New credit policy issued by Reserve Bank of India on Oct 31st, 2006

On October 31st, 2006 Reserve Bank of India (RBI) governer Y V Reddy announced mid-term credit policy.

• The main aspect of this policy is the increase in repo rate by 25 basis points (100 basis points equals 1 percent), while reverse repo rate has been left untouched. So now repo rate shall stand at 7.25%.[Repo rate is the rate at which banks take loan from RBI, and reverse repo rate is the rate at which banks park their money with RBI]

• RBI had earlier given a deadline of Mar'07 to banks for impolementing Basel II norms, however, it has extended the same by two years for banks not having high overseas exposure, and one year for others.


• RBI has raised annual growth rate target for GDP to 8% from earlier estimate of 7.5-8%.


• Inflation target has been kept at 5-5.5%

This whole year vitnessed the dramatic rise in oil prices, from around $ 55 per barrel in January it crossed $78 mark in July. but since then the prices have come down by as much as 20%. Considering this there was no immidiate need to recommend a hike.

Last time US Federal Reserve sit to consider changing its interest rate in August 2006, it decided against any change, this also would mean that there was no immidiate need for a hike.

However since the inception of UPA (United Progressive Alliance, led by Indian National Congress) government at New Delhi, inflation rate seems to in contineous bullish mood. Hon'ble governer had already expressed his concern by saying:

"We are most concerned about the inflationary expectations. Unless there is a convincing reason that oil prices are easing off on a sustained basis, the inflationary expectations will not be significantly altered"
- YV Reddy, Governor, RBI

There could be a lot other factors to be considered, such as:

1. India's growth target. Since India is targetting a growth rate of 10% in its 11th five year plan, it calls against any hike in price hike.

2. Current account deficit. India's current account deficit has widened to $ 6+ billion in FY2007Q1 as compared to around &3.5 billion in FY2006Q1. Thus slowing down the accruation of Forex reserves.

3. State elections. Year 2007 shall vitness elections in states of Uttar Pradesh, Punjab and Uttaranchal. Therefore this is the right time to make any changes rather than waiting for next quarter review in Jan'07. Atleast UPA would like RBI to do the same.

As per news reports coming in, most of the banks have declared that the hike in repo rate would not have much impact on them.

Though it has done nothing much towards the side of interest rates, it has issued a statement that it can consider changes in any rates even before its next scheduled review meeting.

[INPUTS TAKEN FROM MONETARY POLICY ARTICLE SUPPLIED BY SHAREKHAN.COM, AND VARIOUS NEWS SOURCES INCLUDING SOME DAILIES]