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Reserve Bank of India’s Tightening Monetary Policy: An Impediment to Economic Growth? “In developing countries like India, the whole question of trade-off between growth and inflation-control --particularly at the margin and during periods of external or domestic uncertainties --- become even more relevant because of a large non-monetized and agricultural economy…A certain amount of target flexibility and balancing of conflicting objectives is unavoidable, particularly when things are not so rosy.”1 - Jalan Bimal, Former Governor, Reserve Bank of India In 2008, when economy was struggling with untamed inflation, the Reserve Bank of India implemented tight monetary policy in an attempt to drag down the wild run. The Reserve Bank increased both the repo rate and the cash reserve ratio, while the reverse repo rate was kept unchanged. Many times, a section of economists considered the inflation control measures taken earlier by RBI was detrimental to the economic growth. This time also, after RBI’s announcement of raising repo rate and CRR, it was feared that the economy might become sluggish. A sense of negative sentiment could be felt among the industrialists and investors in India as well as abroad. For the inflation-hit economy, the implementation of strict monetary policy was viewed as a double blow to many of them. At the same time, another section of experts opined that RBI’s step was actually rational and timely. The tight monetary policy might be painful in the short-run, but many economists were hopeful that it would gradually correct the unstable situation created by soaring inflation in the Indian economy. Thus, it remained to be seen whether the tight monetary policy would paralyze the rejuvenating economy or it would work as a remedy for the steep inflation that is taking place in the country.
Reserve Bank’s Monetary Policy in India: its Inception and Evolution Reserve Bank, the Central Bank of India, was established in 1926 under British Government and started its full fledged operations in 1935. According to Reserve Bank of India Act 1934, the preliminary task of RBI was “..to regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.”2 After independence, the Reserve Bank was brought under the control of Indian government in 1949. The primary task of RBI was to formulate, implement and monitor the monetary system in India. The objective of ensuring stable monetary system entailed extensive responsibility to RBI for regulating monetary flow in the financial system. RBI also managed the entire foreign exchange reserves of the country. RBI’s objective was “maintaining price stability while ensuring adequate flow of credit to productive sectors.” The rise in inflation would affect the consumer demand and investment growth and this put a negative pressure on GDP growth of a country3. Similarly, if money supply was short in the economy, allocation of funds to various sectors gets affected which in turn influence the overall growth of the economy. Thus RBI’s task of Jalan Bimal, “Banking and Finance in the New Millennium”, India’s Economy in the New Millennium, 2nd Edition, UBS Publishers’ Distributors Pvt. Ltd., 2002, pages 107-136 2 Bhattacharya Kaushik, “Monetary policy approaches in India”, www.bis.org/publ/bppdf/bispap31g.pdf, December 2006 3 Gross Domestic Product (GDP) of a fiscal year can be defined as the summation of consumption, investment, government expenditure and net export in that country. 1
This Case was written by Senjuti Ghosh, Kumar Satyaki Ray and Seshagiri Rao Chaganty, IBS Research Center. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was compiled from published sources. © 2009, IBS Research Center. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner.
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maintaining price stability as well as keeping adequate credit flow was related with the task of maintaining stable GDP growth of the country.4 As India embarked on planned economic development since 1951, RBI implemented its monetary policy that was compatible to the strategies and policies of Indian government. As the first two five year plans5 sought to build up strong agricultural and industrial base in the country, it became important to provide credit to farmers, small and medium scale entrepreneurs and big-scale industrialists. RBI realized the need for establishing a proper institutional infrastructure for agricultural and long-term individual credit.6 In 1969, 147 largest banks were nationalized which substantially increased government’s control on banking operations. The nationalization programme gave a thrust on credit allocation to the priority sectors which incorporated agriculture, small-scale industry, retail trade, small business and small transport operators. Among all these sectors, agriculture got maximum priority and banks were bound to provide 18%8 of their net credit to this sector. Apart from credit allocation, banks were also involved in poverty alleviation and employment generation programmes since early 1970s.The nationalization substantially relaxed the terms and conditions for opening bank accounts or providing loans to customers. This move helped to expand banking operations on a massive scale. In 1970s, after nationalization, RBI directed the banks to extend their branch network to smaller towns and rural areas in order to extend the banking operations amongst the masses of the country. Thus the network of commercial banks had increased from 8261 in July 1969 to 65,521 branches in 20009. To give a boost to the bank nationalization programme six more banks were nationalized in 198010. Apart from monitoring the banking operations of commercial banks in the country, RBI tightly regulated the movements of the foreign exchange flows.11 Up to 1980s, the foreign exchange rate was not market determined and the inflows and outflows of foreign exchange were highly restricted. RBI was also instrumental in fixing the deposit and advance rates of banks. To facilitate borrowing by consumers, lending rate was kept at artificially low level of 9%12 till the end of 1970s. After the oil shock13 during 1979-80, there was a gradual improvement in the economy.14 During 1980-81 to 1984-85, India’s GDP growth stood at 5.6%15, which was quite impressive when compared to the growth rates during the previous period of 197576 to 1979-80. Moreover, during this period, economy was also in a much stable position, if monetary system16 and perseverance from shocks17 were taken into account. Although inflation came down from 15% in 1981 to 9.5% in 1984, still it was high18. During 1985, a committee was set up under the Chairmanship of Sukhomoy Chakraborty to review the working of the monetary system in India and the committee suggested implementing price stability as a major monetary policy decision of RBI. As per the recommendations of the “Monetary policy approaches in India”, op.cit Five Year Plans were introduced in India in 1951 to achieve a controlled as well as high growth of the economy 6 “Changing Profile with Changing Time”, http://rbidocs.rbi.org.in/rdocs/Opportunities/history.html, 2008 7 Bhattacharya Tapan, “Three Decades of Bank Nationalization”pib.nic.in/feature/feyr2002/fjul2002/f310720021.html - 32k, 31st July 2002 8 Ghosh Jayati, “Bank Nationalization: The Record”, http://www.macroscan.org/cur/jul05/cur210705Bank_Nationalisation.htm, July 21st 2005 9 Ibid. 10 Mohan Rakesh, “Evolution of Central Banking in India”, http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=285, 17th Many 2006 11 “Monetary policy approaches in India”, op.cit 12 “Interest Rate in India”, http://www.ier.hit-u.ac.jp/COE/Japanese/discussionpapers/DP97.14/hyou3-8.htm, 1996 13 The oil shock in 1979 occurred with the wake of Iranian revolution and it was the second oil shock after the 1973 oil shock 14 “Monetary policy approaches in India”, op.cit. 15 “Monetary policy approaches in India”, op.cit. 16 Monetary stability implies maintaining almost same value of different monetary variables like interest rate, price etc. over a period of time 17 Perseverance from shocks of an economy can be defined as a situation when financial system of the economy remains stable in the face of internal as well as external challenges 18 “Price and Price Policy”, http://indiabudget.nic.in/es1983-84/esmain.htm, 2008 4 5
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committee’s report, RBI implemented “monetary targeting policy”19 (MT) in 1985. For smooth implementation of the monetary targeting policy, RBI proposed to establish a particular co-operative body20 between RBI and the Central Government to come to an agreement on the levels of monetization of fiscal deficit and monetary expansion21. The RBI’s perspective of MT was different from conventional MT policy22 in which a fixed amount of money was supplied in the economy by the central bank. However, in India, no specific money supply target was set up by RBI during the second half of the ‘80s, except fixing a ceiling to average growth of broad money23. In the late 1980s, banks were given freedom to fix their interest rates, but it was withdrawn immediately as RBI felt that the banks were unable to handle the reform measures suggested to them. Later, RBI tried to control the money market in a different way and introduced Treasury bills24 of 182 days duration to improve money market operations. The period of late 1980s also saw introduction of new financial instruments such as certificates of deposits25 and commercial papers26. To facilitate money market operations in the country, Discount and Finance House of India (DFHI)27 was set up by RBI to provide liquidity to these short term financial instruments. Even while these structural changes were going on, the fiscal deficit28 situation in India did not show any signs of improvement. Thus the high fiscal deficit during the entire decade of 1980 was one of the key reasons behind the balance of payment crisis29 that India faced in 1990-91. Continuous decline in foreign exchange reserves through the entire second half of 1980s was another important factor behind the BOP crisis. Hence, the government had no other option but to borrow funds from the International Monetary Fund. But a stable macroeconomic position was a pre-requisite for funding by IMF. However, inflation was high during that period which acted as an impediment for India to avail funds from IMF. Hence, to facilitate the borrowing from IMF, RBI increased statutory liquidity ratio (SLR)30 in 1990 to mitigate the steep price rise in the country. The rise in SLR had sucked money out of the monetary system which was mainly responsible for inflation to go down from 11.5% in September 1990 to 7.5% in September 1991.31 After the 1990 crisis, the government initiated several monetary and fiscal reforms in the country. One of the most important policy reforms was the opening up of different sectors of the economy. Government decided to substitute the fixed exchange rate system by market-driven exchange rate regime. Another reform was the introduction of current account convertibility32 in a phased manner. These reform measures were largely effective as the Balance of Payments crisis was mitigated by the end of 1992-93. The new exchange rate regime coupled with liberalization led to increased capital inflows and that in turn, forced RBI to more actively pursue monetary targeting. When capital inflow increases in a country, it tend to increase inflation because of the increased capital inflow expands domestic money supply without a corresponding rise in Monetary targeting is a kind of monetary policy in which central bank fixes the supply of money in the economy in a particular fiscal year 20 A cooperative body is an association of persons who have united voluntarily to meet their common economic or social interest. 21 “Monetary policy approaches in India”, op.cit 22 In conventional Monetary Targeting policy, central bank of a country determines supply of money into the economy and if money supply changes from predetermined level central bank takes necessary steps to arrive at the fixed level of money supply 23 In general broad money is used to refer total supply of money in monetary system and it is defined as the sum of money in circulation, money in bank deposits, money in small time deposits, overnight repo at commercial banks and noninstitutional money market accounts. It is the indicator of inflation in an economy. 24 Trasury bills are risk-free and short-term debt instrument used by central government of a country. 25 Certificate Deposits (CD) are short term savings deposit with a fixed interest rate offered to customers by banks and credit unions. 26 Commercial Paper is a short-term money market security issued by large banks and corporations. 27 DFHI was established by RBI to support open market operation and provide necessary depth and liquidity to the Secondary market of in Government securities. In 2004, DFHI merged with SBI. 28 When government’s total expenditure exceeds total revenue, government incurs fiscal deficit. 29 Balance of payment is defined as the statement of all economic transaction of a country, both monetary and nonmonetary, with rest of the world. In 1990-91, India faced her worst balance of payment crisis ever 30 SLR, which was uniform for all Indian banks and determined by RBI, is the minimum amount of deposits that a bank has to maintain in the form of cash, gold or approved securities 31 “Economic Survey of India”, http://indiabudget.nic.in/es1992-93/esmain.html., 1990-91 32 Current account convertibility refers to currency convertibility which is required during foreign trade or all other transactions that fall under current account. 19
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domestic production. As a result, too much money chase too few commodities and giving a rise to inflation. To check the inflation and maintain monetary targeting policy, sterilization of capital inflows was followed. By sterilization, domestic monetary supply is reduced to offset the effect of increased capital inflow. There were many possible ways of sterilization – selling Treasury bills, encouraging domestic investors to invest abroad or encouraging foreigners to borrow from domestic economy. To maintain the targeted monetary flow, RBI implemented sterilization policy33 through Treasury bills operations. The second structural change in monetary framework came in 1998-99 when RBI adopted multiple indicator approach34 (MIA). In monetary targeting approach, the demand for money could not be controlled while excess demand over supply of money could lead to increased interest rates and which in turn reduce inflation by making the loans costlier and reducing flow of money in the system. RBI, therefore, took a gradual shift from targeting money supply (Quantity of money) to targeting money demanded (Interest rate). However, it was not possible to shift to interest rate targeting completely as the exact relationship between short-term and longterm interest rates and the role of market-determined interest rates in the real sector was yet not clear. Thus, India had to work on both monetary targeting and interest rate targeting and this was called the MIA policy in India. After adopting MIA approach, the RBI and the government of India jointly adopted new strategies like open market operations (OMO)35, repo and reverse repo operations since late 1990s. These tools were used for short-term liquidity management36 in the country. Following these, the price stability had emerged as the next overriding concern amongst the policy makers. The then RBI Governor, Y.V. Reddy, acknowledged the price stability as “informal mandate.”37 The Reserve Bank had implemented tight monetary policy measures to maintain price stability of economy at various points of time. Although tight monetary policy was considered as a restraint to economic development of a country, it was also an inevitable instrument at times. As Indian economy remained buoyant since 2004, chances of facing inflation were very high in the country38. Thus, the Reserve Bank of India had to perform the tough balancing act of maintaining a moderate inflation rate with accelerated economic growth.
Tight monetary policy at the onset of inflation-hit economy Since the beginning of 2008, inflation in India was rising at an alarming rate. Prices of all necessary commodities, foods, crude oil and metals were rising incessantly. India’s inflation had been marked as “imported inflation”39. The sharp price rise of international intermediate inputs40 like crude oil and heavy metals which fell under the fuel and power group of WPI, kept India’s Wholesale Price Index41 on rise since early 2008. Increase in food prices, which fell under primary group, was another important factor behind the worsening inflation scenario42. The uncontrollable price rise of commodities had kept the Indian economists In a successful sterilization operation, the domestic component of the monetary base (bank reserves plus currency) is reduced to offset the reserve inflow, at least temporarily. In theory, this can be achieved in several ways, such as by encouraging private investment overseas, or allowing foreigners to borrow from the local market. The classical form of sterilization, however, has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component of the monetary base. As a supplementary policy Central banks can use foreign exchange swaps where they can buy foreign currency at a given future date. Foreign currency derivatives can also be used. Source: “Sterilizing Capital Inflows”, http://www.imf.org/EXTERNAL/PUBS/FT/ISSUES7/INDEX.HTM 34 Multiple Indicator approach implies a policy mix of different monetary policies 35 Open market operation is a process through which central bank controls its money supply in the economy by buying and selling government securities and other financial instruments 36 Short term liquidity management is the process of maintaining adequate liquidity for short-run and keeping healthy funding profile. 37 “Monetary policy approaches in India”, op.cit. 38 With economic buoyancy, consumers tend to save less and buy more which leads to inflation in many cases. 39 “Global Inflation and India”, http://www.thehindubusinessline.com/2008/04/08/stories/2008040850360900.htm, April 28th 2008 40 Intermediate inputs are those inputs which are used as raw material in production of a commodity, but they themselves are modified for use in production. 41 Wholesale Price Index is a measure of calculating inflation in the wholesale level with some base year. In India, WPI is divided in three major groups namely primary articles, manufactured goods and Fuel & power. 42 Lilladher Prabhudas, “Banking: Inflation Control Assumes Top Priority”, www.moneycontrol.com/news_html_files/news_attachment/2008/Banking-25-6-08-PL.pdf , June 25th 2008 33
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and policy makers in grave apprehension about the high inflation which could severely damage the economic growth. With inflation, lending had become dearer, prices of commodities were higher and profitability of sellers was lesser. The rising inflation had started to damage the positive spirit of all – consumers, sellers, industrialists or investors43. In such pessimistic situation, the GDP growth rate was expected to be lower than the earlier targeted level. In August 2008, inflation had touched 13.5%, almost double within five months, which was 7.7% at the end of March, 200844. In July 2008, prices of primary articles increased by 10.1%45 compared to the previous year, reflecting the price rise in food grains like rice and wheat, fruits and milk and non-food articles like oilseeds, raw cottons, metals and crude oil. Inflation in fuel group touched 16.9% in July 2008 from 6.8% recorded for March 200846. This was the result of price rise in petrol, diesel and liquid petroleum gas47. Moreover, the freely-priced petroleum products48 continued to be dearer. Inflation in manufactured products increased from 5.9% in December 2007 to 10.75% in July 200849. Thus, the inflation was mainly driven by exceptional price rise in primary articles, fuel and power. Observing the steep growth of inflation, RBI had raised the expected inflation rate from 5.5% to 7% for the fiscal year 2008-0950 (Exhibit I). Exhibit I Trend of Wholesale Price Index in Different Commodity Groups (April 2006-June 2008)
Source: Lilladher Prabhudas, “Banking: Inflation Control Assumes Top Priority”, www.moneycontrol.com/news_html_files/news_attachment/2008/Banking-25-6-08-PL.pdf , June 25th 2008
Both the government and Reserve Bank were desperate to combat the inflation. To reduce the rise in food prices, Government reduced import duty on several products like maize, soya oil and palm oil.51 Government also banned export of non-basmati rice and pulses. Government also asked steel producers not to raise price of steel. RBI also came up with several inflation controlling measures like increase in repo rate52 and Cash Reserve Ratio53 through which supply of money in the money market could be restricted. On 25th June 2008, RBI increased the repo rate and Cash Reserve Ratio by 50 basis points each to 9% and 8.75% respectively54, while the reverse repo55 had been left unchanged. The repo rate was increased with immediate effect whereas the cash reserve ratio was increased in two phases – from 8.25% to 8.5% from July 5th and from 8.5% to 8.75% from July 19th 200856. The increased CRR would ensure reduction in “Banking: Inflation Control Assumes Top Priority”, op.cit. “Inflation through RBI Lense”, http://www.indiaonestop.com/inflation.htm, July 2008 45 “Inflation through RBI Lense”, op.cit. 46 “Inflation through RBI Lense”, op.cit. 47 Anand Amit, “Hawkish on Inflation, Still Pretty Bullish on Growth”, www.moneycontrol.com/news_html_files/news_attachment/2008/RBI-Q1FY09-AMP%20Review.pdf, August 1st 2008 48 Prices of Naptha, furnace oil, aviation turbine fuel, bitumen etc. are not registered in India 49 “Inflation through RBI Lense”, op.cit. 50 “Hawkish on Inflation, Still Pretty Bullish on Growth”, op.cit. 51 “Export Import News”, http://www.indiaagronet.com/indiaagronet/exportimport/right.htm, 2008 52 Repo rate is the rate at which central bank lends money to other commercial banks 53 Cash Reserve Ratio is the minimum amount of money to be kept against each customer’s deposit. 54 “The Economy: Review and Prospects”, http://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=810, 29th August 2008 55 Reverse repo is the return banks earn on excess funds that they park with the central bank in exchange of government securities 56 “RBI’s Double Whammy Makes India Inc See Red”, http://www.businessstandard.com/india/storypage.php?autono=327036, June 25th 2008 43 44
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liquidity and the rise in repo rate would make money from RBI dearer. The hike was a signal to the market that money lending would be costly and forced the commercial banks to increase their lending rates. The tight monetary policy proved effective in drying up liquidity from market. By the end of July 2008, the tight policy reportedly sucked out INR 200 billion from the system57. After the implementation of the second phase of CRR hike, the average daily net liquidity injection58 declined from INR 279.61 billion in June to INR 229.28 billion in August 1-14, 200859 (Exhibit II). Exhibit II Movements of Repo Rate, Reverse Repo Rate and Cash Reserve Ratio (2001-2008)
Source: Lilladher Prabhudas, “Banking: Inflation Control Assumes Top Priority”, www.moneycontrol.com/news_html_files/news_attachment/2008/Banking-25-6-08-PL.pdf , June 25th 2008
The Funneling of Money – Its Sectoral Impact The tightening of credit flow was more significant because of an increase of 150 basis points in three phases in CRR and 50 basis points in repo rate since the start of the fiscal year 2007-0860. The industrialists and economists of the country expressed their concerns over the increased interest regime as in their opinion that increased interest rates would likely affect the economic growth of the country. Except a few areas like agricultural sector and defence, most of the Indian industries were opened up to international competition during the 1990s. The agricultural sector, which was a thrust area of the Government of India, was however insulated to some extent from RBI’s monetary policy. The financial institutions had been directed to provide adequate agricultural credit at a nominal interest rate of 7%61 p.a. to the ultimate borrowers. In fact, the agricultural sector has been growing marginally and production of food-grains and non-food grains increased from 547.5 million tonnes in 2006-07 to 629.4 million tones in 2007-0862. But apart from agriculture, major industries like automobile, real estate, banking, retail and infrastructure industries faced the heat. The Indian industries had been subjected to successive interest rate hikes for the past one and a half years, while international competition had increased during the same period63. The increased interest rates and tight monetary policy had an effect on their profitability. With expected slowdown in different industries, the anticipated year-on-year growth rate already had been revised downwards from 11% to 8% by RBI64. The hike in CRR and repo rate would have an impact on banks’ profitability. Following RBI’s decision of tightening monetary policy, the banking sector was expected to remain under pressure. With rise in repo rate, borrowing would be costlier and increase in CRR would reduce the liquidity. However, the Finance Minister, Mr. P. Chidambaram was optimistic about the Indian banking scenario and confident that the “A fight against rising inflation”, op.cit. Net liquidity injection can be defined by the net amount of money supplied in the Markey by RBI through open market operation. 59 “The Working and Operations of Reserve Bank of India”, rbidocs.rbi.org.in/rdocs/AnnualReport/DOCs/2883.doc, 29th August 2008 60 “The Economy: Review and Prospects”, http://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=810, August 29th 2008 61 “Annual Report of National Bank for Agricultural and Rural Development”, http://www.nabard.org/FileUpload/DataBank/AnnualReports/EngBook2008.pdf, 2007-08 62 “Annual Report of National Bank for Agricultural and Rural Development”, op.cit 63 “Bankers See PLR Hike, Indian Inc See Inflation”, http://www.moneycontrol.com/india/news/economy/bankers-see-plrhikes-india-inc-reaction-mixed/19/33/349358, July 29th 2008 64 “Hawkish on Inflation, Still Pretty Bullish on Growth”, op.cit. 57 58
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Indian banks had enough potential to overcome the increased cost of banking operations and the performance of the banks would be a decent one65. Mr. Chidambaram assured that “There is enough money in circulation outside the banking system that must be brought into the banking system by way of current and savings accounts and this is the accurate way to mitigate the burden of high interest rate”66. As inflation touched 13.5%67 in August 2008, the banks faced a pressure to increase the interest rates on loans. In such a situation, increase in repo rate and CRR was really a bad news for the banking sector. With the rise in repo rate, commercial lending rates by Banks would be expected to go up. This was a double whammy for the banking sector; the real rate of interest was already low due to inflation and increase in the lending rate would further affect lending to the borrowers. To overcome the increase in the interest cost, many nationalized and private banks revised their lending rates upwards. However, it was not possible to totally pass the increased cost to the borrowers as it would reduce the demand for loans68. It would also worsen the asset quality because the customers may not be able to pay the increased interest on loans69. This would increase the bank’s doubtful assets or losses70. Hence, the alternative left to Banks is to absorb a substantial part of increased cost. (Exhibit III). Exhibit III Increase in Lending Rate of Different Banks (Before and After July 2008) Bank
Rate of interest after July 2008 (p.a.)
Rate of interest before July 2008 (p.a.)
State Bank of India
13.75%
12.75%
Axis Bank
15.75%
15.25%
PNB Bank
13.5%
13%
IDBI Bank
14.25%
13.75%
ICICI Bank
17.25%
16.50%
HDFC Bank
16.5%
16%
Bank of Rajasthan
16%
15%
Yes Bank
17%
16.50%
Source: Compiled by the authors from “State Bank of India”,www.statebankofindia.com/viewsection.jsp?lang=0&id=0,453,106 - 51k -, “Punjab National Bank”, pnbindia.com
Apart from Banking, Indian automobile industry would get affected by the tight monetary policy. In the automobile sector, the small car segment was registering spectacular growth and had become a “global hub” for exporting small cars all over the world.71 Leading domestic as well as international automakers like Tata Motors, Toyota, General Motors and Hyundai were planning to introduce a number of small cars and variants of existing models in India by 201072. However, according to analysts73, during the fiscal year 2008“Impact of rate hike on Banking sector,” http://myiris.com/newsCentre/storyShow.php?fileR=20080802210952194&dir=2008/08/02&secID=fromnewsroom&code1=& code=, August 3rd 2008 66 “Impact of rate hike on Banking sector,” op.cit. 67 “Inflation through RBI Lense”, op.cit. 68 Lilladher Prabhudas, “Banking: Inflation Control Assumes Top Priority”, www.moneycontrol.com/news_html_files/news_attachment/2008/Banking-25-6-08-PL.pdf , June 25th 2008 69 Ibid 70 Doubtful assets are those loans which could not be recovered from primary sources within 180 to 360 days and secondary sources like sales of fixed assets or refinancing is required to service the debt. Losses are those loans which are considered irrecoverable and delinquent for more than 1 year. 71 Kushan Mitra, “Small Cars, Big Promise”, Business Today, March 9th 2008 72 Ibid. 73 “Automotive Industry in India”, http://www.business-in-asia.com/countries/automotive_industry_india.html, 2007 65
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09, the growth in the automobile industry which was already sluggish due to rising metal and oil prices, will get affected severely if there is an increase in the interest rates on loans due to rise in repo rates. According to P. Balendran, “The growth is happening only in the small car segment. Peoples buying small cars are much cost conscious, so any interest hike will affect the sales”.74 Thus experts in auto industry anticipated that the annual growth in the auto sector might drop down from double digits to a single digit by the end of F200875. So the expectation of high growth of auto industry for the year FY2009 might not get realized in the raised interest rate regime. Besides auto, the real estate industry was also highly price sensitive. The real estate industry registered 35%76 growth rate in FY2008 over FY2007. However, the tight monetary regime posed a big challenge for the realty developers. The availability of funds to real estate developers declined following the CRR hike. After RBI’s increase in the repo rate, many major banks like State Bank of India, ICICI bank raised the lending rates of housing loans. As a result, demand for these loans reduced and the real estate sector experienced difficulties. Moreover, lending rates to the commercial real estate investors were raised from time to time. Due to governmental restriction on providing loans to real estate developers, enough credit was not always available for this industry. As per industry observers77, the credit crunch had delayed the completion of the residential and commercial projects in the past. Apart from the squeeze in liquidity, the real estate players were grappling with dwindling sales, increase in land prices and rising input costs. The tight monetary policy would further worsen the situation. The costlier housing loan would be another problem to the real estate industry. As housing loans became dearer, many aspiring home buyers would stay away from taking home loans and wait for lower rates of interest in future. Sectors like retail and infrastructure were also faced with difficulties after implementation of tight monetary policy. High interest rates mean higher interest cost which might thwart the expansion plans of the retail industry as a whole. The effect would be almost similar for infrastructure industry. With the rise in the interest rates, investment in infrastructure would become costlier. The impact and results of tight monetary policy, however, were debatable78. The economists and industrialists were divided regarding the impact of RBI’s decision79. Some analysts welcomed the RBI’s stance whereas some analysts were doubtful about the consequences of the monetary policy. It was true that in the short run, the tight monetary policy would hamper the economic development of the country, but at the same time, the policy might bring some relief to the economy by stopping the progress of the increasing trend of the inflation80. Although the inflation in India was affected by external shocks, still the supply of money was very high in the economy. At the same time, the non-food credit growth had outstripped the deposit growth by a huge margin. As per many analysts, RBI’s decision was well justified keeping in mind of the developments of money supply81. Growth rate in service sector was expected to pick up at the end of the fiscal 2008-09 and it might improve the overall growth of the economy82. Thus it was tough for economists to arrive at a consensus about the impact of RBI’s monetary policy. Tight monetary policy was necessary to combat steep inflation but at the same time it might affect the growth momentum of the country. Whether India Inc. could overcome the rampant inflation by the tight monetary policies implemented by RBI or the policies would become a burden to the Indians in general was yet to be seen. “Interest Rate Hike to Affect Small Car Segments”, http://www.financialexpress.com/news/Interest-rate-hike-to-affectsmall-car-segment/342509/, July 30th 2008 75 Ibid. 76 “In 2008, Retail and Real are Poised for Growth”, http://www.inrnews.com/realestateproperty/india/in_2008_retail_real_estate_poi.html, 2008 77 “CRR Hike May Impact Realty Players”, http://www.indianrealestateforum.com/banks-and-hfcs/t-crr-hike-may-impactrealty-players-2192.html, October 30th 2008 78 “RBI Hikes CRR, Repo Rate”, http://www.radianceproperties.com/economy.html, 2008 79 Ibid. 80 “RBI eyes ways to ease inflation”, http://www.rediff.com/money/2008/jun/23infla8.htm, June 23rd 2008 81 “Annual Monetary Policy 2008-09”, www.fiwm.co.in/articles/technical/crisil%20research_credit%20Policy%2008-09_impact%20analysis.pdf April 2008 82 “The Economy: Review and Prospects”, http://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=810, 2008 74
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