Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan is hopeful that with interest rates at their current levels, the central bank will be able to achieve its target of lowering inflation measured by the consumer price index (CPI) to 6% by January 2016. If retail inflation drops to 6% before that, RBI will cut interest rates, he said in an interview on Wednesday. Rajan, 51, who left the key repo rate, at which RBI lends overnight funds to commercial banks, unchanged at 8% in Tuesday’s monetary policy review, also said his agenda includes bringing down the statutory liquidity ratio (SLR), or the proportion of deposits that banks need to invest in government bonds, from the current level of 23%.
“To the extent that the new government can provide an assurance that the fiscal situation is under control, we can move to bring SLR down, purely as a way of reducing distortions in the system. It is good for the economy if there is a credible, sensible fiscal consolidation path the new government lays out,” he said. Edited excerpts:
Your guidance says further policy tightening in the near term is not anticipated. Could you give us a sense of how near is the near term? Have we reached the end of the rate tightening cycle?
We should stick to exactly what we said, which is given the information we have, we think the policy rate is sufficient to put us firmly on the disinflationary path. If there are surprises occurring from change in data, and if the surprises are thought of as durable enough, we will have to act on it. Surprises can be on both sides—yesterday (Tuesday) for example, we had the CPI industrial rate coming in at an astonishingly low 6.7%. It turns out that food (price inflation) is still a big part. But the other factors start coming in—surprises which are positive for the economy. There could also be negative surprises, like crude shocks, etc.
Can you achieve 6% retail inflation by January 2016 without further rate tightening?
Our anticipation is that we will be firmly on the path. I think that if there are surprises we will have to act accordingly. But as of now, we believe the rates are set at a level consistent with the disinflationary path. You see, as disinflation kicks in, the effective real rate even at this policy rate will start increasing. That will create some disinflationary momentum.
We have seen some disinflationary impact in services. This is a new economy, this was not the economy two years back or four years ago. We don’t have very precise judgments. Nobody can have. Let’s wait and see.
Will you cut rates if inflation moves directionally to the 6% number by January 2016?
The reason we gave both the number and the date is that we want to make people comfortable for the pace of the disinflationary process. If, for example, we feel that with the current level of interest rates it would hit 6% way before January 2016, that would suggest the pace of disinflation may be stronger than we necessarily want and we would want to cut interest rates at that point. If, on the other hand, we find that inflation has come down but that in order to hit that 6% it would need to come down further, we would have less of an incentive to cut interest rates.
It’s not directional in the sense that we want to hit that number not before, not after, but around that time. So, the interest rates we set will have to be consistent with hitting that. If we can hit way before, we can certainly cut interest rates. If we find that we are going to hit it way after, we will have to raise interest rates.
You have reduced banks’ access to daily repo (overnight funds) but increased the access to term repo (periodic auctions through which RBI infuses liquidity into the banking system). As term repo rate is auction-based, you’re making the repo rate less relevant.
Not really. Remember, the minimum bid for term repo is the repo rate—we are setting a floor. Second, there will be some access to some liquidity at that rate. Third, we said again and again our intention is to provide as much liquidity through term repo as necessary to bring the call money rate (the rate at which banks lend overnight funds to one another) close to the repo rate.
So the repo rate is our effective call money rate. Now the term repo may be 15-20 basis points over the rate. Our intention is to put into the market as much liquidity possible as necessary to make the call money rate hug the repo rate as far as possible. (One basis point is one-hundredth of a percentage point.)
Banks’ compulsory bond holding now is 23% but they hold close to 29% and up to 24.5% holding, they do not need to trade.
We will look at both those issues. To the extent that the new government can provide an assurance that the fiscal situation is under control, we can move to bring SLR down, purely as a way of reducing distortions in the system. We can’t bring it down so far that we hit liquidity coverage ratio limits, but we will bring it down to the extent we need, consistently and prudentially. It is good for the economy if there is a credible, sensible fiscal consolidation path the new government lays out.
Are you concerned that the rupee is getting over-valued?
There is a range of tolerance, and you can’t be overly reactive to numbers within that range of tolerance. I can’t give you a specific range but let me give you an example. There was a study done by a couple of economists in the finance ministry when I was there, which basically said that 60-62 was a reasonable range given the CPI inflation etc. It’s very hard to know what is the equilibrium range, because there are various factors—inflation, competitiveness, productivity. And today I would say that if we were at 55 (against the dollar), it would be too strong. In the summer of last year, I said 70 (against the dollar) would be too weak.
A 2012 World Bank working paper says only 35% of Indian adults have access to formal banking services. If indeed financial inclusion is the mantra, how many new banks do we need?
We certainly need a certain number of universal banks—big banks that can take on large projects because of our infrastructure needs, that have those kind of capabilities. But as far as inclusion goes, what is the best way to do it? Is it through these universal banks? Some people would say yes. They feel confident if they go to, say, an SBI (State Bank of India) branch. But could it also be through some sort of a payment bank? Could it be through a relationship between a universal bank and a mobile company? Could it be through a local bank? Could some finance companies turn into local banks? Could some urban cooperatives turn into commercial banks? We have to explore all these possibilities.
How critical is the issue of capital of state-owned banks?
I think that capital is important. The government will have to find a way to contribute its share, or at some point decide that it has to give up some of its share. That’s a constraint they will face. I think what is important from the perspective of public sector banks over the next five years is to create more confidence in the profitability and governance, so that they can sell their shares at a healthy price and thereby raise capital through the normal processes. First, increase profitability; second, increase the anticipation of profitability by improving governance and the management structure. Those are things that we are talking to the government about. There have been some discussions and as the new government comes in there will be more discussions. I am not worried about capitalizing the public sector banks, if there is an appetite for reforming the governance and management structures. I think capital will then come in. The problem will arise if there is no appetite for reform. Many of the public sector bank CEOs know what needs to be done, but they need to be given the space and time to do what is needed. So it’s not so much ownership which is the issue but whether the current ownership allows the flexibility needed.
Will bringing down the government stake in state-owned banks be a crucial part of these reforms?
It’s not necessary. There are other ways. The issue is of giving public sector banks the freedom of action. That could be done by bringing down stake or changing the way the stake is held. For example, creating a layer, or a holding company, between the government and the bank, which makes it easier for public sector banks to move away from the need to adhere to the government’s rules on a number of issues.
None of the systemically important foreign banks have opted to create Indian subsidiaries, even though RBI said that is preferable.
We never set a time on that issue. I am not overly worried about the risk of foreign banks. Over time, we want to make ourselves less subject to contagion from outside and, therefore, we would want them to move towards the subsidiary structure. Some of them have raised questions around (lending to the) priority sector and so on. As we address those issues, we will look at them. I also think that right now they don’t see the branching freedom that is being given. But I have no doubt that as some of them see the growth in second tier and third tier towns, (they) will be much more interested. We have given them some carrots but right now they don’t find those carrots particularly tasty. Some of them are still evaluating the issue. That may also have to do with the nature of the economy. Eventually if we feel it is a systemic risk, we can always exert our authority as regulator.
Most of the macroeconomic indicators have stabilized. What, at this point in time, are the key risks?
It’s work in progress. I think there is a lot more to do. We have just started on the disinflationary process. We were blessed or lucky, with a few months of lower vegetable prices. But we need to wait to see if it feeds into the remaining parts of the economy.
There are bad loans in the banking system; projects need to be revived; banks have to recognize losses that are on the way and not evergreen loans.
The health of the public sector banks is another issue. It’s not a systemic issue because ultimately the government will back them, but it is an issue from the tax payers’ perspective.
There are also a lot of structural reforms that you need to think about. How do we achieve inclusion? Why are people accessing finance via chit funds, etc, because they do not have access to the system. Can we reduce the cost of transaction? Can we reduce the cost of opening an account? Can we make KYC (know your customer) norms less of a box-ticking exercise?
How are you viewing the possible change in government?
The RBI is a regulatory organization. It is run by technocrats. We are apolitical. We don’t take a political stance either way. Whatever new government comes, we have to build a relationship with that government. The most critical relationship, in the interest of the health of the economy, is between the finance ministry and the RBI. It’s not a one-way relationship but it’s an important relationship to make things work smoothly. That is something we will have to work on. Usually a number of the bureaucrats in the finance ministry stay on, so relationships that have been built with the bureaucrats will continue. So the key relationship that has to be rebuilt is with whoever happens to be the finance minister.
