Raghuram Rajan defends rate cut, says no contradiction with inflation view11 min read . Updated: 04 Jun 2015, 08:55 AM IST
Rajan says he will use whatever room he has and the RBI is worried about investment from a medium-term perspective
Rajan says he will use whatever room he has and the RBI is worried about investment from a medium-term perspective
Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan defended Tuesday’s interest rate cut, saying there is no contradiction between the decision to cut the benchmark repurchase rate and the upward revision of the inflation projection. “There was some room to cut and we utilized it because investment on the ground remains weak," Rajan said in an interview on Wednesday. He also put an end to the debate over full capital account convertibility, saying it is still 5-10 years away. Edited excerpts:
Everyone is still puzzled about why you cut rates even as you raised your inflation projection for January 2016. Given that you are now formally an inflation-targeting central bank, can you explain?
I have said repeatedly that I will use what room I have. We had a little room and we were undershooting 6%. Even with the noise around the monsoon, we still thought we would be at about 6%, so we used that room to do a rate cut. I don’t see any contradiction. Given the current information, we have done what we could. We did what we could because the economy is weak. We see that in the corporate numbers, you see it in the PMI (Purchasing Managers’ Index) readings that came out today for services. The economy is picking up but from a relatively low level and investment still hasn’t picked up.
We are also worried about investment from a medium-term perspective. If we are to get the 4% in 2018, we need stronger investment and the supply side to pick up. So we are sort of balancing the short run versus the longer run; growth versus inflation and using as much room as we have. So the notion that there is a contradiction between these two, I don’t find plausible.
Your inflation projection for January 2016 is now 6%. The probability chart you put out with the policy on Tuesday shows that there is a reasonable degree of probability that you could hit 6.5%. As an inflation-targeting central bank, should you not be acting based on that forward projection?
Well it does mean that if things pan out as we expect, we don’t have more room (for rate cuts). If they do work better than we expect, some room may build up. As of now, we are reasonably satisfied that we won’t go off the disinflationary path. But without the supply side kicking in, it will be harder to reach the next set of targets of (inflation) going down to 5% by 2017 and 4% by 2018.
If we see inflation overshooting the 6% mark, could we see a relatively quick turnaround in the rate cycle?
I don’t necessarily think so. Depends on whether we see those factors as being temporary. We have to see how investment looks, how demand looks. So I don’t think it’s a straightforward answer.
What is your judgement of demand and growth conditions? Are you seeing an early recovery that is starting to stall?
I wouldn’t say that anything is stalling. I would say that if anything, there is evidence of pickup. You can see it in things like auto sales, some of the freight numbers are picking up. You look at passenger traffic in airlines—that has been picking up. So there are enough indicators that things are moving forward. However, I am most concerned about the lack of investment. You talk to all the bankers and they are not getting significant increase in demand for investment funding. That needs to be rectified over time if we want to get to a sustainable growth path.
Part of this has to do with low capacity utilization. But how much of it also has to do with high leverage on the balance sheets of these firms?
I think it’s a bit of both. Some of it because of overcapacity. Some of that overcapacity is also being driven by weak foreign demand. But another reason is that in some areas, especially as far as some of the big infrastructure projects go, the big entities are highly levered. That’s why we are encouraging them to do with this problem, which may involve selling assets so that they can re-invest in other places. The good news is that there are a bunch of players coming in who want to buy these assets. I meet some investors who have expressed great interest. With that and with banks taking a stronger role in cleaning up, that should help revitalize the sector. Infrastructure, real estate—if those sector pick up, they will create conditions for much stronger growth because they spur demand for steel, cement and labour.
Coming to the external sector, very simply, is the rupee overvalued? The real effective exchange rate index seems to suggest so. And the fear is that it is hurting the rupee.
Our position is that a lot of what you see in terms of export decline is primarily because of oil prices falling. There is some volume effect that we are also seeing, but a lot of it can be attributed to two other issues other than rupee overvaluation. One is that partner countries’ growth has slowed down and second is that in certain exports, such as iron ore, we have shut down for a variety of reasons. Remember that around the value of the rupee, other things also adjust. If the rupee is stronger for example and you are a software firm, you find it harder to compete so you are less liberal with your wages. On the other hand, if you find the rupee is weak, you pay higher wages. Inflation also adjusts itself. Other than fighting volatility, I don’t think our role is to determine the value of the rupee, contradictory to what reasonable people in the market would want. We let the market forces play out and in case we feel that large flows are changing the value substantially, we do intervene. By and large, I am not unhappy with where the rupee is.
At a student gathering, you mentioned that we should achieve complete capital convertibility in a short number of years. It led to quite a public debate. Could you expand on what you had in mind when you said that?
We have been making steady progress on liberalization, except during the period of volatility in 2013, where we went back on some policies. We have constantly been revising and reducing regulation. Even now, we are looking at all our market regulations to see if we really need some of the constraints and prohibitions and what we can do away with. This is so that we can get more people into the market and have a more liberal market. Let us not treat the speculator as an evil animal; he does provide liquidity and having some is not a bad thing for the markets. Given the general trend towards liberalization, when I look at what we need to get to full capital account convertibility, what it seems to me is that there are only two or three areas where we are less than fully convertible. One is on outflows from individuals and households. Today, if you want to take out $100 million a year, then you can’t. But you can take up to $1 million a year. As far as companies go, you can invest up to $1 billion without asking us for any permission through the automatic approval route. On inflows, we limit inflows into the debt market to over three years. But over time, that will also get liberalized. So there is not that much left in terms of being fully convertible. It’s not like China, where a household can only take out $50,000 a year for anything. We are 20 times that with about one tenth the reserves.
I would say that anywhere between 5-10 years, we should be fully convertible. The sequence would be to first reach macro stability and gain confidence on it. The next step would be to liberalize much more on certain fronts. I think our liberalization has always been opportunistic. We figure out where we can do it and we do it. But we won’t do it based on necessity, without fixing the issues around it.
What about liberalization on the ECB (external commercial borrowing) front in particular? The Sahoo Committee report had suggested doing away with ECB restrictions completely and replacing them with a mandatory hedging policy.
I am a little more wary about opening up at this point without any limits. I will tell you why. One, if it was easy to know how much people should hedge and to monitor that hedging, I think it would be a reasonable implication. I think if everyone borrowed ECBs and immediately converted them directly to rupees, it would be relatively easy to manage currency mismatches. The problem is that it is very hard to monitor that they haven’t offloaded or onloaded that hedge into a different transaction. Then you have to ask what incentive they have. In a stressed situation, especially when you do not have a stringent bankruptcy system, there is an incentive for people to borrow in dollars because interest rates are 2-3%, leave it unhedged and if the dollar strengthens tremendously against the rupee, you go back to the bank and say that sorry we made a mistake, now why don’t you take a hit. If the hit was entirely coming to the owner, they would have the right incentives to go out and do the appropriate hedging. If it does not come to the owner, it is a one-way bet. When you win you make out like a bandit, if the dollar appreciates, I go to my bank and ask them to take the hit. We have an asymmetric system and there you have to be a little more careful about the incentive structure.
If there is a global bond sell-off, will the Indian bond markets be hit by volatility, given that foreign investor holding in the bond market has risen over time? Also are you considering a review of the FII (foreign institutional investor) limit in bonds?
We have done a couple of things in terms of ensuring that the risk is limited. One is that we have pushed foreign institutional investors to the longer term end of the securities. So the FIIs in the market are not in the short end ,which is the most volatile one. Secondly, we have gone a little slow on increasing the limits. So my sense is that guys in there are those who view India as a long-term bet. Over time, we are certainly committed to increasing those limits.We have in mind that we would consider this every six months after we take a view on how things are progressing.
The top eight banks have restructured about 32,000 crore worth of assets in the fourth quarter alone. Isn’t that telling you that banks haven’t taken borrowers to task?
When the deadline (for regulatory forbearance) was coming close, it made sense to restructure so that you provision less, than have it determined an NPA (non-performing asset) and have it provisioned more. We expected there to be a rush when the forbearance was withdrawn. I think what is important, and it is something I have been stressing on, is that we have to recognize the problem and fix it.
We have done everything to say that you recognize and we will even reduce the provisioning, provided you recognize the problem. Tell the world that you have a problem and deal with it. We will also give you tools to deal with the problem, including taking equity and some additional time if you are changing the management. Our system is such that it is very hard to get a large promoter to see these choices. There are always ways to hold up a bank in court. So the banks themselves are fighting with one hand tied behind them and they are doing a good job given the environment. There are some very good promoters also, who have just had some bad luck. This is not meant to be an open season on promoters. What it is meant to be is that you have to learn to tell the good from the bad and make things work right.
In retrospect, do you think it was prudent to include existing projects under the 5/25 refinancing scheme? Considering that a lot of people are jumping on the bandwagon and there is fear that this might turn into an evergreening mechanism.
There are checks and balances, including a committee which has to give its approval on whether a particular asset being refinanced is a good thing. Also, the net present value of the asset has to be same throughout the duration of the refinance. Everyone is trying to get it relaxed, my point is that if the net present value is lower, then the asset is an NPA. So we are sticking to that. Thus far, my sense is that it has not become an explosion. Everyone wants it, but the checks we have put in place seem to be holding. The idea is not to have zero, but also not to refinance everybody who has stress regardless of the duration of the asset.
We were earlier discussing a good bank-bad bank structure. Is there any way that we can have this done to deal with the large chunk of infrastructure loans?
I would love to have a private sector-led bad bank, where some private equity or some asset reconstruction companies come together and try and form the good bank-bad bank structure. My worry is that if you do it through the public sector, almost immediately it will get entangled in allegations of corruption, of non-transparency, there will be litigations filed asking why did you buy a particular loan out? Just imagine the mess this would soon come to, especially given that some of the distressed assets belong in a big way to certain groups. It is not something that you want the government to go into in a big way. I think it is far better to let the banks deal with the problems collectively. Give them the capital to absorb some of the losses they may take and urge them to deal with it quickly.