Subir Gokarn | Slowdown may gain some momentum

Subir Gokarn | Slowdown may gain some momentum

Mumbai: Reserve Bank of India (RBI) deputy governor Subir Gokarn said the impact of a series of rate actions will start to show in both slower growth and low inflation in the second half of current fiscal. In an interview, he said RBI expects the growth to move from the 8.5% to “perhaps" 8% and inflation from 9% to “perhaps" 6% by the end of the year “assuming, of course, no other new shocks appear on the scene." He also said the slowdown that RBI anticipated may gain some momentum. Edited excerpts:

RBI has raised its policy rates 10 times in past 16 months and yet there is no impact on the inflation scenario. Doctor, your medicine is just not working.

That’s not an entirely fair judgement. You don’t know what the inflation scenario would have been, if all these hikes had not been made. I think, it’s fair to say that the number of hikes and overall magnitude of interest rate increases do have a bearing on both economic activities and also on (inflation) expectations. We do expect that over a period of time the (rate) hikes will bring down inflation as a result of two factors—economic activity will slow and inflation expectations will start to be moderated. This will allow people to base their pricing decisions on a lower inflation outlook. It’s a process that takes time.

But an equally important issue is that even while we were in this process starting January 2010, a number of shocks hit us along the way. With each passing quarter, we had a new set of shocks —food-related shocks, commodity-related shocks and some other kinds of global uncertainty-related shocks.

The combination of all these has resulted in a rather complex environment and transmission is not as smooth as it might have been.

So, we will have to wait a little longer for inflation to come down.

Well, we are projecting that inflation will remain high for some time, till at least the middle of the year. But we do expect that the cumulative impact of our rate actions will start to show in both slower growth and low inflation numbers over the second half of 2011-12.

We don’t expect the slowdown to be dramatic. We expect what is now being referred to as soft landing—that is growth will move from the 8.5% of last year to perhaps 8% and along with that inflation will come down from 9% to perhaps 6% by the end of the (fiscal) year assuming, of course, no other new shocks appear on the scene.

Despite many rate hikes, India is possibly the only country in emerging markets where the real policy rate is still negative. In retrospect, could you have been a little more aggressive in rate tightening?

Retrospect is never an option in policy. We have to recognize that every decision is taken in the context of available information and the possible playing out of the scenario.

In the early part of 2010, the inflation pressures were starting to build, but there was also enormous uncertainty about growth. We could not have taken the recovery as something granted and been more aggressive in that phase of the cycle. So, we wanted to calibrate. The second issue is that between November and February, commodity prices began to surge and our calculations, based on a somewhat more benign global commodity scenario, clearly went wrong at that point.

Along with commodity prices, demand pressure started to surge. We were sure that demand pressures were still very much within the system, after a series of 25 basis points (bps) hikes we felt (in May) that at that point we needed to send a stronger signal. It’s fine to describe 25 bps rate hikes as baby steps, but if you look at the numbers, we have moved in every quarter starting from January 2010 at least 50 bps.

What do you see from now onwards?

In the May policy we needed to signal that we had not lost or not in any way diluted the commitment to inflation control. Of course, it came in the context of a debate that was emerging on whether we should accept higher inflation as a price we pay for higher growth. We had to reclaim our position and wanted to signal very clearly that we had not given up on inflation control and it was very much a priority.

After this?

It’s circumstantial. We have clearly in the mid-quarter (policy review in June) gone back to 25 bps hike because there are a couple of factors at work. We have not downgraded the risk of global commodity prices, but clearly in the last few weeks there are some signs of softening because global growth prospects appear quite significantly weakened.

Besides, after a 50 bps hike we felt there was a risk involved if within six weeks again we put the same sort of act with the same intensity. We do recognize that there are some signs of slowdown domestically—not very dramatic and very broad based though.

The global risks to growth, the prospect of commodity prices softening and, perhaps, the domestic slowdown signs told us that we have reclaimed the credibility issue with the 50 (bps hike) and let’s continue with our stance which remains very focused on inflation control.

You have reclaimed the credibility issue. This means you have a feeling that you lost credibility.

Well, I think there was a danger of that—whether it happened or not is a judgement for outside observers to make. But we clearly sensed that there was a risk of that happening.

There are apprehensions that you might go wrong on inflation projection this year too. How confident are you on inflation going down below 9% after September?

Well, that’s not our target —that’s a projection, based on certain assumptions as all projections are. If the assumptions go wrong, the projection will go wrong. There are factors that may cause inflation to increase and there are also factors that may cause inflation to decrease. For instance, the commodity prices may soften.

The second is that economic activities will start to moderate and this will have an impact on pricing power. We see that pricing power remains quite firm, but the corporate world feels that this is a misconception. By the time we announce our quarterly monetary review in July we will have first quarter corporate (earning) numbers. We give a lot of attention to such numbers because more than macro data, earnings reflect actual conditions that business is experiencing. They will tell us whether the pricing pressures are easing.

Are you downplaying the fears because the industrial lobby groups have been saying that you are choking growth?

Clearly there are indications of a deceleration, but from a policy perspective we need to look at the totality of the situation. The fact that the couple of sectors are complaining about high interest rates is valid as it has an impact on their business but the macro perspective is different.

At least our reading of financial performance in terms of earnings growth, profitability, profit margins or profit growth suggest that it is not broad based as yet. It may become and that’s a possibility that we have certainly accommodated. That’s why we did not go for 50 bps (hike) this time. We do feel that the slowdown that we anticipated or is being talked about may gain some momentum. There is a consideration of that factor…

So we are slowly getting into the neutral zone as far as rate is concerned.

Neutral zone is a kind of a nice idea, but it’s very difficult to quantify.

We have had a period of extremely rapid growth and inflation set in quite firmly towards the later part of that period. Do you have benchmarks which say this much and no further? I think that will take some time to crystalize as a number. Conceptually, perhaps, we are in a zone where it is possible for us to think of reversal very fairly quickly. That’s a situation that we had in 2008.

We were 9% repo (rate) and within a few months it came down to 4.75%. So, if you are hit by a severe shock, you do have the capacity (to cut rates).

Even if we are not hit by any severe shock, as circumstances stand now, are we close to a level where you’ll say: this far and no further?

The test of that will be what happens to the inflation trend. If the overall inflation and particularly the non-food manufacturing inflation, starts to stabilize… We need to keep an eye on that.

It should remain stable for how many months?

There was some stability actually and if you recall we actually paused once in the cycle in December.

You must have regretted that later?

No, you can’t have regret in this business. You learn from it but you don’t regret it. The reason for the pause was that the non-food manufacturing inflation had stabilized.

So we must see non-food manufacturing inflation going down for a few months continuously before you pause.

Not just going down, but coming to levels that we feel comfortable. The medium-term trend for that number is 4% or 4.5%

The March final number was 8.5%. We do expect the April and May numbers to be revised upwards. It’s probably more in the zone of 8%.

You spoke about the protein factor. There are many other structural issues in inflation that monetary policy can’t address. Is fiscal authority doing its bit?

I would like to use a football metaphor. The monetary policy is like the goalkeeper who has special powers, but only in the box. When the ball is in mid-field the goalkeeper is actually an idle resource.

When capacity utilization is high in the economy and we are growing at 8% or above, the supply-side factors, food prices, commodity prices, etc. have a high possibility of spilling over because there is pricing power. Input prices tend to spill over into final product prices. That’s the scenario where the ball is actually approaching the goal.

It doesn’t matter how it got there, whether your midfielder or the defenders didn’t pick up the opponent. The ball is reaching the goalkeeper and he cannot sit around saying well I am not going to do my job... You have to take action when the risk of a goal being scored is high and you do it. There is role for government actions and it was well reflected in the budget.

But is the government playing the role?

Now that’s a question you have to ask the government.

The investment scenario is worsening and you are raising the rates. This means corporations are not expanding and the supply-side issues are not being addressed. By raising interest rates aren’t you actually fuelling inflation?

Investment is an outcome of several factors. The cost of fund is one of them, but the expectations about the future, long-term stability including whether the average rate of inflation is going to be stable, etc. are considerations.

Yes, interest rates might impact investment negatively at a point in time, but the benefits that you get from stabilizing inflation may offset that. Ultimately, it’s really a question of postponing or pushing back investment in time.

When do we see savings bank rate deregulation?

We were not planning to deregulate it. We wanted to consider the possibility. We have been getting feedback from various sources, including hand written post cards… We are in the process of accumulating this. We will have a proposal fairly soon and then a decision will be taken.

What is your point of view?

I think there is certainly merit in it being deregulated because it is consistent with the overall financial reform strategy. But we have to take into account the fact that a lot of people see this (as) a safe and a reliable source of monthly income. That’s the view point that has come very strongly from a variety of stakeholders, individuals, pensioners and so you can’t just say we are not going to address your concerns.

I would presume that the outcome will be either status quo or some sort of middle ground where these stakeholders’ interest are given some consideration. The challenge is really to find that middle ground.

People have not seen you smile. Has central banking taught you this?

I think it’s more a reflection of my personality. The reason I chose economics as a career was because early in my life somebody told me it was a dismal science and I thought that was absolutely appropriate for my personal orientation. I am glad I made that choice.

This is an edited transcript of an interview that was first telecast on Bloomberg UTV on Thursday.