The Reserve Bank of India governor Yaga Venugopal Reddy on Monday left a vast galaxy of bankers and traders confused by his decision to not cut any rates in the Mid-Term Review of The Monetary and Credit Policy, 2003-04.

However, he has laid a lot of emphasis on the three Cs: credit delivery, credit culture and credit pricing.

RBI's Monetary and Credit Policy : Complete Coverage

The three Cs are seen as being crucial in the larger framework of things as there's the market perception that credit delivery is not taking place across the board as it should be.

While the monetary policy points to a credit pick-up, systems and processes are not in place or geared to deliver as they should, pointed out analysts.

Even as the RBI has confidently upwards revised its projections on gross domestic product (GDP) -- looking at the industrial recovery, better than expected monsoon, competitiveness of India's exports and overall global confidence in India -- the central bank seems concerned over the aspect of credit delivery especially to the small scale sector and the credit culture, which should take care of depositors.

At first glance, the Mid-Term Policy looks like it could easily have been scripted by Reddy's predecessor Bimal Jalan -- the overall status quo, the rationalisation of prime lending rate, the phasing out of non-banking players from the call money market and the negotiated dealing system for call money and government securities.

However, Reddy has also set the stage for Big Change, for the next stage of reforms. Being his first policy as governor, Reddy cannot afford to have any preconceived notions, and has thus put forth various proposals for change in the way liquidity is managed.

Addressing the need for proper change in the credit delivery, the RBI has pushed the ball to Indian Banks' Association as far as working out the benchmark prime lending rate (PLR).

It has further enhanced the loan limit to SSIs from Rs 15 lakh (Rs 1.5 million) to Rs 25 lakh (Rs 2.5 million) for dispensation of collateral requirement.

In a further attempt to enhance credit to SSI units, interest rates on deposits of foreign banks placed with Small Industries Development Bank of India towards their priority sector shortfall has been reduced from 6.75 per cent to the bank rate (six per cent).

In addition, to push credit delivery to the SSI sector, all new loans granted by banks to non-banking financial companies would be reckoned as priority sector lending.

Further, the central bank has asked banks to provide adequate incentives to branches for financing self-help groups.

While the policy augurs well for SSI units, it has failed to enthuse the market -- specifically, the bond market was absolutely lukewarm.

"Though Reddy's world view on interest rates is well known, the markets were betting on at least a 25-50 basis point cut in the bank rate and a similar cut in the repo rate," a bond market trader said.

The market had expected the credit policy to give some direction on where the interest rates are headed. When the new governor decided not to tinker the overall stance of his predecessor, bond prices fell by as much as Rs 2. They recovered slightly later, when Reddy said at a press conference that the soft interest rate bias will continue.

Dealers aver the market would now rally on the back of the liquidity. One-day repo subscriptions rose sharply to Rs 10,000 crore (Rs 100 billion) on Monday compared with Rs 1,500-2,000 crore (Rs 15-20 billion) seen in the last couple of days.

Even though the RBI had forewarned all through Deputy Governor Rakesh Mohan's 'irrational expectations' comment and OMOs, players refused to get the message, and continued to bank on rate cuts, said Standard Chartered Bank global treasury head M A Ravi Kumar.

A cut in the short-term interest rates, especially the repo rate, would have 'shaped' the yield curve, which have over the recent past, turned flattish.

A senior banker said a bank rate cut could have provided impetus to banks to cut their deposit and lending rates.

"The soft interest rate environment continues, given the overhang of liquidity in the money markets. But the RBI's stance seems to suggest that it is having second thoughts on how long the rates can be pegged at the current low levels," the banker added.

Analysts reasoned that the RBI may have decided to consolidate the substantial cuts in the benchmark rates in the last two years and to take stock as to why the market has not responded positively to these cuts.

Bond dealers argue that liquidity in the system will not be strained just because the RBI has refrained from cutting the cash reserve ratio (CRR).

"The autonomous infusion of liquidity arising out of foreign exchange flows will be more than enough to sustain the current soft interest rate regime," a dealer argued.

He further added that the RBI's actual stance will be known only from it intervention policy in the next few months.

"They have only refrained from adding to the liquidity overhang, but they haven't said how they will tackle the surplus already in the system," he added.
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