Reserve Bank of India [Get Quote] Governor Y V Reddy has sent a strong signal to banks that they must manage their funds well or else money will be dearer.

In an interview to Business Standard, Reddy justified higher credit growth, citing extraordinary entrepreneurial spirit, quicker project completion and all-round credit penetration. Excerpts:

Have you signalled a tight money policy?

I would put it slightly differently. At the moment, we have acted to clearly indicate that if there are liquidity constraints in the system, banks should be prepared to pay a higher price for funds.

Going ahead, if there are unexpected developments, we should be prepared to use all instruments. We are sensitising banks to the possible issue of excessive demand.

Do you see hardening of rates?

Much will depend on how the banks are going to rebalance. From our side, too, we should be prepared for constant rebalancing. We are permitting banks to borrow money overseas. So banks have slightly more varied instruments available for deposit mobilisation.

The reverse repo rate is unchanged but the repo rate was raised. Why?

In the last 4-5 years, the spread between the repo rate and reverse repo rate used to be as much as 275 basis points. It was only in October 2004 that the spread came down to 100 basis points. So it is not unprecedented.

Given that growth is stronger, overall stability is there but there are issues relating to whether there is overheating. It is quite possible that productivity is increasing and the lagged effect may still take place.

Under the circumstances, the signal the RBI is trying to send is in case there is a further demand for funds, it will be more expensive. Secondly, we have the discretion to accept or not accept bids for funds under the liquidity adjustment facility.

So it is not automatic for banks to get money from the RBI?

That has always been the case. We are saying this because we want to make sure nobody forgets it.

You are keeping banks on their toes...

Not exactly. We are watching and in future, if they have a liquidity problem and require money from the central bank, it is likely to be more expensive. So they better ensure an appropriate savings-investment and deposit-credit balance from now.

Having done this, I have also indicated that if there are circumstances, new situations that evolve or new evidence that comes in, we can consider any other measure.

Are there signs of liquidity hardening?

With the type of demand pressures and growth that is happening, more active liquidity management is called for by the market participants and by us.

Can we expect a CRR (cash reserve ratio) cut to ease the strain on liquidity, if required?

We have added a few words in the stance, saying we will take "all possible measures and promptly". There is no preconceived notion of a particular response for a particular situation evolving. I used the term "all possible measures" deliberately because sometimes we are accustomed to some measure, which we would have taken last year or the year before.

At this point, all I will say is that all possible measures in all possible directions should be considered appropriate. I am not saying there are additional risks and greater uncertainties. Growth is high, there is demand pressure and incipient inflation pressure and one has to be watchful to see how they work out.

Bank credit is still growing at over 30 per cent. Did you not want to bring it down to 20 per cent?

Yes, credit growth is extraordinary but the entrepreneurial spirit is also extraordinary. Besides, the project cycle has shortened enormously. What used to take six years is now being completed in 2-3 years. Technology, construction capabilities, institutional developments�all contributed to this.

In the current context, 30 per cent credit growth is high but it does not need to go down to below 20 per cent. If you had asked me three months ago, our feeling was credit growth should be closer to 20 per cent.

But the project cycle is getting quicker, output has grown so fast that they require working capital finance and credit penetration is taking place. While some amount of deceleration in credit growth would still be desirable, a fair amount of high credit growth is understandable.

Will 25 per cent credit growth be okay?

We do not have any particular number in mind but we are comfortable with credit growth consistent with financial stability. If productivity catches up, we may not have that much of discomfort.

Our credit-GDP ratio is still less than 40 per cent...

The credit-GDP ratio has to improve in a sustainable manner. It should be matched by aggregate savings and investment balance. If you want to have higher credit growth, banks should be able to mobilise more deposits, otherwise there will be imbalance.

The objective of increasing credit in terms of penetration and ratio is perfectly correct. But that should be in conjunction with deposit mobilisation in the interest of stability.

In the policy document one can feel a sense of exuberance...

I would not say there is exuberance.... Till recently we were closely watching global uncertainties. Some uncertainties have abated...The type of concerns on global imbalances - oil and monetary measures that existed till 2-3 months ago - do not exist now.

Domestically, we find there is sustained growth and there are reasonably good signs of fiscal adjustment.

Till a few months ago, there were occasional question marks about the process of fiscal consolidation. These are the reasons why we are slightly more comfortable. The only question mark is with regard to the possible excess demand pressures on which there is no conclusive evidence and, therefore, we are keeping a vigil.

You have punished the banks involved in the IPO scam by not allowing them to open new branches. How long will the ban continue?