The monetary and credit policy - or credit policy as is popularly known - is the Reserve Bank of India's (RBI) most important initiative to steer the country's economy. Announced twice in a year (usually in April and November), the RBI uses the credit policy to manage and monitor the Indian financial system, with a special focus on banks, the foreign exchange market, inflation, interest rates, currency management and government's finances. For example, if the Bank believes that economic growth is being held back due to lack of money, that is, business is not getting enough capital, it may lower interest rates. It may keep them steady if the economy is on course. Or if the economy is heating too fast, it may raise these rates. Dr Y V Reddy, the new RBI Governor, last week announced a cautious policy without opting for any interest rate cuts. The RBI uses the credit policy to make important changes to stabilise various financial parameters or correct any imbalance in the monetary system of the country. This impacts us as interest rates may fall or rise and investment in mutual funds, homes, bonds and other instruments could become cheaper or costlier. If the RBI wants to cut interest rates to increase credit supply in the economy, it will reduce the bank rate, the benchmark rate at which it finances banks, or the cut cash reserve ratio (CRR) the portion of deposits that banks have to keep with the RBI. Taking a cue, banks in turn will cut interest rates on loans and deposits. So, we as depositors get lower interest rates and as borrowers get credit at lower rates. By not cutting any rates, Reddy signals a steady ship. The following are some policy measures and their impact that connect with our lives: 1. Bank rate, repo rate and the CRR unchanged. While keeping the rate structure steady, the Governor has retained the right to change these between the two credit policies at any time that the RBI thinks fit. The market was expecting a rate cut and this caused some quick reactions, like bank stocks dipping. A closer look at the impact: a. Bank stocks dip and recover Bank stocks fell on Monday after the RBI did not announce any interest rate reduction, that the market had anticipated. The knee-jerk reaction was due to the fact that a good chunk of banks' profits come from treasury operations. But since overall profitability is not under attack, these stocks should recover, bankers say. b. Impact on Debt funds Though there is no direct policy directive, RBI's bias towards a softer interest rate regime persists. Bond yields are going to rise (and bond prices fall) given that yields had fallen significantly in anticipation of a rate cut. Investors in debt funds may see an erosion in their debt fund investments with a fall in the net asset value (NAV). Debt funds score over comparable investment avenues in terms of better liquidity, tax-efficiency (dividends are tax-free and long-term capital gains are eligible for indexation benefit) and the potential to clock higher growth from trading in bonds Bonds (infrastructure bonds, US 64 bonds, GOI Bonds) do not fare as well on these parameters. Investors can use the fall in debt fund NAVs as an opportunity to enter a good debt fund with a steady track record as the overall outlook is good. c. Impact on Gilt funds As the bank rate, repo rate and cash reserve ratio were untouched, there is no major pressure on interest rates to go down in the immediate future. In short, there will not be any major turbulence in government securities (gilts or g-secs) where gilt funds invest their money. After Monday's fall, gilt prices rose later when the market read the policy's fine-print. After the initial blip, gilt funds are back to square one. In another move, the RBI has allowed market participants to sell gilts already contracted for purchase. The move is not exactly short-selling of gilts but will allow intra-day squaring-off of transactions. Gilt funds can take advantage of this relaxation. Gilts, then, remain good for the long term investors. 2. Overseas funds get RBI clearance The RBI has now allowed a single-window clearance general permission to asset management companies (AMCs) to issue units, remit dividend and redeem the units issued, once SEBI's approval is obtained for launching offshore funds. Earlier AMC were required to take SEBI's approval and get the RBI nod separately. This measure will result in faster issuance of units, payment of dividend and redemption. This will speed things up for the overseas investors, including non-resident Indians. It may also prompt more Indian mutual funds to launch offshore funds and mobilise money from overseas investors. Indian market and investors will also benefit as more funds come to India. 3. Tax refunds get ECS The RBI decided to allow payment of tax refunds through the electronic clearing services (ECS) to tax payers in select cities where banks currently offer this facility. To begin with, as a pilot project, tax refunds up to Rs 25,000 are proposed to be made through the ECS to the beneficiaries in these select cities. The means tax payers won't have to run with their near-expiry cheques. Win-win for the tax-payers and the IT Department.
