Mumbai: Interest rates may have peaked in the country, though the full impact of monetary tightening by the Reserve Bank of India (RBI) is not felt yet, former governor Y.V. Reddy said.
“The interest rate already has increased and, therefore, we have to see how much more monetary action is required or is it required at all. I will put this as a question mark,” Reddy said in an interview in the Banker’s Trust programme on Bloomberg UTV to be telecast this week.
“RBI has acted pretty well. The monetary policy transmission will take time and, hence, one has to be careful whether any further tightening is required at this stage,” he said.
Since its monetary tightening process started in January 2010, the Indian central bank has hiked banks’ cash reserve ratio, or the portion of deposits that banks need to keep with RBI, by 100 basis points (bps) and the policy rate by 425 bps through 10 incremental hikes. After the latest hike on 16 June, the policy rate is now 7.5%. One basis point is one-hundredth of a percentage point.
Policymakers and analysts may have overestimated the capacity of the economy to grow and it is inherently a wrong approach to think that economy is slowing because it is now growing at 8-8.5%, Reddy said.
On the contrary, it could be the sustainable growth rate for the economy as 9% growth is beyond its absorptive capacity and something that has led to overheating, the offshoot of which is now evident in the prevailing high inflation.
“We should be growing only at 8.5%, and since we allowed us to grow at 9%, we are suffering from inflation now,” Reddy said. “When growth hit 9%, I used the word overheating. Everybody was unhappy with it and I stopped using the word, but I took whatever action was required.”
Reddy was RBI governor for five years between 2003 and 2008. He stepped down in September 2008, a week before the collapse of US investment bank Lehman Brothers Holdings Inc.
India’s economy grew at around 9.5% for three successive years between 2006 and 2008 and Reddy raised policy rates by 300 bps to 9% to fight inflation that hit a 13-year high of 12.5% in early August of 2008.
Reddy, widely credited to keep the Indian banking system safe from the global credit crisis, said notions such as inflation targeting may not be the right approach for a country like India where fiscal prudence is questionable.
“When there is a fiscal dominance, what will just inflation targeting do?” he asked. “Post-crisis, the supporters for inflation targeting are becoming less. The wisdom is not in favour of inflation targeting and the Indian conditions haven’t been changed.”
A proponent of an independent debt office, Reddy was candid enough to admit that he was “immature” in doing so. Referring to the sovereign debt crisis in Greece, he is of the view that any such debt offices can be easily influenced by outsiders and, hence, debt management should be a mandate of the central bank, which is in charge of financial stability and inflation management.
“At one stage I myself was a proponent of this (independent debt management office), but at that time I was immature. I went by the textbook. I went on the assumption that fiscal consolidation will take place,” he said. “Afterwards I realized…that if we have independent debt office, it’s a recipe for problems, especially if you have high debt.”
The Indian banking system is shirking its core responsibility, according to Reddy. A “hollow” banking is emerging, he warned, that is taking away banks from their core work of providing credit to agriculture, small and medium enterprises and other productive sectors of the economy.
“Everybody encourages banks to do everything other than the core function. There is a hollowing of banking in India,” he said, “and that’s not good for the economy.”
However, Reddy is not worried about the “vulnerability” of the banking system, as banks’ balance sheets are “fairly strong”.
They have grown some bad assets “but there is enough capital,” he said.