Inflation expectations are still high: Rajan

Says stressed assets in the financial system continue to be high

Despite retail inflation for July falling to record lows, the country’s central bank still thinks inflation expectations are still high indicating its unwillingness to drop guard against price rise.

“While consumer price inflation has moderated, inflation expectations amongst the public are still high, creating a gap between the real rates that savers expect and the rates corporations think they pay,” Reserve Bank of India governor Raghuram Rajan said in a speech at the FICCI-IBA banking seminar.

High inflation expectation was among the three challenges that the country is facing according to the former chief economist of International Monetary Fund. Economic growth which is yet to recover and high level of stressed assets in the banking system are seen as the other two challenges.

Concern over inflation had made the central bank to take a long pause before cutting rates. RBI started reduced interest rate in January this year and till now it has reduced the repo rate by 75 bps. Banks are however reduced their base rate by only 25-30 bps in response to central bank’s action.

“Stressed assets in the financial system continue to be high, which holds back growth and new lending, even while dampening bank incentives to cut base rates,” Rajan said.

According to Rajan, the short term macroeconomic priorities of the central bank are in help growth to revive by bringing down inflation in line with the proposed glide path, thus creating room for monetary easing; and to work with the Government and banks on speeding up the resolution of distressed projects and cleaning up bank balance sheets.

“While low inflation for a while will lower the public’s inflationary expectations and increase their real disposable income, in order to achieve a sustainable victory against inflation the public has to believe that inflation will stay low even after commodity prices start picking up in the future,” Rajan said.

The governor has dismissed arguments made by his critics that the monetary policy is a blunt instrument which argues that supply side issues which causes inflation cannot be addressed with rate revision.

“Perhaps more informative is a recent study which suggests that the disinflation that has happened over the last year and a half follows from a combination of good food management by the Government, good luck because of external factors such as lower crude prices, and monetary policy, including the new framework.3 We believe this is a fair view of the disinflation so far, entirely uninfluenced by the fact that two of the three authors are from the RBI,” Rajan said.

The research paper which the governor mentioned is titled, What is Responsible for India’s Sharp Disinflation?”, which is authored by Sajjid Chinoy, India Economist, JP Morgan, Pankaj Kumar, and Prachi Mishra. Both Kumar and Mishra are from the department of economic and policy research of RBI.

On stressed assets, the governor admitted that the stress in the system is still very high. While RBI had initiated a host of measures, including a 5/25 schedule ( a 25 year loan can be given by a bank for 5 years and other banks can take it over every 5 years for four times which enables the lenders to share risk). However, the central bank had expressed its concern that the rule is not been followed true spirit and used by banks to evergreen loans. Now, the governor said new norms will be announced to improve the functioning of joint lenders’ forum. JLF is the group of bankers which is formed once a loan is overdue for 60 days. The mandate of JLF is to evolve a mechanism to resolve the stress.

“We have discussed the experience with the JLF with banks, and we will shortly announce some measures that should improve their functioning,” Rajan added