Home / Politics / Policy /  We want to see previous rate cuts pass through: Raghuram Rajan

Mumbai: The cash reserve ratio (CRR) is nearing its statutory minimum requirement and the Reserve Bank of India (RBI) did not think the CRR was a “compelling instrument" to use and change liquidity conditions, RBI governor Raghuram Rajan said in an interaction with reporters following the central bank’s monetary policy review on Tuesday.

Rajan added that there was no point in cutting the policy rate by 50 basis points without removing the overhang of inadequate transmission. (A basis point is one-hundredth of a percentage point.) The liquidity management will be a combination of interventions in the forex markets and injections through bond buys.

On bank asset quality, Rajan said that banks may take some further pain for the quarter ended 31 March, but added that lenders are following RBI’s asset quality review in spirit.

Edited excerpts:

If the intention was to reduce the liquidity deficit, why didn’t the RBI cut the cash reserve ratio (CRR) upfront? Is 4% the minimum CRR you want to maintain?

CRR is already pretty low. By our statutory requirements, the minimum level is 3%, so we are pretty close to that minimum. Also, internationally, what happens is that the developed country central banks have dispensed with the uncompensated CRR. They have a CRR but they compensate.

Most emerging market central banks have uncompensated CRR, which typically varies between 4% and 15%. So we are at the lower end of that scale too. Given that, it didn’t seem to us that the CRR is the most compelling instrument. There were other things we thought we could do.

Some had argued that a 50 basis point (bps) cut could have been justified given falling inflation and weak growth. You don’t agree?

What we have been doing is cutting rates as we see room emerge from the economic environment. Our sense is that the 25 bps cut was justified by all the things that have happened. At this point, we want to get a better sense of what the big uncertainties surrounding the economy are before we take further action.

More importantly, we want to see the past rate cuts pass through. There is no point just cutting rates, which makes the market happy for a day, but the economy doesn’t benefit if the pass-through doesn’t happen. What we are trying to do is ensure the pass-through happens so that there is not this great overhang of lack of pass-through.

So I think the sequencing is better if you first make the pass-through happen by taking away all the impediments. There were significant and important steps on liquidity taken today. That will help the pass-through take place so that further rate cuts happen without this overhang.

As you straddle liquidity management through forex operations and open market operations, what will be the impact on the rupee?

The foreign exchange operations follow the rule that we want to minimize unnecessary volatility. But we are not trying to pick a level on the rupee.

Given our target growth rate for durable liquidity, the amount that we infuse or take out will be the residual amount after accounting for interventions in the foreign exchange market.

As a hypothetical example, if we want to infuse 25,000 crore in liquidity and we infuse 15,000 crore through foreign exchange purchases, the remaining 10,000 crore will be infused through other means like open market operations. We won’t do forex intervention only to manage liquidity. That would have its own logic.

Your forecast on inflation has come down and inflation expectations have also come down. Does this mean the battle on inflation has been won?

Battle on inflation is never won. It is always a temporary victory before some other factor comes in. The battle that we are really fighting today is for credibility. Credibility that at the first sign of trouble, we don’t abandon our policy regime.

Once we gain that credibility, even if the economy is hit by shocks, we won’t have a significant movement in flows in and out and maybe even in inflation. If we build that credibility, we will have immensely more room to cut interest rates and have a low interest rate regime.

Having said that, I am quite encouraged by the fact that for the first time, the survey results show that the modal inflation forecast (the category which has the highest concentration of responses) is now 5-6% from the double digits that it was earlier. That is very encouraging.

While the government has maintained its deficit at 3.5%, the off-balance sheet borrowings through state-owned entities like NHAI (National Highway Authority of India) are much higher. State borrowings are also likely to rise. Isn’t this a concern?

These are legitimate concerns. This was, therefore, an important reason that the fiscal deficit had to be contained.

I’m certainly on the side which says we need to be careful about public sector borrowings. Clearly we need savings to fund those public sector borrowings and if those savings aren’t coming from domestic or external sources, then the pressure on interest rates will be higher. That is reiterating the point that maintaining the fiscal deficit was not an option but a necessity that the government fulfilled.

What is your outlook on non-performing assets (NPAs) in the banking sector? Will we see a rise in the quarter ended March too?

It is an evolving situation. Our first focus was on assets that were very weak and needed to be classified as NPA under our rules. I want to emphasize that our rules haven’t changed. We are just enforcing them. Then there were assets that have inbuilt weaknesses but haven’t yet crossed the threshold, but could. Over the course of next year, the focus will be on those assets.

Some banks have done more than what we had indicated to them in the third quarter. Broadly they were asked to spread this over two quarters. But remember that this time has also given them the opportunity to rehabilitate certain assets. So let’s see what the final outcome is but the banks are fully following what the spirit of the clean-up that was intended.

What is your assessment of the schemes introduced to help this process along?

Some schemes, like the 5/25 scheme, are more about setting the loan structure right according to the project being financed. Some other schemes are there because we don’t really have a bankruptcy code yet.

So, for example, taking control of a firm, without explicit acquisition of equity is not possible in India. The SDR (strategic debt restructuring) mechanism is to allow banks to take control when the promoter is deemed not appropriate to continue controlling the project.

All these schemes and developments are attempts to create a proper restructuring process outside of a formal bankruptcy system. We have to make sure that banks don’t misuse this to hide stressed assets. So we have made some adjustments along the way and banks are fully aware that we are watching very closely.

What we are seeing now is that promoters are selling assets, promoters are trying to get the permissions they need, new money is sometimes coming in. I think the pressure we have put has been beneficial but we continue monitoring the process.

There was a suggestion in the economic survey that RBI should use its reserves to recapitalize banks. What do you make of that?

I think whoever wrote that doesn’t understand balance sheets of central banks and monetary economics as well as they should. I’d be happy to teach them.

There is an equity position RBI has. Think of this as the government’s assets in RBI. The government’s liabilities are its debt. So this offsets the debt to some extent by the amount of equity RBI has.

Now, let us understand the rationale for not taking this back from the RBI and using this to buy back bonds. You could do that. Or you could trump it from every rooftop that you have so much in terms of assets with RBI. Why do we think it’s useful for it to stay in the RBI? Because you need an entity in the economy which has a pristine rating. So, for example, if you want to do swap arrangements with other economies, you are better placed if you have a AAA-rated entity.

Now, what is being suggested is that we monetize this amount. If we have, hypothetically, 2 lakh crore by which we can monetize our assets. If we give half of that to the government, that means we have 1 lakh crore. The residual value of what we have left is spent on buying government bonds. That means we have 1 lakh crore less to buy government bonds.

So who is going to buy the rest? They will go into the markets, which will increase cost of borrowing. So any money extra that we give to the government, reduces our buying of government bonds directly.

So that is why we are saying this is not a free asset to be given back. But anytime some asks you for the size of your debt, say it is X% of GDP minus the amount of assets held by RBI.

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