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Not enough to its credit

With inflation eating up the growth momentum, energy prices and banking may undergo changes.

india Updated: May 05, 2011 21:27 IST

The Reserve Bank of India (RBI) is now in the midst of a full-fledged firefight against inflation. The half a percentage point increase this week in the rate at which the central bank lends overnight money to banks is being seen as a precursor to a similar hike over the next six months during which the RBI expects inflation to stay close to the 9% clocked in March 2011 before it begins to drift down towards 6% in the second half of this financial year. The impact of dearer money shows up in the central bank's assessment that the economy will grow in the region of 7.4-8.5%, slower than the government's budgetary projection of 9% for 2011-12. Inflation is now clearly eating into the country's growth momentum and RBI Governor Duvvuri Subbarao makes a strong case for the government to raise suppressed energy prices that are fueling incipient inflation, despite the short term pain that this entails.

Despite having raised interest rates by 3 percentage points since March 2010, when the RBI embarked on its rate-tightening cycle, the demand for credit has not flagged, growing 21.4% in 2010-11, above the central bank's comfort level of 20%. Industry and services, respectively, borrowed 23.6% and 23.9% more during the year, while farm credit growth fell to 10.6% from 22.9% a year ago. Households borrowed 17% more, a big jump from the 4% growth logged in 2009-10. Credit rating agency ICRA reckons a high base and a further monetary tightening leading to persistently high interest rates could bring down the overall credit growth in credit in 2011-12 to around 18-19%.

Inflation control has not kept the central bank completely occupied in its latest credit policy. A slew of structural changes for the banking industry should help improve the monetary mechanism that is set in motion from Mumbai's Mint Road. A half a percentage point hike in the savings rate is halfway house towards deregulation. A cap on money banks can park in mutual fund schemes that offer better returns than the overnight central bank rate should lessen the slippages from the system. A fixed spread between the rates at which banks borrow and lend from the central bank provides consistency in liquidity management. And it always helps to set more money aside for bad debts. The RBI has also come out with rules for loans to micro-financiers to qualify for an interest subsidy. The central bank's stocktaking of measures to strengthen banking regulation over the past year yields a mixed bag with a central registry for loans, rules for new banks, changes in banks' holding structure, and improved real-time settlement of transactions all being in the works.