Mumbai: Reserve Bank of India (RBI) governor D. Subbarao on Tuesday ruled out a reversal in the Indian central bank’s monetary policy even if inflation drops to 7% by March 2012 and remains at that level for months. After presenting the quarterly review of monetary policy to bankers, Subbarao said in an interview, “It’s not clear what would be the triggers and what would be the macroeconomic environment that would prompt a reversal (of the policy),” but it will be a wrong inference that RBI will start cutting rates when inflation drops to 7%. “Because we have said in the policy document that the long-term inflation should come down even below that. So 7% is not the threshold.”
The governor also ruled out selling dollars in the foreign exchange market to stem the depreciation of the Indian currency as a tool to fight inflation. A depreciating rupee pushes up the cost of imports and many analysts have been advocating aggressive RBI intervention to fight imported inflation, but Subbarao said, “Intervention in the foreign exchange market is guided by other considerations. That is a different ball game... We will not prevent depreciation of rupee as an anti-inflationary policy.”
Defending RBI’s guidance that the possibility of a rate hike in December is “relatively low” and a “further rate hike may not be warranted” if inflation does not remain high, he said, “The motivation for the guidance was to give some certainty and predictability to investors so that they can take informed decisions.”
Edited excerpts:
The real surprise of the policy was not the rate hike, but the deregulation of the savings rate. What prompted you to do that?
All interest rates are deregulated, and this is the last interest rate to be deregulated. We have to do it some time; that’s the way forward. It was on the cards.
We have been discussing it for longer than one year, and we had put out a discussion paper in April 2011. So, banks had enough time to understand this, and mentally and institutionally prepare for the response.
What is the correct time to this? There is a never a correct time for this. Even if you go back 25 years, can you think of a precise time when you could have said this is the right time to deregulate savings bank account rates? We thought that we had given the banking system adequate time and this is a good enough time to do this.
You had given the impression that you would free the rate in phases, but have done it at one go.
Yes, there was one alternative under consideration—that was do it in two phases. In the first phase, deregulate the rate but keep a floor, and in the second phase, remove the floor. Such suggestions were made by some people, but we thought it would be better to deregulate it completely. There is not much to gain from setting a floor and removing it. The banks have told us that there is going to be a challenge, but it is not going to disrupt the system.
Have you done any cost analysis— what kind of hit the banks will have to take?
Internally, there have been calculations, and for some banks, cost may go up, and (for) some others, cost may come down. But the banking system as a whole and individual banks will be able to adjust to it.
There is a change in the stance of the policy. So far inflation has been the only concern and you have been blaming the government for fiscal management, but now you are almost silent about the fiscal side.
I will think that’s a misreading of our policy stance and monetary policy direction. It is very clearly written in the document and we have reiterated in the policy today that there will be two considerations that will form this policy. First is core inflation. The headline numbers are high, but the momentum is downwards. The second is, of course, growth.
We said explicitly (that) growth is moderated and as much as some decline in growth is a necessary cost to pay for bringing inflation down. At some point, we have got to balance growth and inflation considerations.
To the second part of your question, which is the fiscal deficit dimension of the inflation management, we have said that clearly even in this document—how fiscal deficit adjustment is necessary to bring inflation down and how fiscal expansion is adding to inflation concerns. To my understanding, we did that in this statement as in other statements.
On the one hand, we have a tight money policy, and on the other, a loose fiscal policy. The document talks about the oil subsidy and so on. How do we get out of this vicious loop?
I wouldn’t call it a vicious loop. But certainly we are having a tough time, where there has been monetary tightening unaccompanied by fiscal tightening. The government is having its fiscal compulsions, but I can say that the government is deeply sensitive (that) there is a need for fiscal consolidation. We expect and hope that in the mid-term statement in Parliament and in the budget for 2012-13 that the finance minister will announce in February (that) there will be more credible and contestable steps for fiscal consolidation.
You have hiked the policy rate, but balanced it saying the likelihood of a further rate hike is relatively low. In some sense, it looks like a wasted hike as your guidance has killed its effect.
I wouldn’t say it is a wasted hike. See, there was this current inflation situation, which is 9.7% WPI (Wholesale Price Index-based inflation) and it’s going to be at this level in the next two months. So if RBI had paused now, there was a risk of fuelling inflationary expectations. So we took action now.
About our guidance for December and thereafter, we thought that given our shift in inflation and growth (dynamics), we had to give a certainty to potential investors about the inflation and interest rate environment. The motivation for the guidance was to give some certainty and predictability to investors so that they can take informed decisions.
Are you certain that inflation will come down after two months?
Well, I’m reasonably certain and that is the expectation (of RBI).
Will we see a reversal of policy after March if inflation drops to the targeted level of 7%?
No. It’s not clear what would be the triggers and what would be the macroeconomic environment that would prompt a reversal (of the policy). But certainly, you cannot go away with the impression that March 2012 will be a marker when interest rates will start coming down. Certainly not. That will be a wrong inference. Because we have said in the policy document that the long-term inflation should come down even below that. So 7% is not the threshold.
How will you manage the government’s huge borrowing programme in the second half of the fiscal year? There is not enough liquidity in the system to support it unless you find ways.
Well, there are a number of options before us. I will not go into them, but the broad indication is that the systemic liquidity must be managed in the range of plus-minus 1% of the NDTL (net demand and time liability, or the banking system’s deposits). That remains the guidance. So if there is a systemic deficiency beyond that, we may take some action. That is the only guidance going forward.
Will you go for buying bonds through open-market operations or increase the foreign investment limit in buying government paper?
There are options, you know...
The rupee has lost about 12% since January and the depreciating local currency is adding to inflation. Will you use intervention as a tool to fight inflation?
Depreciation of the rupee certainly adds to inflation and that’s well known. But will we intervene (in the foreign exchange market) to prevent depreciation, or to stop depreciation, or to reverse depreciation as an anti-inflationary tool? No. Because intervention in the foreign exchange market is guided by other considerations. That is a different ball game and different segment of the policy. We will not prevent depreciation of rupee as an anti inflationary policy.
Are you concerned about rupee depreciation?
We must remember that rupee depreciation has nothing much to do with our economic fundamentals, but with external situations. As the external situations unwind, some of the depreciation will unwind. We should be worried or concerned if it has to do with domestic developments.
Tamal Bandyopadhyay & Dinesh Unnikrishnan
CAclubindia
