 "Ashima Goyal")
Ashima Goyal, an external member of the Reserve bank of India’s technical advisory committee and professor of economics at the Indira Gandhi Institute for Development Research, Mumbai, discusses a range of issues with Neelasri Barman. Edited excerpts:
Are we at the end of the rate hike cycle, at least for the time being?
Yes, I think so. The realisation from last year should be that there are many instruments to reduce volatility in currency markets. Other instruments are more effective than raising (interest) rates. Even if US rates rise, we should not see the kind of rate hikes we saw last year.
With a rising El Niño risk threatening the monsoon and inflation rising in March, what will be the trajectory, considering food is an important component of Consumer Price Index-based inflation?
There is a lot of uncertainty about that. It is not yet clear how El Niño, if it materialises, will affect the rains. A recent domestic forecast is the monsoon might be delayed but there might not be a severe shortfall. Since this is after a season when we had good rainfall, the water reservoirs are full. So, agriculture might be able to absorb a delay. The government has got huge foodgrain stocks, which can be used if we have a problem. Although a shortfall in rain is a negative, we have a number of buffers in place, so it need not have such a sharp impact on inflation.
It is important, though, to take immediate supply-side measures. We hope the new government will realise this. The outgoing government did not realise the criticality of food inflation because they were so focused on food security and building stocks, beside pumping money in agriculture. All these measures raised demand for different varieties of food but they did not give attention to the bottlenecks that prevented supply from adjusting suitably. In recent years, growth in agricultural productivity was high and a large percentage of land moved from cereals to horticulture. But bottlenecks in marketing prevented all this showing up as softer food inflation.
What is your view on inflation targeting as a singular mandate of the central bank?
Strict inflation targeting is absolutely not correct because flexibility is required to accommodate the large supply, external and financial shocks we face. The first step to targeting inflation is for an emerging market to be able to forecast inflation. It helps to anchor inflation expectations if you can explain what causes inflation.
In my interactions with the Patel committee, I had suggested flexible inflation forecast targeting. It is a natural progression from the current multiple indicator approach if it is made clear how the multiple indicators affect inflation forecasts. Despite flexibilities and paying attention to a large number of variables, there is a better anchoring of inflation expectations. There should be forecasting of all the variables that affect inflation. The sensitivity of the financial sector is another reason flexible inflation targeting is required.
Who should decide the tolerance level of inflation? The law makers or the central bank?
Finally, it has to be law makers because bureaucrats at the central bank might have too strong anti-inflation preferences as compared to what the population as a whole wants. The objective should be to implement the preferences of the citizens as a whole. Parliament is supposed to be the aggregator of those preferences. But there is need for dialogue between law makers and the central bank, particularly in technical issues.
Do you think the central bank has a level or a band on the rupee in mind and will try to hold it within that band?
RBI keeps saying the level for the rupee is market- determined and they intervene when there is excess volatility. But in the last regime, there was excess volatility. At one stage, the rupee depreciated so much and was almost near 70 to a dollar. It overshot its fundamental value. But I do not think RBI has a specific value of rupee in mind — RBI is interested in guiding the rupee towards levels determined by fundamentals. The rupee has to depreciate if our inflation is higher than the rest of the world. But it is incorrect to say RBI does not affect the nominal level; if the rupee moves too much, RBI will intervene. It cannot allow too wide a fluctuation in the rupee from equilibrium levels. Implicitly, RBI has a band in mind but it is a shifting band.
Are we at the end of the rate hike cycle, at least for the time being?
Yes, I think so. The realisation from last year should be that there are many instruments to reduce volatility in currency markets. Other instruments are more effective than raising (interest) rates. Even if US rates rise, we should not see the kind of rate hikes we saw last year.
With a rising El Niño risk threatening the monsoon and inflation rising in March, what will be the trajectory, considering food is an important component of Consumer Price Index-based inflation?
There is a lot of uncertainty about that. It is not yet clear how El Niño, if it materialises, will affect the rains. A recent domestic forecast is the monsoon might be delayed but there might not be a severe shortfall. Since this is after a season when we had good rainfall, the water reservoirs are full. So, agriculture might be able to absorb a delay. The government has got huge foodgrain stocks, which can be used if we have a problem. Although a shortfall in rain is a negative, we have a number of buffers in place, so it need not have such a sharp impact on inflation.
It is important, though, to take immediate supply-side measures. We hope the new government will realise this. The outgoing government did not realise the criticality of food inflation because they were so focused on food security and building stocks, beside pumping money in agriculture. All these measures raised demand for different varieties of food but they did not give attention to the bottlenecks that prevented supply from adjusting suitably. In recent years, growth in agricultural productivity was high and a large percentage of land moved from cereals to horticulture. But bottlenecks in marketing prevented all this showing up as softer food inflation.
What is your view on inflation targeting as a singular mandate of the central bank?
Strict inflation targeting is absolutely not correct because flexibility is required to accommodate the large supply, external and financial shocks we face. The first step to targeting inflation is for an emerging market to be able to forecast inflation. It helps to anchor inflation expectations if you can explain what causes inflation.
In my interactions with the Patel committee, I had suggested flexible inflation forecast targeting. It is a natural progression from the current multiple indicator approach if it is made clear how the multiple indicators affect inflation forecasts. Despite flexibilities and paying attention to a large number of variables, there is a better anchoring of inflation expectations. There should be forecasting of all the variables that affect inflation. The sensitivity of the financial sector is another reason flexible inflation targeting is required.
Who should decide the tolerance level of inflation? The law makers or the central bank?
Finally, it has to be law makers because bureaucrats at the central bank might have too strong anti-inflation preferences as compared to what the population as a whole wants. The objective should be to implement the preferences of the citizens as a whole. Parliament is supposed to be the aggregator of those preferences. But there is need for dialogue between law makers and the central bank, particularly in technical issues.
Do you think the central bank has a level or a band on the rupee in mind and will try to hold it within that band?
RBI keeps saying the level for the rupee is market- determined and they intervene when there is excess volatility. But in the last regime, there was excess volatility. At one stage, the rupee depreciated so much and was almost near 70 to a dollar. It overshot its fundamental value. But I do not think RBI has a specific value of rupee in mind — RBI is interested in guiding the rupee towards levels determined by fundamentals. The rupee has to depreciate if our inflation is higher than the rest of the world. But it is incorrect to say RBI does not affect the nominal level; if the rupee moves too much, RBI will intervene. It cannot allow too wide a fluctuation in the rupee from equilibrium levels. Implicitly, RBI has a band in mind but it is a shifting band.
According to RBI's monetary policy real GDP is projected to pick up from a little below 5% in 2013-14 to a range of 5 to 6% in 2014-15. In a scenario when we continue to face situations like domestic supply bottlenecks, stalled projects and uncertainties in global environment, what according to you shall drive this growth?
Our potential growth is much higher than what we have had for the last couple of years. But over the last one year I have been one of the most pessimistic regarding short-term growth because for the first time we have seen services growth fall. That is such a large share of the economy. Demand destruction has becomes so widespread that it is affecting services growth also. If we have a stable government and if they take some sensible measures then we should see recovery in growth. Investment has not fallen that much suggesting that as the output capital ratio rises, as staled projects turn around, growth could be around 7%. If the government doesn’t take actions then growth may be below 5%.
The deposit growth of the banking system has been ahead of the credit growth in last fiscal. Do you see a reversal in trend this fiscal considering healthy credit growth is a key parameter of growth in the economy?
It depends on what happens to credit. If there is a revival in credit then we could have more rapid credit growth. Rise in interest rates may have raised deposit growth. It is a healthy sign of better financial intermediation of savings.
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There are concerns that the CAD may again pick up. How big will this end up becoming a concern for the economy? Do you think it is a right move towards slowly removing the restrictions on gold imports?
Export growth shows some decline over the last couple of months. Our exports are linked to the global cycle. They recovered quickly after the Lehman crisis. But growth got affected in 2011 when the European crisis intensified because Europe is an important trading partner. They recovered last year with some signs of US recovery. What is hitting them now is the Chinese slowdown. We did take some good steps in terms of diversifying our exports destinations. But supply side delays need to be removed. Measures to improve exports will help in sustaining CAD in the longer-term. Internationally gold prices are softening and that is good for CAD. Higher interest rates and lower inflation will also taper household demand for gold. In the long-term there is a need for substituting away from oil consumption—reduction in oil subsidies is helping in this.
As per the Urjit Committee report the Monetary Policy Committee should be accountable for failure to establish and achieve the nominal anchor. Failure is defined as the inability to achieve the inflation target of 4% (+/- 2%) for three successive quarters. Considering inflation control also is depends on steps taken by the government to remove supply bottlenecks do you think this is justifiable?
This is a very long-term condition because at present they are on the glide path towards that 4%. This condition will come in only at a later stage. But three quarters may be too short given the kind of shocks we face.
The Urjit Patel committee asked the government to ensure that the fiscal deficit as a ratio to GDP (gross domestic product) is brought down to 3.0% by 2016-17. How realistic is this target and what shall ensure this?
We are well on our way to reaching that after the FRBM Act was implemented. Under Pranab Mukherjee the government did not take sufficient steps. But since P Chidambaram has come in and there were pressures from international rating agencies since the CAD was widening, we are seeing a strong commitment to bringing down the deficit.
What is your view on Monetary Policy Committee? Do you think, majority of members should be external and selected by the government or it should be on the lines of Urjit Patel panel's suggestions?
Most countries have a much larger monetary policy committee. It is necessary to have objective experts. RBI officers, government or political nominees, or industry insiders may all have a particular interest or bias. Some of the criteria used to select members of Technical Advisory Committee (TAC) are useful. They should be independent analysts with some academic or other expertise, and no conflicts of interest.
