Common goal of both govt and RBI is growth: Raghuram Rajan
Reserve Bank of India Governor Raghuram Rajan spoke to a group of magazine reporters, including Business Today's Anand Adhikari, immediately after announcing his second monetary policy review.
Print Edition: Nov 24, 2013
RBI Governor Raghuram Rajan <em>Photo: Rachit Goswami/www.indiatodayimages.com</em>
Reserve bank of India Governor Raghuram Rajan, 50, spoke to a group of magazine reporters, including Business Today's Anand Adhikari immediately after announcing his second monetary policy review. Edited excerpts:
On the relationship between the RBI and the government:
(The RBI's) autonomy was strongly emphasised by my predecessor D. Subbarao, too. The finance minister was unhappy with a decision taken by somebody who was his direct subordinate and whom he appointed as the RBI governor…How much more autonomy can you get than that? It reflects the fact that you are independent. Now does that mean you never listen (to the finance ministry)? Of course not. You listen and you try and accommodate where necessary, where you are on the same page. Where you think you are on a different path, you try and distance yourself or you try and convince the other. The common goal (of both the finance ministry and the RBI) is growth with low inflation. But our view of the timeframe in which this will be achieved, and what is necessary for that to happen can be different from that of the government's. We have different views on some issues. I don't think there is lack of communication.
On high inflation persisting despite the repo rate being raised by nearly 400 basis points between March 2010 and October 2011:
Remember, we were hit by a number of supply shocks during this period. Oil prices and food prices went up. Rural wages increased because of a variety of reasons including construction activity and minimum support prices. You should ask what the inflation rate would have been if the RBI hadn't raised rates then. That's the question you cannot answer by just looking at the correlation. An interest rate hike does have an impact on inflation. Now, is our transmission mechanism as clear and strong as in the industrial countries? The answer is no, because the interest rate sensitive segment of our population is relatively limited and the interest rate sensitive sectors are relatively limited. But yes, interest rates do have an effect on inflation and we should not dismiss it.
On the need to tackle supply side issues to contain inflation with the same intensity the government showed in controlling the current account deficit (CAD):
The government explicitly talked about projections of the CAD. That made a difference. Everybody then started latching on to the CAD target of $70 billion. Second were the measures (higher duties) taken to control gold imports. They helped, they brought down one big element of imports. [On November 1, Finance Minister P. Chidambaram said he was confident of keeping the CAD at or under $60 billion] The third element was convincing the people about financing the CAD. We were in a situation where people thought we could not finance the CAD. That was when banks, companies and the government have access to international financing. The financing was never in doubt.
The real question was how much we have to raise through special means to compensate for any FII outflows. So that was feasible. But if you turn to the supply side, how do you build the supply chain across rural India? It's being built. I think the supply-side response will kick in but probably slower than all of us would like. But it will happen.
On his statement in the US on considering allowing foreign lenders to buy small banks in India:
The intent is to move foreign banks to the wholly owned subsidiary model because that is beneficial to us from a regulatory perspective. We cannot force them to convert from branches to subsidiary. We have to give them incentives. We promised in our earlier documents that we would give them 'near national' treatment. The important thing about 'near national' treatment is that their rights and privileges are on par with domestic banks. We will examine how they perform over time and see whether further privileges are warranted. Those privileges will not be anything more than what Indian banks enjoy.
What I said (about buying small banks), that's a possibility. It is something that will happen after we review the performance of foreign banks taking into account the needs of the system as a whole. We will put enough safeguards into the policy so that there is no chance of having a foreign-dominated banking system. At the same time, let us not be afraid of foreign banks bringing in more innovation capabilities. The system will benefit. This is not responsibility-free benefit (for the foreign banks). It is not a new policy.
I think the emphasis in the speech was on certain elements. Certain things got picked up and blown up more than was intended. But let us be clear that having a more competitive and innovative banking system is a benefit to everyone.
On the cost the RBI has to pay for its swap window for foreign currency non-resident deposits:
The subsidy comes out to be around $250 million on $10-12 billion. I see that as insurance. It is really not a cost if you look at the opportunity cost. If the alternative was doing a quasi sovereign bond issue, we would have paid the same amount of money in a different way. In the State Bank of India millennium bond issue some years ago, we have given them a guarantee. It was effectively a swap arrangement we have now. I don't think it's a net cost to the economy, but certainly we are paying it out from our coffers in an attempt to stabilise the economy. This worked in terms of changing the sentiment. The benefit is some of the exchange rate stabilisation is because of that, I think what we have saved on oil purchases because of a strong rupee (at 62 against the dollar versus 68 levels earlier). Look at savings in every other import items. A stronger exchange rate reduces the import bill considerably. If a central Banker can do it, it is the price worth paying.
On exports and agriculture driving growth in the second half 2013/14:
Exports have picked up even in the face of global headwinds. That gives me some reason for hope. But this is where one has to be a little cautious to take it for granted. So I have emphasised time and again that we cannot be complacent. We cannot say that all our problems are behind us. I am hopeful that markets have stabilised somewhat, but I will not take it for granted.
On asset reconstruction companies (ARCs):
There are a variety of issues with ARCs. What is true is that the amounts sold to ARCs have come down. I would also suspect that ARCs have not been able to recover as much on the assets in the past than what they would have liked to. We have to work on both fronts -- improve functioning of the ARCs and also improve sales to the ARCs. That is something we are looking at.
On the impact of interest rates on inflation:
Rate hikes do have an effect on inflation. There are long gaps and the transmission mechanism takes time. You don't see it simultaneously. We also have a lot of poor reasoning based on snap views of correlations. Unfortunately, this (view) is peddled to the public. The second misconception in public is that all inflation is just supply side. Let me put it this way. Even if it is only supply side, what they still say is that there is a gap between demand and supply. If your supply side is not reacting in a reasonable amount of time, that means you are going to have very high rates of inflation. That is because demand exceeds supply. Even if it is supply side, some action in quelling demand is warranted. We cannot sit back and let it go. We have to be careful. For instance, if you quell investment completely by raising interest rates to such a level you may prevent the supply-side response to act. You have to be careful.
On a target for the consumer price index (CPI):
We don't understand the (CPI) series that well. We don't understand the behaviour of that series. We don't understand how each component is captured in that series. And, of course, we don't understand how the series reacts, given the short interval that it has been in place, to the measures that we are putting in place. Given all these uncertainties why would I set a target? Because once I set a target, every time you think we are going to exceed that target, the market is going to panic and start pushing us into a corner and saying I want higher and higher rates to reach that target. This is true vice-versa.
On whether India is safe from the likely US tapering of its quantitative easing programme:
I would be completely failing in my duties as a central banker to say [that we are safe]. We cannot even think we are safe. The moment we think we are safe we are not safe. We have to be vigilant. We are better protected than we were in May. I hope when it actually happens we are even better protected.
On the relationship between the RBI and the government:
(The RBI's) autonomy was strongly emphasised by my predecessor D. Subbarao, too. The finance minister was unhappy with a decision taken by somebody who was his direct subordinate and whom he appointed as the RBI governor…How much more autonomy can you get than that? It reflects the fact that you are independent. Now does that mean you never listen (to the finance ministry)? Of course not. You listen and you try and accommodate where necessary, where you are on the same page. Where you think you are on a different path, you try and distance yourself or you try and convince the other. The common goal (of both the finance ministry and the RBI) is growth with low inflation. But our view of the timeframe in which this will be achieved, and what is necessary for that to happen can be different from that of the government's. We have different views on some issues. I don't think there is lack of communication.
On high inflation persisting despite the repo rate being raised by nearly 400 basis points between March 2010 and October 2011:
Remember, we were hit by a number of supply shocks during this period. Oil prices and food prices went up. Rural wages increased because of a variety of reasons including construction activity and minimum support prices. You should ask what the inflation rate would have been if the RBI hadn't raised rates then. That's the question you cannot answer by just looking at the correlation. An interest rate hike does have an impact on inflation. Now, is our transmission mechanism as clear and strong as in the industrial countries? The answer is no, because the interest rate sensitive segment of our population is relatively limited and the interest rate sensitive sectors are relatively limited. But yes, interest rates do have an effect on inflation and we should not dismiss it.
"We will put enough safeguards into the policy so that there is no chance of having a foreigndominated banking system. At the same time, let us not be afraid of foreign banks bringing in more innovation capabilities. The system will benefit...It is not a new policy"
The government explicitly talked about projections of the CAD. That made a difference. Everybody then started latching on to the CAD target of $70 billion. Second were the measures (higher duties) taken to control gold imports. They helped, they brought down one big element of imports. [On November 1, Finance Minister P. Chidambaram said he was confident of keeping the CAD at or under $60 billion] The third element was convincing the people about financing the CAD. We were in a situation where people thought we could not finance the CAD. That was when banks, companies and the government have access to international financing. The financing was never in doubt.
The real question was how much we have to raise through special means to compensate for any FII outflows. So that was feasible. But if you turn to the supply side, how do you build the supply chain across rural India? It's being built. I think the supply-side response will kick in but probably slower than all of us would like. But it will happen.
On his statement in the US on considering allowing foreign lenders to buy small banks in India:
The intent is to move foreign banks to the wholly owned subsidiary model because that is beneficial to us from a regulatory perspective. We cannot force them to convert from branches to subsidiary. We have to give them incentives. We promised in our earlier documents that we would give them 'near national' treatment. The important thing about 'near national' treatment is that their rights and privileges are on par with domestic banks. We will examine how they perform over time and see whether further privileges are warranted. Those privileges will not be anything more than what Indian banks enjoy.
What I said (about buying small banks), that's a possibility. It is something that will happen after we review the performance of foreign banks taking into account the needs of the system as a whole. We will put enough safeguards into the policy so that there is no chance of having a foreign-dominated banking system. At the same time, let us not be afraid of foreign banks bringing in more innovation capabilities. The system will benefit. This is not responsibility-free benefit (for the foreign banks). It is not a new policy.
I think the emphasis in the speech was on certain elements. Certain things got picked up and blown up more than was intended. But let us be clear that having a more competitive and innovative banking system is a benefit to everyone.
On the cost the RBI has to pay for its swap window for foreign currency non-resident deposits:
The subsidy comes out to be around $250 million on $10-12 billion. I see that as insurance. It is really not a cost if you look at the opportunity cost. If the alternative was doing a quasi sovereign bond issue, we would have paid the same amount of money in a different way. In the State Bank of India millennium bond issue some years ago, we have given them a guarantee. It was effectively a swap arrangement we have now. I don't think it's a net cost to the economy, but certainly we are paying it out from our coffers in an attempt to stabilise the economy. This worked in terms of changing the sentiment. The benefit is some of the exchange rate stabilisation is because of that, I think what we have saved on oil purchases because of a strong rupee (at 62 against the dollar versus 68 levels earlier). Look at savings in every other import items. A stronger exchange rate reduces the import bill considerably. If a central Banker can do it, it is the price worth paying.
On exports and agriculture driving growth in the second half 2013/14:
Exports have picked up even in the face of global headwinds. That gives me some reason for hope. But this is where one has to be a little cautious to take it for granted. So I have emphasised time and again that we cannot be complacent. We cannot say that all our problems are behind us. I am hopeful that markets have stabilised somewhat, but I will not take it for granted.
On asset reconstruction companies (ARCs):
There are a variety of issues with ARCs. What is true is that the amounts sold to ARCs have come down. I would also suspect that ARCs have not been able to recover as much on the assets in the past than what they would have liked to. We have to work on both fronts -- improve functioning of the ARCs and also improve sales to the ARCs. That is something we are looking at.
On the impact of interest rates on inflation:
Rate hikes do have an effect on inflation. There are long gaps and the transmission mechanism takes time. You don't see it simultaneously. We also have a lot of poor reasoning based on snap views of correlations. Unfortunately, this (view) is peddled to the public. The second misconception in public is that all inflation is just supply side. Let me put it this way. Even if it is only supply side, what they still say is that there is a gap between demand and supply. If your supply side is not reacting in a reasonable amount of time, that means you are going to have very high rates of inflation. That is because demand exceeds supply. Even if it is supply side, some action in quelling demand is warranted. We cannot sit back and let it go. We have to be careful. For instance, if you quell investment completely by raising interest rates to such a level you may prevent the supply-side response to act. You have to be careful.
On a target for the consumer price index (CPI):
We don't understand the (CPI) series that well. We don't understand the behaviour of that series. We don't understand how each component is captured in that series. And, of course, we don't understand how the series reacts, given the short interval that it has been in place, to the measures that we are putting in place. Given all these uncertainties why would I set a target? Because once I set a target, every time you think we are going to exceed that target, the market is going to panic and start pushing us into a corner and saying I want higher and higher rates to reach that target. This is true vice-versa.
On whether India is safe from the likely US tapering of its quantitative easing programme:
I would be completely failing in my duties as a central banker to say [that we are safe]. We cannot even think we are safe. The moment we think we are safe we are not safe. We have to be vigilant. We are better protected than we were in May. I hope when it actually happens we are even better protected.
