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Government has space for more fiscal stimulus

Government has space for more fiscal stimulus
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First Published: Wed, May 27 2009. 10 23 PM IST

 Straight talk: The outgoing deputy governor of the Reserve Bank says it doesn’t see any difficulty in the management of government debt. Abhijit Bhatlekar / Mint
Straight talk: The outgoing deputy governor of the Reserve Bank says it doesn’t see any difficulty in the management of government debt. Abhijit Bhatlekar / Mint
Updated: Wed, May 27 2009. 10 23 PM IST
Mumbai: Outgoing Reserve Bank of India (RBI) deputy governor Rakesh Mohan is in no hurry to declare that clear signs of an economic recovery have emerged. Mohan sees some “encouraging” signs from the automobile and the cement industries, but for now is not calling them a “turning point” for the economy.
Straight talk: The outgoing deputy governor of the Reserve Bank says it doesn’t see any difficulty in the management of government debt. Abhijit Bhatlekar / Mint
Mohan draws comfort and optimism from the fact that fiscal and monetary measures taken by the government and the RBI are working and says there is some room left for the government to provide more fiscal stimulus.
He does not see any problem in unwinding the stimulus packages because the monetary expansion is in sync with the kind of growth that the central bank has been projecting.
The deputy governor is confident that RBI will be able to manage the government’s massive debt raising plan this year and it will not have to print money.
Mohan, 61, quit RBI in May to take up an assignment at the Stanford Centre for International Development at Stanford University as a distinguished consulting professor. His resignation is effective from 10 June.
In an hour-long interview with Mint last week, he spoke on a variety of subjects, including foreign banks’ role in India and the transformation of the Indian banking industry. Mohan also explained why he thinks foreign investors should not be allowed to buy government bonds and why the government’s debt management should not be separated from RBI. Edited excerpts:
This is not the first time that you have quit RBI. In 2004, before finishing your three-year term, you had left for finance ministry only to come back later. Is this restlessness typical of your generation, those who were born after Independence?
I don’t think there can be any question of restlessness because I first started my carreer in the government of India and associated institutions in December 1986 and since then I’ve been in the Planning Commission, the ministry of industries, and NCAER (National Council for Applied Economic Research). Here I have been for about six years, including both stints. My term is till January 2010 and meanwhile I have got this opportunity to go to Stanford University. There’s no question of restlessness.
You seem to be very unhappy and have quit because you didn’t get the top job.
Well, I think that anyone who has been in the kind of position that I’ve been, in the government and in the Reserve Bank, would obviously aspire for the top job, but one has to realize that many different considerations go into who is selected for the top job. They picked (D) Subbarao, who is a very, very fine person.
You have some successes, some great satisfaction, and some disappointments. You’ve been in charge of monetary policy and are leaving at a time when the government is grappling with rising fiscal deficits. Subbarao will miss you.
From my point of view, I’d rather like people miss me than not miss me.
Is the worst behind us? Are you one of those who are seeing green shoots and saplings?
You have as many people saying that they have not yet seen (a) turn in the world economy as the number of people saying they are seeing some green shoots or saplings or whatever metaphor you care to use. The current information from Europe, Japan, the US, is a little mixed and there are still concerns in terms of the impact of the global financial crisis on the world economy.
However, given the very, very unusual and bold steps that have been taken by most governments and their central banks, and even more importantly, the unusual, almost unprecedented coordination and cooperation between governments and central banks, partly through the G-20 mechanisms, do give cause for comfort and some optimism that these measures will have an effect.
It’s always very difficult during such a period to actually identify the inflection point and the turning point. Even in the US, with all the information available on a high frequency basis and the best economists available, they could not call it a recession until post facto, after a full one year. It is our job as central bankers and as government officials to monitor the economy closely, but I think it would be a bit rash at present to say we are seeing clear signs of an upturn.
When do you think you’ll be in a position to say the worst is behind us?
As I said, during such a period, it’s very difficult to actually identify when the turning point is coming even though one looks for different clues. In our situation, for example, you are getting some encouraging signs from the automobile industry, the cement industry and some others, but I think we will have to wait a little while before we are able to call a clear turning point for the economy, both domestically and internationally.
Fiscal deficit is rising but certain quarters are still talking about headroom being left for more fiscal stimulus.
Given that the oil prices have come down significantly, as have fertilizer prices, internationally, the need for subsidize in these areas will be much lower. That itself gives some room to the government to provide some fiscal stimulus in 2009-10 relative to 2008-09. I think there is some space the government has got here.
Second, I think there is scope for specific capital expenditures and accelerating ongoing projects that the government could identify in terms of the inflows, the power structure, road sector, urban infrastructure, etc. in the context of the Jawaharlal Nehru Urban Renewal Mission and others.
When you talk about headroom being left because of lower subsidies, how much percentage of GDP are you looking at?
Well, one would have to make that calculation a little more carefully. I wouldn’t want to put a number on that. I’m making a general point that the considering the kind of subsidies the government had to give last year because of the very, very unusual rise of oil prices and fertiliser prices, we have some headroom because the prices have come down.
Are the packages working?
It’s too early to say. You don’t have high frequency data on the effect of these programmes but I would say that that the number of people asking for assistance either from the government or from the central bank has clearly declined. There are very few people today among market participants asking for certain specific assistance from the government or the Reserve Bank. This would suggest that there is some effect of all of these measures.
How difficult will it be to unwind all these concessions?
Well, you need to see our management of the monetary situation and the liquidity situation in terms of injecting liquidity into the economy, a consequence of the reversal of capital flows in early 2008 and 2007.
In addition to general problems of liquidity needs, our own actions in terms of forex intervention in the interests of the foreign exchange market meant that we sucked out good deal of rupee liquidity from the market.
We also need to understand that in any given fiscal year, there is a relationship between GDP growth and inflation on one hand, and a corresponding monetary growth that you expect. Corresponding to that, you need a certain amount of growth in the reserve money, or base money, which is the size of the Reserve Bank’s balance sheet.
When you acquire foreign exchange reserves, that actually helps in the expansion of the economy because the base money is expanding at the relevant rate and you also then need to sterilize the excess reserves that might be accumulated.
You don’t have to sterilize the whole thing as long as your monetary base is expanding according to the kind of projections you have for GDP growth and monetary expansion. The reverse also operates.
All this is related to your question about unwinding. The kind of expansion that has taken place in the base money and Reserve Bank’s balance sheet, after adjusting for the CRR (cash reserve ratio), is consistent with the kind of the expansion we need of the balance sheet.
So, we don’t have unwinding problem -- a long answer to a short question because it is a very important one.
In case of some other countries, who have had to expand their balance sheets very significantly, they do have a problem of unwinding as and when the need arises for unwinding because their balance sheets expanded far more than needed for base money expansion.
In our case, our programme last year as well as this year, including the open market operations, are consistent with our projections (about) what kind of reserve money expansion we need and so we won’t have to really unwind.
Do you see inflationary pressures? The wholesale price based inflation is very low but the consumer price index continues to be very high.
There has been a lot of discussion on this issue and I don’t know if I have anything interesting to add. If you look at the last 10 years’ history of consumer price inflation and wholesale price inflation, they’ve been fairly consistent. If you take a five year average, it’s not very different.
You mean the gap?
There is not much difference in the inflation as measured by the CPI and WPI over the last 10 years or so. Obviously, year-to-year there is a difference -- basically because the CPI measures the consumer basket and the WPI measures the wholesale basket. And, clearly the food weight in the consumer basket is much higher than in the wholesale price basket. It’s not surprising for a short period of time for the divergence to take place.
It’s not a puzzle, because if you understand the weightage of different items in each of these industries, you understand why they are different and it’s only because of very, very unusual price rise of commodities and a very quick price drop in the past year.
At Reserve Bank, we look at multiple indicators. Even though headline inflation in the country is important because it comes out on a weekly basis and is the most widely used indicator, in terms of monetary policy making, we are concerned with an overall view of inflation.
One thing is clear, that there is no concern about inflation at present.
(Phone rings. “That’s that wrong number, as usual. I can tell from the ring it’s a wrong number,” Mohan says in exasperation)
There is no concern about inflation at present, I would say, of any monetary authority in the world. Our projections is around 4% for end of March next year, and you can also see that the consumer price index has started coming down.
Does this mean there is still room for rate cuts?
I don’t think I would like to make a comment on that because as you know, at the Reserve Bank, we’ve had a policy not to give policy guidance. We’ve never done that before and in any case I wont be here ...
Once you called them ‘lazy bankers’ for not lending. Will you now call them “greedy bankers” as they are refusing to lower interest rates?
We’ve been addressing this question formally in our policy statements. The banks do have a role for reducing rates both on the deposit side as well as on the lending side. We said so formally in our annual policy statement.
The question on their being lazy or prudent is, I think, a separate question and I would certainly say bankers have to exercise their judgement in terms of their risk assessment and credit quality assessment and then make their decisions.
At the same time, they also need to be conscious that certain activities which are unviable at interest rate ‘x’ could become viable at interest rate x-delta. They have to be conscious of their risk assessment.
So far, we have not observed any kind of significant decline in credit quality. And it goes to the credit of our banking system, assuming that we don’t see such declines in the future, that despite the very rapid increase in credit growth in the previous five years we have not observed any erosion in credit quality. That is a very creditable aspect of both the Indian economy and the bankers’ prudence.
I would certainly not discourage bankers from being prudent because it’s very important for the general public, and the country at large, to retain their trust in banks. Given what’s happening in the rest of the world, we need to recognize that we are very fortunate at present that our banking system is very healthy and all banks are profitable. All of them, without exception – public, private, foreign, new private – have adequate capital.
It’s important for the banking system to retain their prudence while also understanding that they could, in fact, help in their prudence by looking at the specific needs of their customers. If they are able to reduce their lending rates and help some customers who otherwise would have had difficulty, that’s also part of prudent banking.
Has intimacy with bankers changed your perception?
You know, there’s an old saying by (John Maynard)Keynes, “When facts change, I change my mind. What do you do?”
The fact of the matter is that, between 2003 and 2008, lending grew by 30%. The last thing you can call them is lazy.
How will RBI manage Rs3.6 trillion of government borrowing this year? By printing money and shelving the Fiscal Responsibility and Budget Management (FRBM) Act?
I think you’ve got two different questions.
(Phone rings: “Is that the governor?” Mohan asks his executive assistant.)
One is the shelving of the FRBM Act and the other is the financing (of government debt) part. Let me come to the first one first.
I think it is recognized globally that when you have this kind of financial crisis and private investment and consumption expenditures are slowing down, expanding government expenditure and a fiscal stimulus is the right thing to do. The IMF (International Monetary Fund), the world’s guardian of fiscal prudence, has called for all countries to do a fiscal stimulus.
The only issue that is important for us and other countries as well is that as you see the economy is recovering, you have to scale back. If private expenditure is taking place, you don’t need to do public expenditure. On the other (hand), if private expenditure is not taking place, we do need to have public expenditure to keep up the growth you want, and then there’s no crowding out either.
It will be important for us, the government, the Reserve Bank and observers like you to really keep looking at what’s happening carefully, so we can start unwinding as and when the private economy starts picking up.
Second, as far as the financing goes, as I explained to you earlier, our monetary programme in terms of doing open market operations (is not only meant) to inject liquidity, but at the same to expand the reserve money or the base money at the projected levels is fully consistent with the kind of growth we are projecting. In that sense there is no printing of money.
You don’t see any hiccup in managing the government’s borrowing programme?
We are not seeing any difficulty in the management of the government debt.
In the first half of last year everything was normal and then we had to suddenly expand the market borrowing on behalf of the government in the last quarter. We were able to do that and yet the yield on the benchmark 10-year government bond was actually lower at the end of March 2009 relative to the end of March 2008, and all (bond) auctions succeeded. It was a very testing time but we were able to do it because of all the instruments available to us. It’s a very interesting lesson that most central banks are learning today.
There is an increasing realization that for central banks to operate in the interest of growth, price stability and financial stability, you have to use all of these instruments, which we’ve always been doing and we’ve always said explicitly that we have multiple indicators.
In the case of last quarter of 2008-09, it came as a surprise and we had to do quick management. Now, in 20009-10 we basically know what we have to do.
Of course, there’ll be a new budget as a new government settles down; that will provide some numbers and we’ll have to respond to those numbers in terms of market borrowing. We are able to manage the market borrowing programme of the government consistent with our monetary policy. My view has always been that the Reserve Bank doing debt management for the government is a confluence of interests in monetary management, not a conflict of interest as many people claim.
You have a very strong view on separation of government’s debt management from RBI. The Committee on Financial Sector Assessment (CFSA) which you chaired is in favour of this but you expressed your voice of dissent in the report, made public in March.
The original suggestion for separating debt management from the central bank came from RBI itself and not elsewhere. The basic reasoning for that was then perceived conflict of interest between debt management and monetary policy. We had the long, long experience, from 1950, of automatic monetisation of the government’s fiscal deficit through ad hoc treasury bills and because of the automatic monetisation of fiscal deficit, the fiscal policies governed the monetary policy.
Subsequently, following the agreement (between the government and the RBI) on abolition of ad hoc treasury bills and more importantly, the FRBM, the Reserve Bank now cannot subscribe to government borrowings in the primary market and therefore the interest rate for market borrowing has to be determined by the market. The RBI cannot do anything on that.
So the issue (of conflict ) is no longer there. The second thing I would say is, and I have documented this in my note, in terms of conflict of interest, as long as we have a system in India where the majority of the banking system is owned by the government there is more of a conflict of interest in government institution managing its debt because these banks are major subscribers to government debt.
We also need to look at the market stabilisation scheme (MSS).
(Under this scheme, RBI floats bonds to soak up excess liquidity that is generated out of its dollar buying in the foreign exchange market. It buys dollars when there is too much of capital flow and unless it buys, the rupee gets stronger vis-à-vis dollar hurting exporters.)
In some sense, it’s fortunate that we – between the government and the RBI -- invented the methodology of storing liquidity. Just like you have a buffer stock of food grains so that in years of plenty you pile up food grains and use them when you need, through MSS we are able to accumulate and store liquidity in the system when we have excess capital flow and use it when we need, like the current time. I would expect this kind of situation to continue for sometime. We will need to issue MSS bonds as and when capital flows return.
I reviewed the record of global capital flows in last 30 years and found that there has been a very consistent volatility in capital flows. The emerging market economies have to do all kinds of things to preserve financial and monetary stability.
My expectation is that global capital flows will continue to be volatile and we’ll need to manage MSS both in terms of issuance and unwinding for quite sometime to come. What that means is that the RBI issuing government bonds or unwinding them. If you separate debt management from RBI, it can’t be done.
It will be a mistake to separate this from RBI.
May be in future when the Indian debt market is much more developed and the government securities market becomes a smaller portion of the overall debt market with the fiscal deficit of central and state governments becoming smaller, we can do it.
I must also mention that I had the same view when I was the chief economic advisor and secretary, economic affairs, government of India.
You are also not in favour of foreign entities buying government bonds.
Both the government and RBI have(had) a consistent policy for a very long time on not allowing foreign subscription to government bonds. The experience of the world, particularly Latin America, is pretty conclusive. In fact, some people have called it the original sin of issuing sovereign bond to foreigners.
We have a record of having financial stability. If you open foreign investments in government’s market borrowing, in good time you’ll have a flood of capital coming in and, because the government securities market is very liquid, capital will flow out in times of difficulty. This will add volatility to our government securities market, forex market, interest rates and lead to financial instability. It’s just not desirable at all.
You want to keep the doors shut for foreign banks for ever. The CFSA report reiterates your view.
It’s not my report; 15 of the most respected international experts were involved.
I was the chairman but there were co-chairmen such as secretary, department of economic affairs and former finance secretaries. There were four independent panels with independent members and those were completely independent reports. There was no intervention by either the government or the regulator.
If you ask me about my view, I would say doors are never shut for the foreign banks. Foreign banks have been here from 1850s and India has never shut its doors for foreign banks. Second, the licences given to foreign banks are more liberal (in India) than anywhere else. Once you give a licence to a foreign bank they can do all activities here but this is not the case in most of the countries. So, your assumption is just dead wrong and you should correct it, particularly as an Indian.
In any country, you want financial stability, competition in banking and high growth of the financial system and to the extent the foreign banks help in achieving these, (it) is a good idea. But if you have a large presence of foreign banks, then the host country gets affected by something happening elsewhere. You have observed in the past 12 months that credit growth of foreign banks here is much lower than local banks because of their parents’ problems in terms of capital adequacy, et cetera. I am not making any aspersions on their functioning because there is something happening to their parents and they have to restrain their lending because of constraints in terms of capital adequacy.
In the interest of any country, you need to have some balance between the presence of foreign banks and domestic banks.
Would you favour the government stake in public sector banks coming down?
You must remember that the then finance minister of the NDA (National Democratic Alliance) government had introduced a Bill in Parliament in 2000 to amend the relevant Act to allow the government holding to come down from 51% to 33% in public sector banks. It’s almost 10 years and you don’t have a consensus in the country on this issue and both NDA and UPA (United Progressive Alliance) government have made it clear that the government holding should not go down below 51%. That’s a reality.
In the last decade or so, in response to competition put up by both private and foreign banks, the public sector banks have improved their performance on all measurable metrics. At present, there is convergence of performances of foreign, private and public sector banks.
As we come back to normal growth part of the economy at 8 to 9%, there will be higher credit growth and banks will need to expand their capital base. Then, the government will have to decide whether it is able to subscribe to the capital that banks need to keep their share at 51%. If the government for fiscal or other reasons is not able to do that, then it will have to take decision on how to manage this.
What is most important from the RBI’s point of view is that the banking system should finance the growth that we want. We want a competitive, efficient banking system and financial inclusion. It doesn’t matter whether it’s foreign, private or public sector bank as long as we can achieve these objectives. As the country becomes more open, there will be more competitive pressure and public sector banks will have to respond to that.
What should be the agenda before the new government?
It’s not correct for me to set the agenda.
Through various publications we have recorded comprehensive view on the kind of way forward that we need in terms of reforms. There is a large menu and it will take me three hours…
A reviewer of your book, Monetary Policy in a Globalised Economy: A Practioner’s View, has commented that the government economists are happy and complacent with what they have done. Looking back, could anything be done differently?
There is a universe of possibilities and one has to be extremely stupid to say that something could not have been done differently.
In last five years, there has been highest growth ever and lowest inflation. We are the best performer, apart from China.
It’s for the onlookers to say what these government economists have done. Perhaps it could have been better but the government economists at least did not screw up.
In the last 35 years, more than 100 countries – the number must have gone up now; the last time I counted was a couple of years ago – had faced a financial crisis. We have not. So I think the country should be proud that we have such a system.
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First Published: Wed, May 27 2009. 10 23 PM IST