Mumbai: In his first interview to any newspaper since he took over as Reserve Bank of India (RBI) governor in September 2016, Urjit Patel discussed economic growth, inflation, liquidity and the one-year journey of the monetary policy committee (MPC).
The October monetary policy marked the first anniversary of the MPC, the new architecture in this space that was put in place after the Indian central bank got the mandate for flexible inflation targeting. The MPC has six members—three each from RBI and the academic world—who decide the direction of the country’s monetary policy, and is a move away from the previous architecture that made the RBI governor the ultimate authority on this. Edited excerpts:
Governor, the MPC has been constituted on the basis of the report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework under your chairmanship. The panel outlined the glide path for inflation—from 10% to 8% and 6%, in phases—and finally suggested a 4% target with a +/- band of 2%. But now it seems that you have a single point target—4%.
Yes, 4% is the government mandated target to the MPC. The plus/minus 2 percentage-point upper and lower bands are the tolerance levels specified by the government. If we breach those for three consecutive quarters, we need to inform the government of why that happened, and what we propose to do to bring inflation within the two bands.
This is the mandated target for five years. We have completed one year. So, the objective remains to have a 4% inflation target on a durable basis; but because of the band, we have a flexible inflation targeting mechanism.
Since it is the policy of MPC, why are you still sticking to the ritual of meeting the finance ministry before announcing any policy?
It is not a ritual. It gives both the finance minister and the governor an opportunity to discuss and exchange views on the whole macroeconomic scenario, as also the wider financial sector. After all, both growth and inflation are an outcome of the overall national policy mix. In most countries, this kind of interaction would be taking place regularly.
Your report said that while the MPC will have an inflation target, it must also take into consideration the output gap—that is, the actual output growth relative to the trend and potential. Clearly, you cannot throw growth out of the window. Is there any level fixed for the output gap?
The two important variables for the policy formulation are projected inflation and the output gap. There is no clear hidebound mathematics that we must give ‘X’ weight to inflation and ‘Y’ weight to growth and form the associated policy. But what is clearly laid down is the 4% inflation target; and we will strive to achieve that, keeping in mind the objective of growth.
Growth is always there in the MPC’s scheme of things; we don’t lose sight of that, but not at the cost of inflation. However, we have to be careful—we should aim at achieving the inflation target without losing sight of supporting economic growth.
But we get confused because of multiple views on the output gap (difference between the output of an economy and the maximum potential output of the economy, expressed as a percentage of GDP, or gross domestic product). There is a wide variance between what RBI feels and what outside experts say.
That is natural. There will always be divergence of views on the output gap as it is unobservable in a rigorous direct sense. There are only estimates. How can there be a strong consensus on that? How do we actually and directly measure the potential of the economy and say this much is the gap at this point in time? This is why we listen to different views of reasonable people. And we make these views public. This is why we place the minutes of the MPC meetings on our website.
This time, the MPC acknowledged the likelihood of the output gap widening but felt the need for more data to ascertain better the transient versus sustained headwinds in the recent growth prints. And that is why the rate was unchanged. The MPC also made suggestions for the faster closure of the output gap.
An emerging market economy is prone to many shocks. And then you have structural disruptions such as demonetisation and goods and services tax (GST). Can the MPC be rigid about its inflation target?
Certainly not. Look at the fan charts of inflation that the monetary policy resolution contains. They capture the uncertainties. We need to take a balanced view. Yes, there is a drop in the GDP growth in the June quarter (to 5.7%), but we need to take into account the transitory effects relating to GST.
We have reduced our full-year growth forecast from 7.3% to 6.7%, but we feel, and our projections based on high frequency real economy indicators suggest, that growth will pick up in the third and fourth quarters (of the current fiscal year) to above 7%. Our full-year estimates are in line with OECD’s (Organisation for Economic Cooperation and Development’s) most recent estimate of India’s growth, but lower than that of the Asian Development Bank (7%).
We have started seeing the upturn. The Nikkei India Services PMI Business Activity Index rose more than 3 percentage points in September over August; the core sector IIP (Index of Industrial Production) saw a 4.9% rise in August. If you look at some of the high-frequency data such as automobile and two-wheeler sales, you also see the upturn there.
Another important aspect of the new monetary policy framework is liquidity management. The liquidity in the system should be in sync with the interest rate policy and the monetary stance. You have a neutral stance, but the system has excess liquidity.
There has been excess liquidity for a variety of well-known reasons, but the liquidity overhang is tapering off. Our objective is to keep the weighted average call money rate as close to the repo rate as possible.
With the decline in liquidity in the system, the weighted average call rate which, on an average, traded below the repo rate by 18 basis points during July has, subsequently, risen by 5 basis points in September. (One basis point is one-hundredth of a percentage point.) Even during the most challenging times regarding liquidity over the past 12 months, the broad integrity of the monetary stance was maintained by RBI.
Your report recommended a special deposit facility to soak up excess liquidity. What happened to that?
The special deposit facility is a long-standing request of RBI. The RBI Act needs to be amended to facilitate that. This will give us one more tool and impart flexibility in our liquidity management. Squeezing out liquidity has a cost, and this instrument will help us optimize over that fiscal cost, and we would perhaps not have to resort to a ‘violent’ measure like a very large increase in the CRR which we had to undertake in 2016. (CRR, or cash reserve ratio, refers to the portion of deposits that commercial banks are required to keep with RBI on which they do not earn any interest.)
In due course, would you like bankers or treasury managers at the MPC? Many of the US Federal Reserve bosses are from the market.
We have an excellent MPC. Out of six members, we have three external members. They are respected as researchers. They have notable academic backgrounds; teach at top institutions in our country; and have thought about Indian macroeconomics for most of their professional lives.
The FOMC (Federal Open Market Committee, the policymaking body of the US Federal Reserve) does not have outsiders. Yes, they have people from the markets but they are from the Fed system itself. We have the requisite expertise within RBI.
You must appreciate that the current government, the strongest one in about three decades by virtue of a clear majority in Parliament, has actually ceded powers by constituting an MPC with external members, and the GST Council, where the centre is not in the majority. These are two important new institutions—one in the monetary policy space and the other in the fiscal space. Can we ask for more?
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story, and Bandhan: The Making of a Bank. His Twitter handle is @tamalbandyo.