Mumbai: Inflation is hovering above 7% and banks’ credit growth has come down to around 20% but Reserve Bank of India governor Yaga Venugopal Reddy firmly believes that the economic growth is not under attack. According to him, the economy will certainly grow at more than 8% in current fiscal as there is no serious dip on supply or the demand side and there is only a marginal reduction in the consumer spending.
In an exclusive interview with Mint, after presenting his last annual monetary policy, Reddy talks on a host of issues, ranging from interest rates to RBI’s exchange rate policy to banks’ aggressing sale of derivatives to corpoate customers. According to him, there is no systemic crisis on derivatives deals and even at the worst-case scenario, banks have enough capital to absorb the losses.
You could have hiked the CRR at one go instead of raising it in mid-April and again now. It seems that you are keen to be seen doing something.
I can frankly share the thinking process. We were monitoring the liquidity (condition) and about a few weeks ago, money coming through the overnight reverse repo window shot up. It was possible to immediately start taking action and, at that point of time, the numbers would have warranted 50 basis points straight CRR hike.
We analyzed the anticipated liquidity conditions. The liquidity conditions keep changing and the major sources of liquidity, apart from normal economic activity, are cash balances of the government and capital flows.
We tried to understand the underlying liquidity pressure and what is the cyclical or volatile component (of liquidity) and decided to go for a 50 basis points, two-stage hike. It’s true that at that point of time there was one school of thought internally that said 100 basis points hike should be alright. But in times of high uncertainty, there is no need to appear to be too vehement in any position you take. In these situations, it is better to be approximately right than precisely wrong.
What The Policy Means (Graphic)
We knew that two weeks down the line another 25 basis points (CRR hike) would be appropriate to maintain the liquidity conditions and, therefore, we thought this is as good an opportunity as any other.
Extending the logic, can we expect another 25 basis points CRR hike in a month?
The liquidity management has three components. We have use of MSS (market stabilisation scheme), CRR, and then LAF (liquidity adjustment facility). To what extent each of the component is used will depend on the nature of liquidity iself. Each component has its own effectiveness. Let me put it this way: Incrementally which liquidity instrument will be used will depend on the nature of liquidity and availablity of each instrument.
Why did you leave the rate unchanged? Last time you hiked the rate was sometime in March 2007.
Well, I think the Reserve Bank should take credit for that. Our policy rates have been stable for more than a year in spite of the fact that we are having high growth which had to be moderated and in spite of the inflation pressures. The existence of the variety of instruments and the reasonable assessment of the ongoing developments have helped us achieve a fairly stable policy framework. The stable policy framework was attempted in order to enable the growth and price stability and the financial stability. We have by and large achieved that but there have been significant external factors including a supply shock.
But this does not necessarily mean that we should not use it rate hikes. From our point of view, if the challenge requires that it has to be used, it has to be used.
That’s the last priority
No, I wouldn’t say that. All appropriate instruments have to be used. There is no prioritization for instruments; there is prioritization for objectives. Contextually, it is price stability. But there is no question of preferred or non-preferrred instrument. It has to be an appropriate instrument.
The inflation is primary supply side driven, not demand driven
Not entirely. There are certain underlying demands pressures. But during the last fortnight, it is significantly supply driven. There are some cyclical factors also.
Are you certain about taming the inflation through the CRR hike?
Our current assessment is that it should help in the matter of inflation expectations. It has and it is still impacting. Some of the supply side measures certainly impact the inflation and we are making sure that the demand conditions supplement and compliment the type of supply managemen. As we move along we have to look at the incoming information.
The Raghuram Rajan Committee on Financial Sector Reforms has suggested that RBI should target inflation and use only interest rate to signal monetary policy stance. Your comment.
Well there are a number of views expressed. This report has been given to Planning Commission and is in public domain. So, lets see how it evolves. All views will have to be taken very seriously and examined internally. Most of the issues that have been raised are broader public policy issues.
Aren’t you too bullish in projecting 8-8.5% growth? Specially, when inflation is so high and you are curbing liquidity
My track record has been that the GDP outcome is always more than what I have indicated evem though the finance minister always says that I am too conservative. Being central bankers, we tend to be very conservative, but it doesn’t mean that we are always necessarily so. As far as the current assessment is concerned, it is certainly based on our understanding of the situation.
The underlying macro conditions are conducive to growth. The second issue is whether there will be cyclical downturn. For the last couple of years we have been trying to moderate a bit and unless one feels that we are overshot in terms of moderation that it goes to recession, it is very unlikely that the cycle will turn. How can it turn unless we are mucking up the policy? I would like to believe we are not mucking up the policy. We are being very stable and we provided the right amount of stability last year and brought about moderation, in terms of soft landing.
You would agree that there is no instability coming from financials sector; there is no serious dip on supply side; and there is no serious dip on the demand side. There is only marginal reduction in the consumer spending.
So it is a conservative estimate.
I wouldn’t say conservative. As always, I would like to insist that it is realistic. It is neither conservative nor aggressive; it is a realistic estimae. If we have a normal monsoon, agriculture should grow at 3% and services, if you see the track record as well as the current circumstances, should grow at 10%. If you take about 8 to 9% from the industry, which is not out of track, we should have a growth rate between 8% and 8.5%.
Even if there is a serious global slowdown, we will grow at closer to 8% but if the current situation continues, then growth should should be 8.2% to 8.3%.
Despite your clampdown on credit growth?
Yes. Yes, indeed. Last year, the credit growth was closer to 21%. Incidentally, 21% credit growth is compatible to 8.7% growth. So, the new target is not non-compatible.
Why don’t you allow the rupee to find its own level. You do not want the local currency to appreciate and which is why you buy dollars from the market. This forces you to raise CRR to soak up excess liquidity from the system.
As far as the exchange rate is concerned, the policy is very clear. It is essentially determined by demand and supply. The question is when you discuss volatility and flexibility, how do you define them and at over what time frame. We are not targeting exchang rate.
But you are not allowing the rupee to rise against the dollar.
No. What we are doing is continuing with the policy that has served us well for well over a decade. And it is unique. It is constantly being reviewed at any point in time. If a change is required in the policy with reference to outcomes, it should be changed. But the policy does not need to be changed simply because some theorists say so.
Don’t you feel that the rupee is overvalued?
No. As I said, my feelings don’t count because I am not targeting rupee.
Many firms are making huge mark to market losses in derivatives trade and they are blaming banks for mis-selling. How serious is the issue?
As you know there are existing guidelines (for derivatives trade). And we believe that as long as these guidelines are implemented in letter and spirit, there cannot be such scope for dispute. There are some banks which have specialized in this type of activity. We had one round of discussions with them and we have come to the conclusion that it is not a systemic issue. It depends on individual cases whether there has been misselling or not because each product is structured in different ways and if there is any dispute it has to be settled between the two parties. We are not in a position to take a view on that.
In terms of accounting standards and disclosure, we have to go by the institute (Institute of Chartered Accountants of India). We are doing inspection which will give us an insight into what is happening... Even in the worst case scenario, the banks involved have enough capital to be able to absorb the losses and therefore there is no systemic issue.
After the CRR hike, will banks hike their lending rates?
The bankers said it is a very very balanced polcy. And I don’t think anyone made any references to a hardening of interest rates.