labels: rbi, economy - general, banks & institutions
RBI has established a neutral ratenews
25 July 2006

Chief economist at CRISIL, Subir Gokarn says that RBI's statement is good from the signaling perspective; 6 per cent is a neutral rate. Also, he does not expect banks to just hold rates at this point. CNBC-TV18 shares excerpts of its exclusive interview with Subir Gokarn with domain-b:

A word on the message, no change in inflation outlook and this is called a preemptive action?
This is the beginning of the RBI establishing what I would call a neutral rate; a rate that is consistent with stable growth. It gives it room, which essentially what has motivated the Fed's action over the last couple of years, to take the rate up to a point where it can act on either side.

So far, the reason why the market and the RBI is a bit out of sync in terms of signals and expectations, is because we had no real benchmark of what a neutral rate for the Indian economy is. Maybe in today's statement there is a signal that 6 per cent is a neutral rate. So one will not expect to see changes unless circumstances warrant. If we remain in this 7.5 - 8 per cent growth, 5- 5.5 per cent inflation configuration, then we would not expect to see any changes in the monetary policies.

So that is a good thing from a signaling perspective that one may agree or disagree with the needs for hikes and any specific instance. If we know what the benchmark rate is, once we know the neutral rate, we can predict moves a little easily.

If this is indeed sounding like a neutral policy do you think that banks will go forward and hike rates? Do you see further pressure on rates at all for the next quarter or so?
When one looks at the overall growth momentum, as more than 20 per cent growth in capital goods in the first two months and 17 per cent growth in consumer durables, both of these are significantly correlated with bank credit. If there is that kind of growth momentum for credit, one saw a slowdown in credit growth from March to June. But it seems to have picked up again in July. So these are some confusing signals, but if bank credit is going to grow, then banks, from a purely business perspective, will raise rates.

So I do not expect banks to just hold rates at this point. But the impact it will have on lending is a bit difficult to take a call on because we are seeing that for more than a year, rates have steadily gone up.
But none of the interest sensitive sectors have shown any signs of slowdown, so it is difficult to say that banks hiking rates will have any impact. It may eventually have an impact, but so far there has been no impact on borrowing or spending activities.

You have been mentioning that there were expectations of growth slowdown. Are you seeing early signs that things could be slowing down? Do you think the RBI governor himself is seeing early signs and therefore his statement almost rules out future rate hikes unless indicated by data?
I think there are few signs, if one wants to go down to narrowly defined sectors and so on, one might find it. But at the macro level at this point, it is difficult to find signs. I have been talking about slowdown or potential slowdown for a longtime based on this sustained hike in interest rates.

But at least on the basis of last quarter's numbers; industrial production, manufacturing, and the corporate numbers that have been revealed, at least the early indications and again anecdotal evidence from businesses, do not suggest any signs of a slowdown.

I am particularly intrigued by the fact that the two most interest sensitive components of the Index of industrial production, capital goods and consumer durables, were the fastest growing in April and May. So either higher interest rates are having no impact or other demand drivers have swamped them.

I would expect to see some slowdown in the later half of the year, simply because of cumulative impact of interest rates starting to take a toll. We have the ten year yield now above 8 per cent, it's not been there for a longtime, which is going to push lending rates up and it has to take a toll at some point.

also see : Update: Reactions to RBI rate hikes
RBI rate hike largely expected: ICICI Bank: Kalpana Morparia, ICICI Bank
Rate hike in line with expectations: V Srikanth, Citibank
Bond markts to view credit policy positively: Ajay Mahajan, Yes Bank
High interest rate not to impact growth rate
Policy may not lead to hike in lending rates: Janak Desai, ING Vysya

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RBI has established a neutral rate