Mumbai:Reserve Bank of India Governor Yaga Venugopal Reddy has refrained from tinkering with the policy rates and banks’ cash reserve ratio, but this should not give one the impression that the Indian central bank is through with it rate tightening cycle. In an interview with Tamal Bandyopadhay and Rana Rosen of Mint, Reddy says there is no change in the stance of the monetary policy and the RBI reserves the right to act on rates any time in future. He also says the real effective exchange rate of the rupee is more of an academic discussion and people no long consider foreign exchange “valuable” anymore. Even though he refuses to commit on the ideal level of the rupee, this marks a clear shift in RBI’s foreign exchange policy. Extracts:
You have the habit of surprising markets. In April 2006, you had left the rates unchanged but raised them in June. Is it a pause or have we reached the neutral zone from where rates can move either way?
The stance taken three months ago continues even now. It has not changed.
What does that mean?
We have to react to (changing) circumstances.
Does this mean you can act at any time?
We have an advisory committee that advises the RBI in framing its monetary policy. The Federal Reserve in the US and the Monetary Policy Committee of England have their statutory committees that decide (on the policy). In the Indian context, the decision-making is with the RBI as it has been before… So, the advisory committee offers its suggestions and analysis, which we are sharing with the public. But the decision-making and the timing (of the rate hike) is ours. That can’t change because the law hasn’t changed.
So at any given point of time you are free to hike the rate.
But that has been the case all along. The law has not changed.
Price control: The Governor says he wants to see inflation at 5% in the current year, and at 4-4.5% in the medium termWe see a clear shift in your approach. You are less hawkish and seem to be pushing more for growth.
Your reading is not correct. The RBI mandate is somewhat similar to that of the Federal Reserve of the US. It has a mandate for both, growth and stability, on an equal footing. The emphasis will have to be contextual and will depend on the circumstances. Earlier, when the economy needed impetus, we emphasized on growth and virtually pushed banks towards higher credit growth. The situation is different today and the emphasis has to be on price stability. The policy is restating what was said three months ago. The last paragraph of the stance is a reproduction. So there is no real change in the stance at all. The question of whether or not this is a pause isn’t an easy to answer. I think it is time we gave a pause to the debate on pause.
You have lowered the GDP projection from 9.2% to 8.5% but raised the money supply target from 15% to 17.5%. Are you indicating an easy money policy?
No. We’ve had a lot of debate on this. There are multiple considerations that need to be taken into account. … In some sense, there is an overhang of liquidity. Not everything can be corrected in the short term. What we are really saying is money supply growth is 20% now and we’d like to bring it down. And we should be able to bring it down to 17-17.5% in a non-disruptive manner.
How realistic is your 5% inflation target?
We expect to contain it at about 5%.
And even at 4- 4.5%?
That’s a medium term objective. For the current year, the idea is to bring it down to 5% and that, of course, is subject to supply management and management of capital account. We believe it should be possible to have inflation around 5%. Still, in the context of trying to integrate globally, we’ll have to bring it down to 4-4.5% in the medium term. Again you have to see where the base is. If it is 6% for the past so many weeks, we can’t try to moderate inflation in a very non-disruptive fashion.
So, disruption will be there…more rate hikes to contain inflation.
The idea is to make it non-disruptive. We must look at not only the destination but at the starting point. From the starting point you have to see how far you can go in a given period.
Are you confident about achieving 5% inflation?
That’s our objective. If there are no adverse developments on based on current developments, we expect inflation to end around 5%.
Do you require specific action to achieve this?
As of today, no. If we required action, I would have taken it this morning.
You want bank credit to grow by 25% but you haven’t said anything about removing the floor for banks’ investment in government bonds. The government has passed an ordinance and given RBI the go-ahead to do so, but you haven’t acted yet.
The government has given us the flexibility and an enabling mechanism. We would be in a position to use this mechanism as and when warranted.
When do you plan to do that?
It will certainly be done when it is warranted. It depends on the growth of overall bank credit. Technically, it can go up or down. In the case of banks’ cash reserve ratio (CRR), the medium-term objective is to bring it down. Earlier, we had talked about 3%; now it could be even zero. That is the medium-term objective. What can be done immediately will depend on the current monetary conditions. Technically, banks’ investment in government bonds, which is 25% of their liabilities now, can go up or down.
Unless you bring it down, the high demand for government bonds will continue to distort the interest rate structure. With banks chasing bonds, yields are not going as high as they should.
This is an argument you can give with regard to any government securities market, because wherever there are contractual savings, you will always prescribe a minimum requirement investment in securities. In that sense, you can always argue that whenever there is a stipulation for a certain amount to be put in government securities, it tends to distort interest rates. That is an extreme position to take.
However, I agree with you that the current stipulated level of investment in government bonds does operate as some sort of a tax on the banking system.
As the contractual savings component in the country increases, the demand for government securities will come from non-banking sources also. We need to sequence the reduction in bank’s investment in government bonds in such a way that it does not disrupt the securities market and also the credit market. I would call for a non-disruptive way of changing the balance. I agree with you that the medium-term objective will be to bring down banks’ statutory investment in government bonds.
You’ve taken a series of measures to spur dollar demand in the system. You are even allowing individuals to punt on currency movements.
Not true. As far as dollar inflows are concerned, we’ve been very liberal. There is virtual capital-account convertibility as far as inflows are concerned. And as far as inflows are concerned we are much more liberal than many other economies, including China.
On the outflow side, we have already encouraged corporate acquisitions overseas as part of integration with the global economy. When it comes to financial intermediaries, we are still conservative, as they could create some volatility at this stage.
As far as individuals are concerned, their problem was what I call the irrational preference or psychological fixation about the higher value of foreign currency, particularly the dollar and the pound.
“Marketization” foreign currency has altered this mindset considerably. We have more or less achieved this (market-driven exchange rates) in the last three years, evident by the fact that the rupee has moved both ways. Unlike the scene five-six years ago, no one describes foreign exchange as “valuable” today. Now that that fixation has gone, what we are now trying to do now to enable individuals to take a view on the currency.
You can call it punting. Individuals send their children abroad for education. They can now book forward dollars and take positions if they have the money. But there is a limit. But the most important thing in the context of capital-account management is that this is not a mechanism for easing the burden of capital inflows.
When there are large capital inflows, even if you liberalize outflows, they don’t happen at that point in time. Outflows normally happen when inflows are reversed. Our approach is to enable outflows with limits and safeguards.
How far are we away from full float of the rupee?
The issue is not of full float but fuller float, fullest float (laughs). We have been given a roadmap. There are recommendations and, given the existing legal structure, we will have to wait for implementing some of them. We are focusing only on those moves that can be taken with certain safeguards.
All these measures will have an impact in the medium term. But how will you rein in rupee appreciation in the interim period?
The exchange rate policy continues to be what it has been and we have no pre-conceived notion about any particular appropriate level.
But the rupee is over-valued by 12% on REER (real effective exchange rate) basis.
The REER is useful for analysts and market participants. The rupee has moved both ways in the last four years. The exchange rate flexibility has increased over the last four years and it is increasing month after month. As the financial sector develops there will be greater flexibility. The market moves the exchange rate.
How long will you stay away from the market? Exporters are getting hurt.
I don’t under stand the question. The Reserve Bank of India does not go to the market whenever exporters complain or importers complain. That has not been the case in the last four years. There have always been occasions when some one or the other is unhappy. We don’t care who is happy and who is not happy (in dealing with appropriately with forex market issues).
So, you’re happy with the value of the rupee…
No I am not unhappy — because if I were, I would have taken action.