RBI?s monetary policy statement has given market participants the impression the central bank will hike repo rates if it finds core CPI hasn?t moved much. In an interview to Aparna Iyer and Shobhana Subramanian, RBI governor Raghuram Rajan suggests the markets may be over-reacting since the CPI isn?t fully established as yet. Rajan added that while monetary transmission took place in many ways, the forward-looking expectations channel was largely adaptive. Edited excerpts:
Are we to conclude the RBI will raise the repo rate in January if core CPI doesn?t fall but headline CPI does?
We need to see both conditions. I would like to see both a decline in headline inflation as well as core inflation ? the 3% core WPI is a number that the RBI has been put out for some time. We have not put out a number for CPI because I am not too sure that I understand the series and I am not too sure that understand how to deflate and therefore I don?t want to put out a number. I think the clear message is that we want CPI to come down.
Since services growth is slowing, is the CPI flawed?
That?s why I said let us give it time. One possibility is that certain prices are not getting adjusted and over time they would adjust. What I want to do is to react to data that I can understand. Monetary policy today will have effects six to nine months from now. Let us try to see what the consequences are of what we have already done. Reacting to numbers on a six-weekly basis may not be warranted. I have not said we have paused, I have only said we are waiting for more data.
RBI hikes rates but banks are cutting them… Where is the transmission?
Our actions since September have effectively reduced the cost of funding because we moved down from higher rates. But whether the current rates are sufficient is something that we will have to look at the data and decide. There are multiple ways through which transmission plays out. One is through the negative output gap, we could make it even more negative by hiking rates. Consumption demand is weakening, we could weaken it more. There is an expectations channel. I am not sure how strong forward-looking expectations channel is. There are adaptive expectations.
Are we in stagflation?
Both in 2010 and in 2011, we had very strong growth. We are for the first time in a period of high inflation and weak growth. I don’t know (whether there is stagflation). I will say that growth is lower than what we would like it to be and inflation is higher than what we want it to be. We believe the growth is below economy’s potential so there are disinflationary pressures.
In times of low growth, is it prudent to cut fiscal spending?
It depends on the quality of fiscal spending.
That is another factor in our thinking ? the finance ministry has stated publicly and also in conversations which I have had with officials that the fiscal deficit would be reined in at 4.8%. So that would imply some spending cuts over the next few months and that would also provide disinflationary forces.
Does the US Fed’s taper match your estimates?
The Fed has been very careful announcing a level of taper that is moderate and also couching it with very strong statements about the direction of monetary policy direction. So the taper has been seen as not an immediate tightening of the monetary policy. In India, we are in a better position to absorb the effects of taper now than before, there is more confidence. $75 billion is a reasonable number.
Should prudential norms on company and group exposure be re-looked at?
Over time they should come down, I think it is too high. Right now, we want to make sure we can clean up the system. When the system is weak, you don’t put in more constraints. I think banks have got the message. Incrementally, credit growth is weak as far as lending to these kind of enterprises go. The problems we have today comes from loans that were given in 2007, 2009, when it looked as if the economy was growing.
Do you favour giving one-time dispensations to treat restructured assets as standard ones ? the government reportedly wants this for Dabhol.
I will never say never. There may be situations in the future where we have to examine this carefully but I don’t think this is something we should do. You cannot fool the market and when an asset is problematic, we should recognise it. As a regulator, I don’t want to push things under the carpet.
Will the NPA suggestions reduce bad loans or just increase provisioning?
I am hoping that the stock of NPAs is dealt with in a sustainable fashion as well as the flow of incoming NPAs. What we need to make sure is that the asset is put back into action. Secondly, we need to ensure that the banks recover and have the expectation of recovering much of the loan. We are certainly not at levels where we should panic. But I think these are levels where we need to take resolute action. I don’t think there is a system level issue.
When can we expect the curbs on gold being eased?
We need the CAD to be naturally lower. It has come down due to rising exports. It has come down due to imports, even non-oil imports having come down. But we need to be more comfortable about it. So I don’t want to use these curbs on gold as some sort of policy variable which we adjust every month.
Is the ceiling on LAF here to stay?
I think for the foreseeable future, we are trying to bring some discipline into the borrowing from the overnight market. The RBI should not be the lender of the first resort. So for emergency liquidity purposes, we are willing to allow borrowing from LAF. But if you are borrowing on a repeated basis, then you are not using it for emergency purpose but as a primary source of finance. What we are doing is providing 1.5% of NDTL at this point via the LAF, the term repo and export refinance. There is significant amount of liquidity we are providing and we have no intention of increasing this.
Is there a downside to being part of a global bond index?
I think to the extent that we get more stable investors, there is some value in becoming part of an index. But they want us to do away with limits completely ? that would be difficult at this point. One thing we can do very quickly is make bonds Euroclearable. The idea is that Euroclear can have a local agent who can be allowed to buy and sell bonds on behalf of foreign investors. That can add to liquidity in domestic market because there are new trades coming in. It can also mean foreign investors can hold Indian bonds instead of coming through the FII route, they can come through Euroclear.
