Credit expansion by banks on the back of overnight borrowing from the repo window is not a sustainable mode of growth, Subir Gokarn, Reserve Bank of India (RBI) deputy governor, said in an interview after the monetary policy was announced. Edited excerpts:
Since the 2008 crisis, is this possibly the toughest policy review for RBI as it’s fighting high inflation?
I would not agree... I think over the last one year, we have seen a dramatic change in the environment. Every time we had different indicators on the growth side, inflation side and external side. Whenever we felt that something is beginning to stabilize, the situation changed quite dramatically in a few weeks. For example, last April there was some positive news about global recovery, and then came the European sovereign debt crisis. It has been a very volatile and turbulent environment, and it continues.
You have hiked the inflation projection by 150 basis points (bps) but policy rate only by 25 bps. Isn’t that too passive a response?
It’s a legitimate question. To cut a long story short, the bulk of the revision in inflation prediction is because of what we see as the persistence of current supply side factors. Some of them will disappear as we go into next year. So the inflation scenario that we are responding to in terms of policy action is what we see as a reversal in the tendency of non-food manufacturing inflation, which has actually contributed only 18 bps in the November-December surge.
When we talk about monetary policy, it is really being seen in the context of how it impacts this reflection of demand side pressures. But the projection is for the headline as a whole. Given that these supply side pressures are likely to persist over the next two months, we felt the realistic projection will be 7%.
How soon do you expect inflation to cool down?
We want to do everything to keep it under control. When we look at what happened in the last couple of months, clearly there has been a shock on onions and vegetables. That is not likely to persist. Just on the basis of understanding the production cycle, one could say with some confidence that the pressure will start to ease. But we have been talking over the past several months on the persistence of price increases in protein items like eggs, milk, meat and fish and that is, we think, a much more persistent phenomenon, and something that requires an integrated and very strong supply response. It will take some time. It is not a problem that is going to be solved overnight. The risk is, then, you will have not only higher inflation, but also slower growth. That is the balancing act we have to do.
Where do we stand in the rate hike cycle?
The guidance we have given is that our anti-inflationary stance will persist. In November, we had given a specific reference to rate action. We are not doing that anymore. If the stand is to persist, then that obviously has its own implications.
Banks have hiked rates in past two months. Do you see more room for increases?
I think you are underestimating to the extent that banks have hiked rates. If you look at the extent to which both deposit rates and lending rates have been hiked, you’ll find that transmission is visible and obviously, as the liquidity scenario persists, which is a deficit, then any central bank actions should, maybe with a little bit of lag, transmit through. It is putting pressure on banks’ cost of funds.
You have said you will monitor and if necessary “engage” with banks which show an abnormal incremental credit deposit ratio. What does this mean?
Although for the system as a whole the credit deposit ratio is slightly over 100%, there is a huge difference across individual banks. Some banks are showing very high numbers. Is this is being financed significantly by the borrowing from the LAF (Liquidity Adjustment Facility) or capital infusion? We have to look at how these banks are financing their rapid credit growth and then engage with them, try and see whether a sustainable balance can be achieved.
Credit is growing at 24.1% and deposits 16.5%. So banks are not taking in as much money (in the form of deposits) as they need to finance their credit growth. The gap between two needs to be narrowed.
Does RBI have enough tools to tackle inflation, driven by supply side factors?
It is not fair to say that inflation has gone from the demand side to the supply side. There are two sets of drivers. When the economy is growing at a high rate, the risks of supply side spilling over to the demand side is what we can manage and that is what we have been trying to do.
We cannot, through our actions, influence the production or immediate outputs of any of these commodities. In that sense, I think we have to take a longer-term view of what is required from the government and from the financial sector to have an impact on food production, particularly the items that are causing these problems. It has to be an integrated approach.
The narrow domains of monetary policy will essentially address demand-side pressures.
Are you planning any new measures to ease the liquidity crunch in the system?
I think it is important to distinguish the frictional and structural aspects of liquidity deficit. Keep in mind that the measures we took were to offset the frictional deficit. The frictional element came in because the government took a lot of money through various channels and it is not something they can spend overnight.
There has been a build-up of cash balances on the government part and this is something we felt that the banking system should not be penalized for. To offset that build-up, we thought we should take steps to bring some of that liquidity back into the system. But there is also a structural element. Credit is growing significantly faster than deposits.
If banks are growing credit on the back of overnight borrowing from the repo window, this is not a sustainable way of growth and we have sent the signals…We are concerned about this.