August 2009, however, the RBI appears to have followed a hands-off policy and has hardly intervened in the market. What has guided this new approach and what are the implications for the real value of the rupee? And under what circumstances is this policy likely to change?

Base Rate Transition and Transparency Issues

While it will take some time for the new base rate system to have its full impact on the pricing of loans, certain patterns are already discernible. The BR of all banks is considerably lower than the former benchmark prime lending rate and the range of the BR in various bank groups is also narrower than the BPLR earlier. Following the State Bank of India's decision to launch BR-based deposits, an intriguing question is that while deposit rates are to infl uence the BR, if the latter itself determines the former, what then is to determine the BR? With the shift to the BR, corporates are showing signs of moving to non-bank sources for their working capital. The burden of higher borrowing costs may then fall on the public sector which was earlier drawing on sub-BPLR fi nance.

An Arbitrary Law for Arbitration

The Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010 is an avoidable intrusion into the otherwise satisfactory institutional arrangement existing on matters relevant to it. Where cooperation between regulatory agencies is the need of the hour, the Ordinance seeks to give precedence to arbitration over cooperation. This column examines the key provisions of the Ordinance and comments on some underlying assumptions, lack of clarity on certain issues and implications for success of the arbitration process that the new law seeks to achieve.

Back to Base: Setting the Base Rate for Banks

In order to ensure greater transparency in setting lending rates, banks are expected to replace from 1 July the existing benchmark prime lending rate system with the new one of a base rate. Yet, the methodology and the approach that each bank will follow in setting this rate is still not clear. According to the Reserve Bank of India's guidelines, determination of the base rate will depend on the cost structure of bank liabilities as also the capacity to charge lower interest rates for certain groups of borrowers. Therefore, the base rate is likely to hover around the minimum lending rates charged at present by different bank groups (public sector, private sector and foreign banks). Since these rates differ across bank groups, the base rates too are likely to differ, leading to some competition. However, given the new system that the banks are going to introduce, it will take a while before a clear picture emerges.

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