Reserve Bank of India [Get Quote] Governor Y V Reddy exudes confidence that what the central bank announced has gone down well with the market.

In a free-wheeling interview with Business Standard, just after announcing the annual policy, the Governor said interest rates on sub-prime lending rate loans might go up, though banks had not indicated any hike in the PLR.

Finance minister P Chidambaram has laid emphasis on benign interest rates. But you have hiked interest rates. Is there a disconnect between North Block and the Reserve Bank of India?

Our policy is absolutely consistent with what the finance minister has emphasised.

The finance minister did talk about benign interest rates and I think the interest rates that we have now, including the interest rate measure that we have announced, should be treated as benign.

Highlights of the Credit Policy 2005-06

A benign interest rate is what is conducive to the system and takes care of growth needs. We are practising a benign interest rate regime.

From now on, will we see a quarterly review of rates?

Not necessarily. (Monetary) measures are taken whenever they have to be taken. So the same situation will continue. It is possible that the measure may emanate out of the analysis.

If any situation warrants any particular measure, it has to be taken. It will be done whenever it is required.

But certainly, there will be a structured communication on the macroeconomic situation and monetary developments every quarter. If such a structured analysis results in taking a measure or action, it is only incidental.

Will banks hike their lending rates?

They have not indicated anything in regard to their rate plans. Nor did I seek any information (on this).

Do you think that lending rate increases are imminent?

In 2004-2005, there was no intimate connection between interest rates in the financial markets and credit markets. About 60 per cent of loans are disbursed at below the PLRs of banks.

Given the current competitive situation in the banking system, there will be pressure on reducing the margin between the deposit and lending rates.

At the same time, one has to recognise that there are some interest rate signals that are coming up.

What is the significance of the share of sub-PLR lending growing?

Honestly, I was also quite surprised to find this number. There is anecdotal evidence that the sub-PLR rates have actually hardened. More borrowers may be raising loans at sub-PLR because of competitive pressures but sub-PLR rates have certainly hardened. The trend may continue.

The government will be hurt the most by the rate hike. It will be the biggest loser.

It is not a question of who loses or who gains. I have to see what the appropriate interest rate is that is consistent with stability.

If we keep an artificially low interest rate regime, the government's borrowing programme may appear to be less costly now, but for how long?

Further borrowing at a low cost could become difficult for the government and the aggregate cost may turn out to be more. Secondly, the balance sheets of those who acquired government paper at this rate will be affected.

It is appropriate for the monetary authority to take into account the balance sheets of individuals, corporates, financial intermediaries and the balance sheet of the government.

Basically, what I want to say is that the idea that just because the Reserve Bank happens to be the government's debt manager the dominant consideration is somehow making it cheaper for the government is certainly not true.

Is your 7 per cent growth projection too optimistic?

You need to disaggregate it. In agriculture, you have a base of 1.1 per cent. But if you see the average for the last 30 years, it has been 3 per cent plus. So if you have a base of 1.1 per cent, the actual growth would be 4-5 per cent. I have been very conservative.

Growth in the manufacturing sector has been looking up to over 8 per cent and growth in the services sector has been consistently over 8 per cent.

Growth that could have happened in the absence of an oil shock has been moderated. That is the sentiment I have indicated somewhere in the policy. The number I have given is after the moderation. But for the oil shock it would have been very much more than 7 per cent.

We have seen huge credit growth. Where is this credit going?

It is quite a diversified flow. Earlier, it was mostly going to the retail sector but now we see credit flowing into the infrastructure sector and agriculture.

Is there a retail bubble?

We are monitoring the scene closely and we have sensitised the market. The banks have modified their policies taking into consideration our concerns.

Are you concerned about the health of one large residuary non-banking finance company?

We have articulated our position in the last credit policy. We have been looking at the growth of the RNBCs. They have got into fixed liabilities.

They are having some stress like many other financial institutions. One institution has been growing rather fast while another has moderate growth.

There are two areas where we will have to move -- greater prudence in financial management and minimising the discretion in asset creation. We have given them a two-year programme and they have indicated that they are complying and we are holding discussions in the next few days.

We want to improve governance because the size is large and it has systemic implications. We have indicated what we desire and they have in principle agreed (to that) and are moving in that direction.

Are there concerns about the health of some private banks?

We are sensitive to this problem in pockets. Both in case of banks and RNBCs, we are having bank-wise and RNBC-wise dialogue.

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