Reserve Bank of India (RBI) governor D. Subbarao spoke on various issues, ranging from inflation to the transmission of monetary policy, the current account deficit and new bank licences, at his press conference at the central bank’s headquarters in Mumbai on Tuesday after announcing the quarterly monetary policy review. Edited excerpts:
On the cut in repo rate and CRR (cash reserve ratio):
We did both to ensure there is transmission of monetary policy to (banks’) lending rates. The momentum of inflation has been coming down and there has been a deceleration of growth—not just of investment but also of exports and consumption demand. The third consideration was of liquidity, which was tight over the last few months. We have pumped in liquidity of Rs.35,000 crore because of CRR cuts in September and October, and today’s cut will pump in another Rs.18,000 crore, taking the total to Rs.53,000 crore. We also did OMOs (open market operations) in November and December of Rs.47,000 crore. All these add to Rs.1 trillion. Still, the average LAF (liquidity adjustment facility, or repo) drawings (by banks) were at Rs.91,000 crore in January and this suggests a structural liquidity deficit which promoted the CRR (cut) decision in addition to a rate action.
On future CRR cuts, OMOs
We will look at the liquidity situation, the causes for the situation, and decide on CRR (cuts) and OMOs.
CRR is 4% now and theoretically we can bring it down to zero. Some central banks have tested those limits; but as far as we are concerned, we have quite a lot of cushion there. I am not suggesting we will bring it down to zero or below 4%.
On fiscal deficit reduction and impact on growth
To the extent the government retrenches, there will be an impact on growth; but, consequently, there will be switching of expenditure, with the government vacating the space for the private sector. Therefore, I do not see fiscal deficit reduction as necessarily contradictory and, in fact, it could be growth enhancing.
Our decision to cut the rate was prompted by inflation coming down and growth moderating below trend. The headline inflation has moderated and core inflation is below 4%. The CPI (Consumer Price Index-based inflation) is high but if we knock off food (inflation), it is at 8%. So the trends in growth and inflation make a persuasive case for easing monetary policy even though there are upside risks to inflation.
The first risk is food inflation, which can put upward pressure on inflation expectations and there will be pressure on monetary policy to respond. The monthly diesel price hike is a good thing for long-term inflation management; but in the short-term, it will put pressure on inflation. Global crude prices have plateaued in the last couple of months but there are some upward pressures. Suppressed inflation is another risk factor for inflation.
There is also pressure from wages—the rural wages continue to go up and they are not accompanied by productivity improvement.
The core inflation has come down; fuel inflation is level but food inflation is up. Some people argue that monetary policy does not need to respond to supply constraints and cyclical shocks like food inflation. But if food inflation persists for long enough, it will fuel inflation expectations, and there will be a cause of action for monetary policy to respond.
We have discussed introduction of inflation index bonds to wean people away from gold.
Inflation will remain at around 6.8% in March 2013 and thereafter it may go up a little because of many factors, including suppressed inflation.
On current account deficit
By far the biggest risk to inflation and for macroeconomic management is the current account deficit (CAD) in the context of slowing growth and high fiscal deficit.
For the first half (of the fiscal), CAD was 4.7% and third-quarter trade numbers are quite disturbing. CAD will also be high for the third quarter. If we have a high CAD because we are importing capital goods, that’s okay; but if we are having a high current account deficit because we are importing things like gold, then that is a concern.
I don’t rule out the fact that there is going to be a large current account deficit in the third quarter. But we have some more data than that... like export proceeds from banks which we match with customs data. We said a sustainable current account deficit is 2.5% and 5%, 5.5%, or 6% is way above that level.
On monetary policy stance
If inflation eases more than we expect it to and if CAD moderates more than we expect to, there will be more room for monetary policy easing; but if they go along the currently expected lines, the space for monetary policy is quite limited.
On transmission of policy decisions
As far as monetary policy transmission was concerned, banks were more forthcoming (at the policy meeting) than before. On deposit rates, the signal was not uniform—some banks thought deposits rates will come down while some said there was no room for deposit rates to come down. The liquidity constraint is not uniform across banks and so we gave a message to banks that accessing MSF (marginal standing facility) is not a stigma. (Money borrowed through MSF is costlier than repo rate.)
On the wedge between deposit and credit growth
Credit growth has been at 16.2% and deposit growth at 13.3% in January. That is one of the structural reasons for the liquidity deficit and that also explains the reluctance of banks to reduce deposit rates. I would worry about the wedge from a liquidity management point of view, but I would not worry about the deposit rates being too low.
On new bank licences.
It’s in the final stage. We had consulted the government. They have made certain points to which we have responded, and I don’t know how many reiterations it might go through; but now we are awaiting the government’s response to that.
Both the government and RBI will want to launch this as soon as possible.