'Stronger action at this point might put some pressure on growth' - Subir Gokarn, RBI Deputy Governor

RBI has sounded very hawkish on inflation in recent times. The macroeconomic and monetary development (MMD) report released a day before the third quarter review said inflation was a dominant concern, while the governor recently said the central bank was desperate to bring down inflation. But a 25-basis-point rise is the least RBI could do...

Words like hawkish and desperate need to be placed in context. We are dealing with inflation of a variety of kinds. We are dealing with inflation related to domestic food prices, in that there are transitory as well as structural problems. We are dealing with inflation related to global commodity prices and, to some extent, inflation driven by domestic demand pressure. Certainly, we want to control inflation in the aggregate. But the use of instruments has to be related to the impact these will have.   So, on why an action of 25 bps as opposed to something stronger, we felt this was appropriate, given the price build-up in the non-food manufacturing segment, to us the best indication of demand-side pressures. Supply-side pressures, if they persist, will spill over and that is the risk we have pointed out. We are aware of that risk, we have repeatedly mentioned risks in the policy document and these essentially tell us we have to persist with the stance.  The actual action has to be seen in the context of the stance. The stance is hawkish. The stance is inflation is a dominant concern but the action is related to the specific circumstances we are dealing with today. Which is, there is some build-up of demand-side pressure, which we see in non-food manufacturing inflation, and stronger action at this point might put some pressure on growth, which we are trying to avoid. As the scenario unfolds, we will make our judgments and we have indicated the stance remains anti-inflationary, and this stance is not changing.

Was the high liquidity deficit a factor in deciding the hike?

It had a role, because one impact that persistent deficit is having is in making life a little difficult for banks, in terms of making long-term commitments (long term is anything beyond the immediate). That has taken call rates up outside the corridor. So, from a market perspective the deficit is somewhat tighter than the policy rates would indicate. In this situation, there was an assessment that a sharper action may have proved disruptive and we thought that was a risk we had to consider.

MMD said downside risk to growth had receded but today RBI spoke of moderation in growth.

MMD’s horizon is this financial year; it is not a very forward-looking document. It is designed to be a review. Looking at what happened in the last quarters, there are not too many risks that can take away the 8.5 per cent growth. And, here we are not giving a projection for the next year, we are giving a guidance. The guidance is simply an initial assessment of drivers of risks. When we look ahead, to some extent we see there are looming risks on growth coming from domestic and global factors, and that is what we have tried to point out.

Will the moderation mean the growth rate will be lower than 8.5 per cent in 2011-12, which RBI has projected for 2010-11?

It is too early to make that call. We will come out with the projection in the April document. There will be a base effect on agriculture which is quite clear. As of now, we expect the momentum in industry and services to continue. So, that might mathematically result in a slightly lower growth rate but not loss of momentum. But we have also highlighted risks, and those have to do with what is emerging as a somewhat unstable macroeconomic environment -- the inflation situation, the current account situation and the fiscal situation. Those are not base-line scenarios but are pointing out risks that are becoming visible, which may affect growth. That is a kind of downside risk.

Do you expect inflation to stay above your comfort zone in 2010-11?

We expect the impact of monetary actions taken so far and possibly taken in the future to keep the core inflation in check. If our baseline scenarios materialise, that is, we have a normal monsoon and some benefit from food prices and global oil prices don’t spiral out of control… but that’s a positive scenario. But if we are realistic about what is happening around us, there are these risks on the upside as well.

When do you see inflation coming back to RBI’s comfort zone?

It is a matter of how these risks materialise. I don’t have a forecast on how these risks are going to play out. It is certainly necessary for us to identify these and look at what impact they might have. That will shape our stance. But I am not in a position now to give a forecast.

Regarding the concern on high incremental credit-deposit ratio, is this a system-wide concern or related to some specific banks?

It is true for the system as a whole, because we have 24 per cent growth in credit and 16 per cent growth in deposits. But within this aggregate, there are huge differences across banks. That is why we have mentioned in the statement that we do plan to engage banks where the disparity is looking somewhat higher than the average. It is, therefore, both a system issue and a micro issue. We are telling banks these gaps are unsustainable; we do not intend to finance them by liquidity infusion. The measures we took for infusing liquidity in December had everything to do with frictional liquidity. There was build-up in government balances and for that we cannot penalise banks. But there is also the dimension that the gap between deposit mobilisation and credit growth, something inherent to the banking system, that’s a structural issue with the banking system. We have said we are not going to accommodate that gap in liquidity.

Is there a concern that banks are borrowing short and lending long?

That is the heart of the concern. If credit is growing at 24 per cent and deposits at 16 per cent, a large part of the gap is funded by borrowing overnight. That’s why the concern about sustainability comes up.

Do you expect lending rates to go up further?

That is part of the monetary transmission mechanism. From our view, having got liquidity in deficit, we would like to see policy actions on rates transmitting through quite effectively into lending rates. From our viewpoint, it is a desirable outcome. It is what we want to achieve in terms of putting a brake on the growth momentum, without disrupting it.

RBI moves gradually to contain inflation

Inflation continued to be the apex bank’s main concern. “The stance of the monetary policy is to contain the spill-over of high food and fuel inflation into generalised inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures,” RBI stated in its third-quarter review of monetary policy. The central bank also red flagged the high incremental credit-deposit ratio, which is at 102 per cent for the banking industry. “The message is exactly as we put out. We told banks that they must increase their deposits and they must restrain their credit. And the credit growth and the deposit growth have to be aligned. Additionally, we also said that we would monitor this very closely and use our supervisory responsibilities to ensure that those banks, which are far out of line, are brought in line,” said RBI Governor D Subbarao at a press briefing after the policy review announcement.

"Inflation is really our key priority" - Wipro Chairman Azim Premji

"Inflation is really our key priority. The hope is that we do not get knee-jerk reaction," Wipro chairman Azim Premji said. Several Indian corporate chiefs have voiced concern against excessive increase in interest rates as they fear that it could affect the pace of economic growth. They have used the recent deceleration in industrial growth to argue their case but RBI made its worries on inflation clear in the quarterly monetary policy review.

RBI warns of difficult times ahead

What the central bank seems to be saying s not just that we will have to live with high inflation and slower growth. What it also says is that inflation (and therefore higher interest rates) may deter consumption and investment, thereby affecting growth. Lower growth in turn could turn off the foreign institutional investor tap, lead to lower stock prices and affect tax collections, thus affecting the fiscal deficit, which again could lead to higher inflation. Faced with such a difficult scenario, all that RBI can do is confine itself to prevent “food and energy prices from spilling over into generalized inflation and anchoring inflation expectations”. It’s an admission that it has no magic bullet. RBI’s monetary policy statement clearly spells out the risks, not just to inflation remaining at an elevated level, but also to growth. This is what it had to say: “The combined risks from inflation, the CAD (current account deficit) and fiscal situation contribute to an increase in uncertainty about economic stability that consumers and investors will have to deal with. To the extent that this deters consumption and investment decisions, growth may be impacted. While slower growth may contribute to some dampening of inflation and a narrowing of the CAD, it can also have significant impact on capital inflows, asset prices and fiscal consolidation, thereby aggravating some of the risks that have already been identified.”