A day after his half-yearly monetary policy review, Reserve Bank of India (RBI) Governor Duvvuri Subbarao met with Chaitanya Kalbag and Anand Adhikari to explain the intent of the bank's policy actions. He also spoke about the growth-inflation debate and the perceived differences between the central bank and the finance ministry. Edited excerpts:
Q: What has made you so resolute in the face of so much pressure to lower interest rates? A: First of all, I want to say that all the criticism that we face is legitimate criticism, it is par for the course. Criticism is value adding, so I have sympathy for it. But there are different points of view. Also it is not correct to say that inflation has not come under control. It has not come down as much as we want, but certainly it has come down from the high of 10.9 per cent in 2010 to 7.5 per cent, averaging over the last several months. We believe that we can bring it down further and we need to bring it down - this is a poor country and inflation is a regressive tax on the poor. We need to bring inflation down. And I believe it is possible to bring inflation down through monetary policy action supplemented by supply response from the economy, which has to be managed by the government. So, together, the government and RBI can bring
inflation down. RBI through demand compression in the short term, and the government by managing the supply response for economic expansion in the short to medium term.
Q: What do you expect in terms of a supply response ? A: First, on
infrastructure. India is unique in the sense that we are one of the economies in the world that is supply constrained. There is shortage of infrastructure both in quantum and quality. We need to improve that so that corporates become more competitive, so that economic production becomes more competitive.
Second, we need to improve supply of food, especially of protein foods. There were some initiatives in last year's budget, and also in this year's budget, to encourage more efficient production of food - protein, pulses, edible oil etc… That must be taken forward.
Third is skilled labour in the country. It is one thing to have a huge labour force but another to have a labour force that is not adequately skilled. The skill shortage is going to be a big threat going forward. We need to focus on that. These are some of the important supply constraints.
Subbarao: We continue to be concerned about food inflation because if you just look at the food basket, even as vegetable prices have come down, prices of cereals have gone up.
A: We have said earlier that announced policies must be translated quickly in order to inspire investment. From the RBI, I do not have a very good sense of what is happening in the field. But from what we hear and what we read, we gather that there are delays in getting permission and approvals. There are delays in getting land. These are essentially governance problems and they need to be resolved in Delhi and the state capitals, and most importantly, at the district level. Then, all the linkages; we talk about so much installed capacity lying idle in the power sector because the linkages have not been established. We need to do that.
In the first instance, since you asked me what can be done in the short term, we must be focusing on those which give us largest marginal returns. Whatever capacity is already installed must be put into production.
Q: You mentioned in your monetary policy review statement that capacity utilisation has fallen drastically. Do you feel there is a danger of stagflation occurring? How real is that fear?
A: I don't think the fear is real. Stagflation is characterised by low growth and persistent high inflation. Admittedly, our growth has moderated and inflation has been stubborn. But you must also recognise that the output gap that we see is quite recent. It is quite small and it is shrinking. So, it will be incorrect to say that we are in a stagflation situation. As I said, if we generate the supply response, inflation will come down and growth will increase. That is in the realm of possibility.
Q: Do you feel there is a need for some austerity?
A: Austerity is always important. Austerity is a value. But when you look at in terms of numbers, savings that austerity can get are quite small. But, as a value, we should promote austerity.
Subbarao: I think there is a strong case for inflation indexed bonds
A: I have no specific response to that characterisation of the political economy situation. When I was speaking about austerity earlier, I was speaking with reference to the austerity measures the government institutes and not in the larger context of fiscal austerity, as is being spoken about in Europe today. If in Europe, it is fiscal austerity versus growth, I believe that in India, it is fiscal austerity for growth. We need fiscal consolidation. That will help rein in inflation. That will make credit available for the private sector. So, the government must spend only in those areas where it needs to spend. Beyond that it must leave it to the private sector.
Q: Is there a compelling case for inflation-indexed bonds in the light of inflation risks? A: I think there is a strong case for inflation indexed bonds. That is good for investors, savers, the RBI and everybody watching the inflation numbers… because you have a better assessment of inflation expectations. It is good for external sector management. The demand for gold, which has driven up the current account deficit, will come down. But there is concern about introducing an inflation indexed bond at a time when inflation is quite high.
Q: But it wasn't a successful experiment when launched in 1997... A: There were some design defects. The principal was not indexed and only the interest was indexed. But now, that's been fixed. The more important point is that it is a conundrum. You don't want to do it when the inflation is high because you have to pay too much. You don't want to do it when inflation is low because there is no incentive to do it. We keep talking about it, but we never do it t. We have to take the plunge and do it.
Q: Going back to the issue of inflation, I remember when Mr. Chidambaram was finance minister earlier, he was arguing that high inflation was not such a high price to pay. Now, he's also saying that we have to worry about growth as much as inflation. What's your thinking on this?
A: We tend to oversimplify this. That it is growth versus inflation - if you want growth, you have to sacrifice inflation or you have got to tolerate high inflation. I don't think we must define the debate on those terms. The terms of the debate must be changed. We must all understand that low and steady inflation is necessary for securing our medium-term growth. Only in an environment of low and steady inflation can consumers, and more importantly, investors, make informed decisions. And that's very important to keep good growth. RBI's effort at reining in inflation is not to the exclusion of growth but very much focusing on growth.
Q: So, do you feel very lonely right now?A: I don't feel very lonely. I think people are making too much of the finance minister's response to our policy action. After all, we have shared goals. Both of us want high growth and low inflation. And there is a division of responsibilities. There is a point of view that we must walk together. But, you know, what is called walking together is understood differently. I think that will be resolved in the course of time.
Q: Given the widening fiscal deficit, is there any room for a rate cut in 2013/14? A: I think 2013/14 is a long way off to stick my neck out. It will depend on how growth and inflation pan out in the course of 2013/14. We have given guidance for the last quarter, to say that there is scope and opportunity for further easing if inflation and growth move along the expected trajectory. We will give out the numbers for 2013/14 in April, but my uninformed view at this point of time, is that growth will increase, inflation will start declining even more rapidly, and that we will be moving towards a more conducive macroeconomic environment in 2013/14.
Q: It is quite extraordinary that you are almost predicting a cut in the first quarter of next year. Is that usual?
A: It is not usual for us, but that was deliberate. We started giving guidance, consistent with the best practice of central banks around the world. At a time of uncertainty, giving definitive guidance is more challenging.
In an uncertain situation, giving guidance becomes more challenging. But in an uncertain situation, giving guidance becomes all the more necessary. Central banks in advanced countries, particularly in the US, give a very definitive guidance about the policy interest-rate regime for the next two years, in order to manage the growth process. Similarly, in giving guidance for the fourth quarter, we decided that we must be as definitive as possible. Because even as we maintained an anti-inflation stance in this policy, we wanted to say that we are concerned about growth, and within the scope available, we will support the growth process. So, it is important to give that guidance and that's why we did it.
Q: While inflation of food items has fallen, it is going up for manufactured products… A: We continue to be concerned about food inflation because if you just look at the food basket, even as vegetable prices have come down, prices of cereals have gone up. Protein price inflation is still high. On the food side, there is a structural factor which we must address. That will be the sustainable solution to the food inflation problem.
On non-food manufacturing inflation - core inflation - metal prices have gone up, and, in general, input prices have gone up, because many of them are imported and the rupee has depreciated, so there is inflation coming in from there. It's important that global prices soften and it's important that our exchange rate is stable, so that the cost push pressures from imported inflation are not transmitted to the domestic economy.
Q: But globally it doesn't look like things are going to get better in a hurry… A: Absolutely, especially on the food side. In the large food-producing countries, there is a drought-like situation, there are price pressures. Our food market is quite closed, but some of this global pressure will transmit to domestic prices, especially on items that we import, such as edible oils, but even on commodities that we do not import.
Q: You are at the helm at a very, very difficult period. Do you honestly feel that this country can call itself economically advanced in the next 10 to 15 years?
A: Well, economically advanced is a different ballgame. But certainly, this country has the potential to grow much faster than we are now growing. And we need to grow much faster. The fundamental drivers are intact. We have the demographic dividend, which we have to exploit, we have the entrepreneurial talent, we have productivity. We have a large middle-class - the demographic dividend will come from there. And we have the capacity levels. So, I believe that the fundamental drivers for faster economic growth are intact. This country's promise is still there to be tapped.
RBI Governor Duvvuri Subbarao 
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