Having projected a lower base line GDP growth of 8 per cent with a possible downward bias and a higher base line projection of head line inflation at 6 per cent with an upward bias in 2011-12, the Monetary Policy seeks to siphon out the excess liquidity with a stiff 50 basis point increase in the repo rate under the liquidity adjustment facility (LAF) so as to rein in demand to ensure price stability.

Particularly, in the light of the impending revision in fuel prices and growing uncertainties in global commodities outlook.

However, the cash reserve ratio (CRR) has been left unchanged at 6 per cent so as not to chock off funds flow to the productive private sector to sustain growth in the medium term.

The indicative growth in non-food credit in 2011-12 is given as 19 per cent.

Interest Rates

As the envisaged interest rate environment for the current year is one that moderates inflation and anchors inflation expectations, there is bound to be an upward bias in bank lending rates.

Pending deregulation, the savings bank rate has been hiked by 50 basis points as immediate compensation to inflation-hit household savers. This will push up banks' cost of deposits by 12-15 basis points, depending on the individual bank's share of such deposits.

The banks will factor this in while revising the lending rates. Funds of short-term maturities may also migrate to savings bank accounts adding to the cost.

The conventional objective of rate hike is not to deny productive credit but to deter unproductive demand. But there is a risk that high rates may negatively impact manufacturing and SME sectors, which are already reeling under growth deceleration.

There is a further risk that higher rates may not deter credit expansion as evident in past cycles of rate hikes.

The current loan growth is being driven by domestic demand and exports, both of which are likely to stay strong in the near future.

Non-food bank credit grew by 20.6 per cent during 2010-11 compared with 16.8 per cent during 2009-10. Credit to the services sector grew by 23.9 per cent during 2010-11 compared with 12.5 per cent in the previous year.

Personal loans grew significantly by 17.0 per cent during 2010-11 compared with 4.1 per cent during the previous year.

EASY MANAGEMENT

The short-term money market rates will continue to maintain upward bias and bond yields are expected to move up from the present levels.

The 10-year yield would inch up to 8.25 per cent and might even go up more up to 8.4 per cent.

However, the liquidity management has been made easy with a single indicative rate and the liquidity situation is expected to remain within the comfort zone at least in the first half of the year.

Banks can now park their excess liquidity with the RBI at 6.25 per cent or borrow from the RBI to meet liquidity shortfalls at 7.25 per cent.

In case of further requirement, banks can avail of the new Marginal Standing Facility (MSF) up to 1 per cent of NDTL at 8.25 per cent.

NPA Provision

The enhanced provisioning requirements on certain categories of non-performing advances and restructured advances will add to the cost, which has to be factored in by banks while re-pricing loan products.

The sub-target given under financial inclusion to cover Tier-5 and Tier-6 centres will lead to wider dispersal of new branches in the unbanked and under-banked centres.

(The author is CMD, Indian Overseas Bank.)

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