D. Subbarao | We are not ruling out a rate increase


Mumbai: Reserve Bank of India (RBI) governor D. Subbarao said in an interview that the decision to cut the policy rate by 50 basis points (bps) was taken based on current data and is a strong signal to banks to cut loan and deposit rates. In future, all options are open, including further rate cuts or even a hike, depending on inflation-growth dynamics. Edited excerpts:
Textbook economics says central banks take policy decisions based on inflation expectations and not the prevailing level of inflation. You seem to be very hawkish when it comes to inflation expectations and yet you have gone for a deep rate cut. Is there a disconnect?
I don’t believe so. We have looked at inflation numbers and how much they have traversed from their highs. You must remember that we had done our last rate hike in October 2011, when headline inflation was 10% and core inflation was above 8%. We have to recognize that there has been a significant drop both in headline and core inflation numbers, and we also have said that over the last one-and-a-half years, our bias has shifted from inflation towards growth.
We have looked at the growth numbers and they have slipped from 7.7% (in the) first quarter to 6.9% (in the) second quarter and 6.1% in the third quarter. I don’t believe that we have changed our response function. We have acted in our best professional judgement.
You have said there’s limited scope for a rate cut in the future. Are you ruling out any rate hike?
Sending a signal: RBI governor D. Subbarao
I am not ruling out either a rate hike or a further rate reduction. We just gave guidance that based on our current understanding of how growth and inflation might roll out, and given that the trend growth rate is around 7.5%, the scope for further rate action is limited. But should the government adjust subsidized prices and should the external situation be better than anticipated, I believe there is scope for further easing.
So you are virtually ruling out any rate hike.
Well, I would not say that we are ruling out a rate hike; that’s also possible. But we have given guidance based on our best judgement.
In some sense, it’s a gamble on growth?
I don’t believe so.
After 13 rate hikes, inflation is still entrenched. Whose fault is this? Has RBI failed to contain inflation? Who do you blame for this?
Well, core inflation—which is the function of demand conditions in the economy—has come down below 5% to 4.7%. There is inflation stemming from supply-side shocks. In fact, food inflation yesterday (Monday) has gone up substantially and we heard the finance minister saying today that the government will take action…. It’s not a question of apportioning blame; it’s a question of sharing responsibility.
Incidentally, the finance minister pre-empted your policy. Half an hour before the policy was announced, at a Confederation of Indian Industry meeting in Delhi, he said RBI is going to take action. How do you react to that?
I have no comment to make.
Is this 50 bps cut a strong signal to banks to cut loan rates?
I believe so. In fact, one of the considerations between a milder policy rate action and what you consider a more decisive action is the impact it will have on transmission. We wanted to send a stronger signal and we found that the inflation print yesterday and the growth deterioration over the last one year indeed support a stronger action. So, both based on the growth-inflation dynamics as well as the need to send a strong signal on monetary transmission, we decided on a bigger reduction.
D. Subbarao talks about the the decision to cut rates, the problem of high inflation, and why banks should make their loans cheaper
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Have you got any assurance from banks on rate cuts?
No. We did discuss with them, but there is no assurance. You know that the central bank only gives the signal and allows the banks to respond; that’s how we are managing it.
The banks perceive that because the inflation expectation continues to be high, if they cut deposit rates, they will not get money, so they will continue to have high deposit rates….
Yes, which means the transmission will be muted. But our expectation is that for a number of reasons, including the bigger rate reduction, transmission would be effective. In fact, there is a statement like in all policies about the effectiveness of monetary transmission, how much it is translating into base rate.
The other thing that made an impression on me was what the State Bank (of India) chairman said. He said that the CRR (cash reserve ratio) reduction of January and March had not played into the system completely. That plus today’s action should make monetary policy quite effective.
Your money supply estimate is 16%. Where will the money come from? In 2012, it had been 13%.
Well, we will have to inject liquidity should that be necessary, and we have said that we will actively, proactively and appropriately manage liquidity if it goes outside the comfort zone conditions…
Through bond buying as well as cuts in CRR?
Well, yes. No option is ruled out.
Your comfort zone as far as liquidity in the system is concerned has been 1% plus or minus bank deposits, but continuously over the last one year that limit has been broken. Has the 1% limit lost relevance?
I don’t believe so. Last year, we had extraordinary circumstances—the government had raised its borrowing in the second half and we had to intervene in the foreign exchange market, and government cash balances built up in a lumpy manner more often than in the past. All these variables had made liquidity management more challenging than in a normal year. We are hoping that those circumstances will not repeat this year.
We believe you have approached the government with a plan to make its cash balance kept with RBI public and auction the money to banks…
Yes, those are issues that we are discussing with the government, but we are yet to reach a conclusion.
Do we expect to see it soon?
The motivation for disclosing government cash balances is that if market players know what the government cash balance is, they will have a more informed view of the liquidity constraints. I believe what prohibits us from disclosing it is the client-bank relationship—the relationship between the government and RBI. We need the government to waive that disclosure privilege.
One of the reasons your bond buying programme was not effective last year was your aggressive intervention in the currency market. You pumped in about Rs 1.3 trillion through bond buying, and an equivalent amount went out because of dollar sales. Will you stop dollar sales? After all, the rupee is overvalued.
I don’t think so. We have always said we will intervene in the market only to manage volatility and to prevent disruption to macroeconomic stability. Beyond that, I don’t think there is any other motivation for intervention in foreign exchange.
How long can you continue to manage the rupee, inflation and interest rates?
We treat the external sector and the intervention in the foreign exchange market on a stand-alone basis. We don’t intervene in the market for liquidity management or inflation management.
You seem to be concerned about the quality of assets in the banking system, but have not taken any action in the policy.
Well, there cannot be a dramatic action in the policy, and this is something that cannot be reduced by fiat. The asset quality has deteriorated because of the crisis, restructuring, low growth, low credit demand, etc. We have conveyed our concern to the banks and have also told them that their risk management systems will have to improve.
I believe, contrary to what you have said, there is something in Part B of the policy which is about setting up a working group to improve risk management in banks vis-à-vis impairment of assets.
You have waived the penalty on prepayment of floating-rate home loans. What about other floating-rate loans such as auto loans, where banks charge a penalty for prepayment?
We have to look into that. I believe this is the largest constituency and much of the complaints have come from the home loan side. But if there is some discrimination in some other sector, we have to look into it.
Finally, as governor, is there a change in your approach? The days of baby steps have gone now. You had cut CRR by 75 bps, and now this 50 bps rate cut, both bold steps. Is this a sign of maturity as a central banker?
Not really. The decisions are always taken based on the analysis of the Reserve Bank and my professional judgement. Whether it is my maturity or something else is for you to decide.

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