In an interview with Manojit Saha, RBI governor Duvvuri Subbarao says he gave a long-term guidance on policy rates, so that investors can take informed decisions. Excerpts:
Given the uncertain global backdrop, how confident is RBI about the projections regarding growth and inflation?
We have to make projections of growth and inflation taking into account all the uncertainties. You cannot wish away the uncertainty. And the uncertainty today is more than what it was a year ago, for example. There were lot of uncertainties during the 2008 crisis and there are a lot of uncertainties today. In evaluating the nature of uncertainty today and that of 2008, I would say that the type of event shock that we had in 2008 is very unlikely. The problem today is the sovereign debt crisis in Europe and the fiscal deficit in the US and UK. So, we may have a process shock but no event shock like in 2008. We have also said one of the risk factors in our growth and inflation projections is the external situation. We have taken into consideration the uncertainties as much as we could.
What was the reason for such a long-term guidance?
There are two broad considerations behind today’s policy decision. First, regarding inflation, the headline numbers are still high but they are going to come down over the next two months. The momentum numbers are turning down. The quarter-on-quarter seasonally adjusted inflation, both for headline and core inflation, is turning down. The second was on growth; it has moderated more than it did three months ago, and we have to take that into account in our policy calculations.
The reason we have some guidance even beyond December is to manage expectations. We should give some indication of our assessment of the macroeconomic situation and how we will respond to that so that markets players, including potential investors, can make informed decisions.
Have you also considered the base effect while making an assessment on inflation?
Yes, certainly. Base effect is one, and there are other variables.
In the first six months of the financial year, the guiding principle was to moderate demand to bring down inflation. But now, are you of the view that supporting the supply side through a stable rate is also anti-inflationary?
I would certainly think so. Restraining demand is one remedy for inflation but that is at best a short-term measure. The more sustainable remedy for non-inflationary growth has to come from a supply response.
So, I would think if there is a supply response, that would certainly be anti-inflationary, indeed on a more sustainable basis and that is indeed what we have projected.
We have indicated in the document, as much as monetary policy is acting from the demand side, there has to be a supply response in terms of ironing out infrastructure bottlenecks, creating a more conducive policy for investment, accelerating structural reforms, etc.
Also, restraining demand beyond a point may not be feasible…
Yes, because restraining demand means restraining growth. And, there has to be a balance between growth and inflation and we are battling that for the last 20 months. The way we addressed the growth-inflation dynamics have changed over the course of 20 months.
How much time do you think it may take to enter into an expansionary policy mode?
Difficult to say but it would be fairly reasonable to predict that this interest rate regime will extend for some time before we think of cutting rates. Inflation must come to more sustainable levels before we can think of reducing interest rates.
You have got an extension in September for two more years. What is your main priority in this term?
That's a challenging question. Twenty two months from now, I would like to pick up the growth trajectory that we have left behind, with financial and price stability.
Why do you think it is the right time to deregulate savings bank rate? There is a view that such steps should be taken when interest rates are neutral.
If you go back to the last 25 years, can you think of a moment or a period of time, no matter how short, when you could have said interest rates are neutral and this is the ideal time to deregulate the savings bank interest rate? You could not have found a moment like that. So, there is never a right time in that sense. But we thought we have given adequate time for banks to internalise these and to prepare mentally and institutionally. We have been talking about it for more than one year. We have done enough of debate and discussion, we have to take a decision.
At this point of time, the competition for deposits will be less intense as it was, say, six months ago.
Do you expect volatility in the short run because of the deregulation?
Well, two answers to that. First, we have experience from the deregulation of term deposit rates. We had managed that reasonably well.
So, we might manage this even better because we have experience. Second, we have checked with banks and they have said it will not be disruptive.
It might be costlier, it may throw other challenges to them but it will not be disruptive. If it is not disruptive, the adjustment will be smooth. But it will be challenging for the banks, no doubt.
Savings bank rate deregulation may also come with higher transaction charges.
Since, RBI emphasised charges should be fair, will there be norms for charges?
Let this regime unfold without much intervention from RBI.
Should there be a major problem down the line, we will address it.
High interest regime has dented the asset quality of banks, which are flooded with loan restructuring proposals. Also, banks have requested the central bank for dispensation regarding loan recast. How big is the concern on the asset quality?
The asset quality of banks is always a concern for the regulator, regardless of what level it is. As far as the numbers go, the gross NPA has remained at the same level as on June 2011, when compared to last year.
But certainly, in times of stress when growth is moderating, when inflation is high for the last 20 months, assets will come under stress. As a part of our bank supervision, we are addressing that on a bank-by-bank basis.
What is the RBI's view on increasing FII investments in government bonds?
This issue is being discussed between the government and the RBI. We are yet to take a view.