Mumbai: Reserve Bank of India (RBI) governor D. Subbarao does not foresee any rate hike till January unless there is a compelling reason to do so. At the same time, there is no certainty that it will hike its rate in January. It seems that the second quantitative easing (QE2) programme of the US Federal Reserve, set to be unveiled this week, will influence the Indian central bank’s rate decisions in future as it will impact capital flow as well as global commodity prices and, hence, inflation.
In an interview with Mint, Subbarao spoke on managing inflation, liquidity, capital flows, an appreciating rupee and likely rate actions. Edited excerpts:
For the first time in many quarters you have given guidance that the likelihood of a further rate action in the immediate future is relatively low. How immediate is the immediate future? Are you actually saying that we are at the end of the rate-hiking cycle?
This is the second time that we are giving a guidance. In the mid-quarter review on 16 September too, we had said given some guidance (monetary situation has come close to normal). We thought that we must adopt the fact to substantiate that we are getting towards that…
Treading cautiously: Subbarao says the central bank will ensure there are no disruptions in the foreign exchange market or in other financial markets. Abhijit Bhatlekar/Mint
By immediate future we mean the next three months. The probability (of a rate hike) is low in the next three months. But I’m not saying that there will be no further rate hike within three months or beyond three months. We have caveated the statement saying if there are unforeseen developments around the world or in India, we will act. Otherwise, we will not act.
Should we take your guidance at face value? In September you said that we were reaching a near normal situation. If that’s true and if there’s no unforeseen event in the interim period, what has prompted you to hike the rate now?
In September we said that we reached a near-normal situation and that further action will be driven by data. Today’s action is consistent with that statement. The rate action is driven by data that came after 16 September. We have the inflation number for September which came on October 14 at 8.6%; we have the PMI (Purchasing Managers’ Index) number. We have the IIP (Index of Industrial Production) numbers. We have data on agriculture production, core infrastructure, exports and imports. A lot of numbers have come. Our policy actions have acknowledged the economic situation that were informed by all these data that have come after the mid-September action.
Can we expect the next rate hike in January?
Unless there are unforeseen developments. But it doesn’t mean that there will be a hike in January. I’m saying that until January, there will not be hikes unless there are unforeseen developments.
Should we assume that since monetary tightening is coming to an end, this is the time for fiscal tightening?
Time for fiscal tightening has emerged for sometime and we understand that the government is on a fiscal consolidation path. They have put out a road map. They have put out some numbers for next year and yes it’s time for fiscal tightening as well.
Your policy document said the current account deficit should not be more than 3% of GDP (gross domestic product).
Yes, we have not referred to any specific number. But I believe that the Rangarajan committee in early 1990s said what percentage of GDP the current account deficit should be. Coming back to the fiscal issue, there is a statement in the policy about the need for fiscal adjustment, need to do expenditure restructuring as well as focus on the quality of fiscal adjustments.
You made an emphatic statement on liquidity management. You also quantified how much liquidity deficit can be tolerated—Rs50,000 crore. You are buying back bonds from the market. Isn’t that monetisation of fiscal deficit?
No, I believe not.
To the first question, yes, we thought that we should take on the responsibility of giving an indication of how much money can RBI infuse through the LAF (liquidity adjustment facility) window.
Liquidity has been a constraint over the last several weeks, particularly over the last weekend, we thought we should give some guidance on this. We took the responsibility of saying that we will endeavour over the next few weeks to keep it at plus-minus 1% of banks’ deposit liability (Rs50,000 crore) level.
So, your bond buying is not monetization of the fiscal deficit?
No. When we are easing a tight liquidity situation, everybody in the market benefits. We cannot say that it is monetization of deficit. It is not done to benefit any particular borrower. Everybody who is borrowing in the market benefits from this.
Doesn’t it amount to quantitative easing that other central banks are doing?
I believe not. Because, their quantitative easing is driven by slowing momentum of recovery apart from deflation concerns. Our liquidity management comes in the context of inflation management.
The US Federal Reserve is set to announce the second round of quantitative easing. What’s your take on the likely portfolio inflow? It was $7 billion (Rs31,080 crore) in October.
I cannot predict the numbers because we don’t know what will be the quantum of QE2. The estimates vary and the median estimate is around $500 billion. Some people have told us that in anticipation of around $1 trillion QE2, market participants have already brought funds here and, if indeed, the QE2 is any different we might see a reverse flow. We don’t know really what might happen.
But I want to say that we are going to look at the situation and ensure that there are no disruptions in our foreign exchange market or in our other financial markets.
Once the QE2 comes, the flood of money will have an impact on the global commodity prices, particularly oil, and that will fuel inflation and impact India’s growth.
Yes, we have in fact pointed this out in the policy document. If there are ultra lose monetary policies in advanced economies it will have upward pressure on commodity prices, appreciation of currency and asset price build-up. All these are consequences of too much of liquidity in the global financial system, which we will have to manage.
There is no reference to growth in your policy stance. Your stance is to contain inflation, maintain an interest rate regime consistent with financial stability and manage liquidity.
The first two stances are the same as in the July policy. Only the stance on liquidity is different.
So liquidity management has replaced growth in your stance?
No, I don’t think so. I don’t want to dispute what you are saying, but only the last bit has changed and the first two are identical to what we had in the July policy. Balancing between growth and financial stability is still a consideration. We have said in the expected outcome of policy measures that we should not disrupt growth.
Managing liquidity and your action in the foreign exchange market are interlinked. If you buy dollars, you can create rupee liquidity. You did intervene in the forex market last week.
I cannot comment (on intervention in forex market).
Our intervention in the foreign exchange market is determined by the exchange rate situation, not by any need to infuse liquidity. If we intervene in the market and that influences the overall liquidity, that’s a by-product. Liquidity itself cannot be a motive for intervention in the foreign exchange market.
But inflation can be a motive behind staying out of the forex market as an appreciating rupee brings down the cost of imports.
We have addressed that question in the past. The pass-through from a rupee appreciation to inflation is relatively low.
You said that manufacturing part of inflation is coming down and food inflation is a structural issue. In the longer term, what’s your inflation management policy?
There has to be supply-side response. Structural food inflation has to be addressed from the supply side. That will take time. There has to be supply side response and we have to manage inflation expectation.
Inflation continues to be high and inflation expectations are even higher. And yet you are saying that possibility of hiking rates is unlikely. Isn’t this contradictory?
No, with the actions taken in the past and today, I think the inflationary expectations should start moderating.