Interest rates a blunt tool, but sole option in inflation fight: RBI governor
Raghuram Rajan also expressed concerns over unhedged forex exposure of Indian firms
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Mumbai: The Reserve Bank of India (RBI) has expressed concern over the unhedged foreign exchange exposure of Indian companies, which according to governor Raghuram Rajan, are “significantly higher than they ought to be”. In a post-monetary policy interaction with select print media journalists on Tuesday, Rajan cautioned Indian companies against getting complacent about the apex bank bailing them out in case currency depreciation affects their profits. Rajan, who kept policy rates unchanged in RBI’s fourth bimonthly monetary policy, said interest rate is the only tool, even if it is a ‘blunt’ one, that the central bank has right now to contain inflation as supply cannot be ramped up in a short period, but demand can be curtailed immediately following a tight money policy. Edited excerpts:
Companies have reduced the hedging of their foreign exchange exposure. Does RBI have any data on how much exposure remain unhedged?
We are monitoring it. Of course, the data on this is not as good as one might think. Our sense is that the unhedged exposures are significantly higher than they ought to be and people are getting little too comfortable with the stability of the rupee. I don’t want to talk about numbers because a lot of these numbers we get through confidential sources, but I will say that the extent of hedging by our measures has come down. And we have to be worried about that.
Now, I also want people to note that even though the rupee seems like it has been depreciating, that’s primarily against the dollar. If you look at other currencies, and take a six-country average or a 36-country average, the rupee has been actually appreciating. So given that, I don’t think they (companies) should be overtly comfortable leaving positions unhedged. Volatility does emerge often at times that are unexpected. Of course, RBI has said that we are not targeting a level of the exchange rate, but we try and diminish undue volatility. Undue volatility doesn’t mean no volatility and doesn’t mean the exchange rate will not adjust to whatever fundamental changes happen. So I don’t think people should be overtly complacent about leaving positions unhedged. Time and again, it does come back to hit companies.
Many companies expect RBI to protect them in case of a currency depreciation. Would you help in such an eventuality?
I don’t want to talk about what we will do with the rupee. Let me repeat what we have been saying again and again. We are not here to protect a level. Our inflation rate is different from the rest of the world, the real value of the rupee keeps changing, the nominal value at some point in time will have to adjust to those, unless productivity also pulls up in the economy. So lots of forces will determine the fundamental value of the rupee. Our objective is not to stand in the way of those forces. All the RBI’s exchange rate policy historically and today has been is that we will prevent undue volatility in the rupee and so I don’t think anybody should therefore assume that it is okay not to hedge exposures and that RBI will bail them out.
In the policy, you said investments should pick up. Doesn’t this make a case for monetary easing?
I think there are two responses to your question. The first is, how much are interest rates the key issue in preventing growth at this point. I would say they are not the most important factor, but they are not irrelevant as a factor. After all, the reason we keep the interest rate high is to curtail demand so that demand comes more in line with supply. So I don’t think they (interest rates) are the most important factor. Second, there is no getting away from the fact that there is a general consensus that we want to bring down inflation.
I have one tool to do that, which is interest rates. Some economists write in the papers that we should encourage supply rather than constrain demand. But they have two different periods over which they act. Today, if I put investment on the ground to create supply, that supply will emerge three or four years down the line, not tomorrow. But the demand is there today. I can curtail demand over two or three quarters using monetary policy. So, in terms of which you want to bring in to balance, probably demand is easier to bring in rather than supply.
That is not to say that we have to neglect supply. That is precisely why we haven’t raised rates to 18% and that is precisely why we keep doing things on the financial development side, to see can we encourage flows to the productive sector, which is code for saying that we are trying to encourage supply that way, if we can get supply going to the best of our ability.
Of course, a lot depends on government action also and some depends on the private sector’s actions. It’s a complicated thing. But whenever someone tells you it is a supply constraint, why are you focusing on demand, your response has to be that if supply constraints do not get fixed, the only way you fix inflation is through demand.
Companies clamour for a rate cut. If interest rates, as you say, are a blunt tool when it comes to bringing down inflation, why not cut rates?
It’s (interest rates) a blunt tool, but it is also the only tool. Give me a better tool and I will use it. You will say improve supply side on food. What is the way to magically increase food? Find a way to produce food, bring down food inflation. I have no problem. I am not standing in the way of anybody increasing the supply side. India is unique in many ways, but sometimes, we believe that the laws of economics in India are also different. Across the world, there is a sense that when supply is constrained and demand is high, you bring down demand to match supply. That’s been the story of how you bring down inflation for close to 20 years across the world. It worked in emerging markets, it has worked in industrial countries.
Of course, you have to be pragmatic about it. It doesn’t work just one way, you can’t do it in one go. The medicine seems to be working. The problem is that before the patient has run the full course of the medicine, you want to take the patient off the medicine and say let’s take a chance. That is always the danger in Indian policy that we have to have the discipline to stay the course.
The same voices that are saying that “We are done. Incremental inflation is zero; so start cutting rates immediately,” they had said the same thing two years ago. If you believe that you cut interest rates and inflation comes down, you are going against the laws of economics.
When do you see credit growth picking up?
You are asking me to look in to the future. Credit depends on investment, investment depends on that nebulous hard-to-fathom thing called “animal spirit”. Now, we thought we had a fair amount of animal spirit with the new government coming in and all the euphoria. Now that has to translate into action by the corporations. Some bankers tell me they are seeing glimmers of action on the smaller items, on the brownfield investments, but it’s not anything to feel tangibly. So, as we have said in the monetary policy, what we need to build this recovery on solidly is tangible strong investment across the board. So, we are waiting for that. I don’t think it has happened yet.
Recently, two courts criticized RBI’s stance on terming board directors as wilful defaulters...
We are not curtailing the right to do business, we are curtailing the right to steal from banks. The Gujarat high court concerns were that you can’t involve every director as a wilful defaulter; some of them might be innocent bystanders. What we are in the process of doing is to look at the role of independent directors and nominee directors. If you can’t prove that they were involved and were negligent and didn’t follow the basic duties of a director as prescribed by the Companies Act, then they should be taken to task. The reason you are earning board fees is that you must exercise some corporate governance. You didn’t, and permitted a wilful default by either negligence or by support, then there should be some liability. If you curtail the process of a lender to recover his loan, you are doing far more damage to the process of running a business.
These measures, wilful defaulter and noncooperative borrowers, are ways to ensure that there is a penalty for non-repayment or misuse of the funds. In that sense, I believe there are ways to make lenders feel confident that the money they lend will be used for the stated purposes, they can charge a reasonable interest rate and the money will be returned. By preventing such money from being returned, I think we are standing further in the way of business than helping it.
Do you think the Supreme Court judgement on coal block deallocation will delay the bad debt recovery cycle?
We don’t know. I don’t think the banks know what these things mean. A lot depends on what the government plans going forward. The government will be auctioning off some of these blocks again. There will be some inflow in to the government. Also, there is a question of what they would do with the assets that have been created on the ground. All those things have to be taken in to account. My sense is that the government will want to treat the banks fairly in this process. Once we know how these things are playing out, we will have a better sense of what the losses are and what the delays may be in repayment. I think until we know what the plans are, its too early to estimate what the losses will be.
If the US increases rates, what kind of pressure will RBI face?
An increase in US rates will certainly put pressure on capital flows here. My hope is that after the initial volatility, financial market will become more discriminating between countries with a fairly good macroeconomic prospect and countries where the prospects are more uncertain. Political prospects also matter, and there, the strong mandate given by the election is a positive for India. I don’t think the US raising rate is inconsequential, but our policy stance will be determined by our views of the evolution of inflation, rather than by outside forces.
RBI’s model forecasts 7% and above inflation by March 2016...
Our models are a work in progress. Models are a tool, they are not a crutch for you to give up thinking. We get an output from the model and then we put out our own estimates as to what is the model missing out and what the model can’t put out into hard data. If we put our view on top of what the model tells us, our view is still that inflation can be centred on 6% in January 2016 following current policies.
We are still working out the model. We are still an economy where substantial structural changes are taking place; so we have to assign some weight to the model but probably not as much as assigned elsewhere.