editorials

Focus on Risk Management

The focus in the central banks second quarter review has been on containing risks.
he Reserve Bank of Indias (RBI) Second Quarter Review of Monetary Policy 2010-11 was largely on expected lines. The hikes in policy rates by 25 basis points on both absorption and injection modes that were announced had already been discounted by the market. By and large, the anti-inflationary stance of policy still continues, though some indication has been given that the rates may not be raised further for about three months. Given the inflationary pressures and the medium-term goal of containing inflation to below 4%, one or two more rounds of rate hikes are very likely before a neutral level is reached. One aspect of the policy that has received considerable attention is the announcement of prudential measures on housing f inance. High growth, urbanisation, the expansion of the middle class, and the availability of finance have resulted in an acceler ation of housing prices in major urban centres, with a spillover into smaller towns as well. While dwelling units are badly n eeded by the growing population, the increase in home prices in a short span has made housing unaffordable to large numbers of the urban population. It is not demand alone that is driving up prices. Speculative forces combined with high liquidity, including of black money, have also contributed to skyrocketing prices. As a result, floor prices are several times higher than construction costs. According to the National Housing Bank RESIDEX, house prices in five major cities increased by 250-300% between 2001 and 2007 and, according to the data updated up to the quarter ending June 2010, the prices in three of these major cities have further risen by more than 50% since 2007. House prices according to the RBI have now crossed their pre-crisis peaks. Furthermore, according to the Trend and Progress of Banking 2009-10 Report of the RBI, which was published earlier this week, the volume of housing finance provided by banks increased by about 20% in 2009-10, after a low growth of 4% in 2008-09. All these have sounded alarm bells and the RBI has correctly initiated steps in the quarterly review to cool down the potential housing market bubble.

In the absence of any regulatory body for the real estate sector, the central bank has but a limited role in arresting real estate bubbles. However, with the only leverage the RBI has banking regulations it has tightened prudential norms for housing loans. The enhancement in provisioning for standard assets to 2% for teaser loans is stiff action against banks for not heeding to RBIs moral suasion against these practices. The RBIs concern is that appraisal of these loans is not undertaken prudentially and that home b uyers are not educated about the financial engineering behind these loans, on which interest rates are initially low (teasers) but then rise. Memory must still be fresh that the US home loan crisis was triggered by large-scale foreclosures of such loans. The increase in risk weight to 125% for loans above Rs 75 lakh and the new loan to valuation norm of a maximum of 80% may not have any significant adverse impact on banks balance sheets since given the present pattern of financing by banks, these threshold levels are reported to be not uncomfortable. These steps have to be viewed more as strong signals to the financial system and, in particular, to the investors about the potential risks in the current trend. Overall, the focus has been on risk containment. Quite unconventionally, the policy statement has taken a view on the exchange rate of the rupee. It considers the real effective exchange rate (REER) based on the 36-currency basket as more relevant for assessing competitiveness than the 6-currency basket since the former includes more countries that are direct trade competitors. From this perspective, it concludes that the impact of the recent nominal appreciation of the rupee may not have a significant implication for competitiveness. Though at a later stage, the policy has identified capital inflows caused by quantity easing in advanced economies as posing a major challenge for exchange rate and monetary management, the RBI looks likely to follow a hands-off approach to the exchange rate, an approach that is not fraught with serious risks. The problem with such a stance is that it will encourage a large volume of foreign institutional investment in the stock market.

From 50 Years Ago

Vol XIi, No 46, november 12, 1960

editorial

President Kennedy
The relief with which the world has greeted the election of Senator John Fitzgerald Kennedy as the next President of the United States is genuine and well-founded. Mr Kennedy seems to have all the qualities of head and heart which are most needed at the moment for a sensible and enlightened tackling of the international

issuesThe President-elect is, a man who arouses strong reactions among people, not all of them favourable. Personal popularity cannot, therefore, have been the main reason for his election. Is it, then, his programme? That, again, is doubtful though it is fairly clear that his promises of social welfare did prove a temptation for a considerable section of the electorate. there was much in common between the declared programmes of Kennedy and Nixon, especially in the field of foreign affairs. On the great question of disarmament, both proclaimed themselves to be disturbed by the might of Russia; indeed, if anything, it is Kennedy who took a stronger stand on a

rogramme of increasing his countrys military p power furtherBoth favoured a programme of giving technical and financial aid to the new countries of Asia and Africa. What, then, could govern the choice of the electors in so confusingly similar a set of alternatives? the choice became clearer in favour of Kennedy, because the majority of the people obviously felt that his party was more likely to let him honour the pledges he made than the Republicans. The pull of party pressures in the Democratic Party, it is generally recognised, will be on the side of enlightenment and a more daring experiment with new ideas; while the Republicans would have dragged Nixon, whatever his electoral promises, towards conservatism.

Economic & Political Weekly EPW november 13, 2010 vol xlv no 46