Liquidity will remain tight: D. Subbarao
Five days after Duvvuri Subbarao stepped into the office of the Governor
of the Reserve Bank of India, Wall Street firm Lehman Brothers
collapsed.
Five days after Duvvuri Subbarao stepped into the office of the Governor of the Reserve Bank of India, Wall Street firm Lehman Brothers collapsed. Two years on, Subbarao, 61, has become the financial world's most admired central banker. He spoke to BT's Brian Carvalho and Puja Mehra about the RBI's strategy amidst the latest global financial developments. Edited excerpts
The RBI is the only central bank that has been ahead of the curve all along since early 2008. How do you do it?
We are the only country that is ahead of other countries in inflation. [RBI has been able to pick signals on macroeconomic developments early from the way inflation has moved.
Should India, as an emerging economy, be worried about the global currency war?
It was agreed amongst the finance ministers and governors of the central banks of the G20 countries at the ministerial [meeting] in Korea in October that "currency wars" is an unfortunate phrase. It should not be used. On a more substantive basis, India is quite different from other countries because we have a current account deficit [broadly, that means India is a net importer] unlike other emerging economies.
We have not been using intervention in the foreign exchange market as an instrument of trade policy. We have intervened for other purposes such as the management of exchange rate volatility and macroeconomic disruptions. We have also not used intervention to build up reserves for self insurance.
What is your view on devaluing currencies to support exports?
Some countries have been doing it but we believe in what was agreed in Korea, that exchange rates must be driven by market fundamentals save for situations like managing volatility.
Your November 2 statement says that there isn't much loss of competitiveness of exports despite the rupee's appreciation because currencies of competing economies are also rising. Is this likely to hold for long?
It is difficult to say, but let me put some numbers to that. Since March 2010, the rupee has appreciated against the dollar in nominal terms by 1.5 per cent. If we take real appreciation [against an index of 36 currencies], it is 0.4 per cent, which means that currencies of countries that are competitors to us have also appreciated. In as much as we have a current account deficit (CAD), the pressure for appreciation in our country will be lower than in countries that have surpluses. So, since the beginning of this fiscal year, the appreciation has not been much. But if we take a longer time frame, if we take 2009-10, there has been significant appreciation.
Has the rupee not appreciated much because the RBI has intervened in the foreign exchange market even if not for influencing trade?
No. I cannot say if we have intervened or not but largely the market adjusted. The CAD has also widened.
So, that means the economy's ability to absorb the higher capital inflows has increased? Will you say that the new normal CAD is four per cent of GDP rather than two per cent?
Yes, our absorptive capacity has expanded and that reflects in the widening CAD. It is possible to structure an economy where you have four per cent CAD, but the question is whether you can sustain a four per cent CAD year on year. You can argue, of course, that you have four per cent CAD, you invest that as foreign savings and that investment generates enough foreign exchange returns to service the external obligations. There is a limit to that argument.
The rising capital inflows are helping India finance the CAD right now... But do you think India could explore Brazil-like tools to curb capital inflows?
That will be the last resort. No option is off the table. We look at what other countries are doing. We look at all those instruments. But transaction taxes or URR [unremunerated reserve requirement] are options that we will not take to very lightly. We have a credible record of managing our capital account by using instruments of both quantity and price on the debt side, and we will continue to calibrate and use them. Extreme measures such as taxes and other requirements will be, as much as they are in the realm of possibility, the last options... Inflows are comfortable so far.
Are you comfortable with the FII-FDI composition?
Not precisely at this point, but the policy document says we must endeavour to seek the more stable, less volatile component of capital inflows. That is good for the economy. That is good for all of us.
In food inflation, does the leverage now lie with the government rather than the RBI?
Yes, absolutely. The standard view is that on food inflation, monetary policy is a blunt instrument except to the extent that persistent food inflation fuels inflationary expectations and can get generalised. So monetary policy has to step in. On top of that we have a structural dimension that food habits are shifting towards cereals. It is quite unconnected to the crop side. I think that will take a little longer to resolve.
Is the government taking enough steps to address the situation?
We have spoken to the government and I am sure they are quite sensitive to the need for managing the supply side issues.
Both frictional liquidity and structural liquidity are somewhat tight. December will see tax outgos and January has some big IPOs lined up. Your November 2 statement says the deficit in the Liquidity Adjustment Facility is outside the RBI's comfort zone. Is the market going to get tighter?
It is going to be in the deficit mode. That is what we said in the July statement, and reiterated in September. I expect it to stay so. That is consistent with an anti-inflationary stance. How much deficit is the question. We had not given an indicative number before. This time we said it has got to be plus/minus one per cent of the NDTL [net demand and time liabilities] of banks. According to the current numbers, that yields a target of plus/minus Rs 50,000 crore. Currently, the injection has been of the order of Rs 80,000 crore barring the outlier last weekend [owing to pressures from the Coal India public offer]. The government's cash balance is about Rs 80,000 crore so that balances out. Add the additional CRR [cash reserve ratio] banks are keeping with us, and there is enough liquidity out there. There will be tax outgos in December, but there will also be additional government spending. I am hoping deposits will pick up. Should we intervene in the foreign exchange market for managing volatility that will also give us liquidity. I want to reiterate we are not going to intervene in the forex market in order to infuse liquidity.
Does the inherently volatile IIP impair the RBI's action?
Not significantly, but it does impair our task of dissemination of policy action. RBI should not have any more information than the markets. There should be no information asymmetry. If IIP becomes too volatile and loses credibility, then different people are reading the same IIP differently.
The RBI is the only central bank that has been ahead of the curve all along since early 2008. How do you do it?
We are the only country that is ahead of other countries in inflation. [RBI has been able to pick signals on macroeconomic developments early from the way inflation has moved.
Should India, as an emerging economy, be worried about the global currency war?
It was agreed amongst the finance ministers and governors of the central banks of the G20 countries at the ministerial [meeting] in Korea in October that "currency wars" is an unfortunate phrase. It should not be used. On a more substantive basis, India is quite different from other countries because we have a current account deficit [broadly, that means India is a net importer] unlike other emerging economies.
We have not been using intervention in the foreign exchange market as an instrument of trade policy. We have intervened for other purposes such as the management of exchange rate volatility and macroeconomic disruptions. We have also not used intervention to build up reserves for self insurance.
What is your view on devaluing currencies to support exports?
Some countries have been doing it but we believe in what was agreed in Korea, that exchange rates must be driven by market fundamentals save for situations like managing volatility.
Your November 2 statement says that there isn't much loss of competitiveness of exports despite the rupee's appreciation because currencies of competing economies are also rising. Is this likely to hold for long?
It is difficult to say, but let me put some numbers to that. Since March 2010, the rupee has appreciated against the dollar in nominal terms by 1.5 per cent. If we take real appreciation [against an index of 36 currencies], it is 0.4 per cent, which means that currencies of countries that are competitors to us have also appreciated. In as much as we have a current account deficit (CAD), the pressure for appreciation in our country will be lower than in countries that have surpluses. So, since the beginning of this fiscal year, the appreciation has not been much. But if we take a longer time frame, if we take 2009-10, there has been significant appreciation.
Has the rupee not appreciated much because the RBI has intervened in the foreign exchange market even if not for influencing trade?
No. I cannot say if we have intervened or not but largely the market adjusted. The CAD has also widened.
So, that means the economy's ability to absorb the higher capital inflows has increased? Will you say that the new normal CAD is four per cent of GDP rather than two per cent?
Yes, our absorptive capacity has expanded and that reflects in the widening CAD. It is possible to structure an economy where you have four per cent CAD, but the question is whether you can sustain a four per cent CAD year on year. You can argue, of course, that you have four per cent CAD, you invest that as foreign savings and that investment generates enough foreign exchange returns to service the external obligations. There is a limit to that argument.
The rising capital inflows are helping India finance the CAD right now... But do you think India could explore Brazil-like tools to curb capital inflows?
That will be the last resort. No option is off the table. We look at what other countries are doing. We look at all those instruments. But transaction taxes or URR [unremunerated reserve requirement] are options that we will not take to very lightly. We have a credible record of managing our capital account by using instruments of both quantity and price on the debt side, and we will continue to calibrate and use them. Extreme measures such as taxes and other requirements will be, as much as they are in the realm of possibility, the last options... Inflows are comfortable so far.
Are you comfortable with the FII-FDI composition?
Not precisely at this point, but the policy document says we must endeavour to seek the more stable, less volatile component of capital inflows. That is good for the economy. That is good for all of us.
In food inflation, does the leverage now lie with the government rather than the RBI?
Yes, absolutely. The standard view is that on food inflation, monetary policy is a blunt instrument except to the extent that persistent food inflation fuels inflationary expectations and can get generalised. So monetary policy has to step in. On top of that we have a structural dimension that food habits are shifting towards cereals. It is quite unconnected to the crop side. I think that will take a little longer to resolve.
Is the government taking enough steps to address the situation?
We have spoken to the government and I am sure they are quite sensitive to the need for managing the supply side issues.
Both frictional liquidity and structural liquidity are somewhat tight. December will see tax outgos and January has some big IPOs lined up. Your November 2 statement says the deficit in the Liquidity Adjustment Facility is outside the RBI's comfort zone. Is the market going to get tighter?
It is going to be in the deficit mode. That is what we said in the July statement, and reiterated in September. I expect it to stay so. That is consistent with an anti-inflationary stance. How much deficit is the question. We had not given an indicative number before. This time we said it has got to be plus/minus one per cent of the NDTL [net demand and time liabilities] of banks. According to the current numbers, that yields a target of plus/minus Rs 50,000 crore. Currently, the injection has been of the order of Rs 80,000 crore barring the outlier last weekend [owing to pressures from the Coal India public offer]. The government's cash balance is about Rs 80,000 crore so that balances out. Add the additional CRR [cash reserve ratio] banks are keeping with us, and there is enough liquidity out there. There will be tax outgos in December, but there will also be additional government spending. I am hoping deposits will pick up. Should we intervene in the foreign exchange market for managing volatility that will also give us liquidity. I want to reiterate we are not going to intervene in the forex market in order to infuse liquidity.
Does the inherently volatile IIP impair the RBI's action?
Not significantly, but it does impair our task of dissemination of policy action. RBI should not have any more information than the markets. There should be no information asymmetry. If IIP becomes too volatile and loses credibility, then different people are reading the same IIP differently.
