Reserve Bank of India Governor D Subbarao addressed a press conference after unveiling the third quarter review of monetary policy. Excerpts from the session:
Why did you decide to hike only CRR (cash reserve ratio) and not policy rates?
I must admit that this time, the policy decision was much more challenging. Getting out of an expansionary policy is incredibly more complex than getting in. It is like the chakravyuh in Mahabharata. You know how to get in but it is very difficult and not many people know how to get out.
During the crisis, tolerance for error was larger. But now, it is low and so we have to calibrate our policy carefully. We struggled with combination of price-based variables and quantity-based variables for this policy.
Four considerations guided us. First, inflation is driven by supply-side factors. Second, the recovery is not broad-based and we need to encourage investment to increase supply before the output gap gets closed. Third, we determined that the process of normalisation has to begin with absorbing liquidity. And fourth, a CRR reduction by 75 bps (basis points) will withdraw liquidity by a predictable amount, because if we had used an interest rate measure, the amount of liquidity we would be absorbing on a day-to-day basis would have been unpredictable.
Given the large amount of liquidity, we wanted to be certain about the amount we were going to absorb. We have done detailed calculations and it is our understanding that there will be sufficient liquidity in the system to meet the potential demand for credit from the private sector. Also, in the growth-inflation trade-off, it is important to recognise that while there is some trade-off in the short-term, inflation is inimical to growth if you look slightly beyond. We expect the CRR hike will anchor inflationary expectations without hurting growth impulses.
What was the response of bankers to the policy statement?
Banks generally welcomed RBI’s policy stance. They indicated that the monetary measures announced would not put immediate pressure on lending rates.
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Apart from monetary policy, the discussion centred around specific issues such as credit growth and monetary transmission, the government’s borrowing programme and infrastructure financing. Banks felt that credit growth prospects remained favourable. They indicated that they had reduced their lending rates in response to monetary easing. Consequently, their NIMs (net interest margins) have come under pressure.
NPAs (non-performing assets) are expected to rise, particularly from restructured assets. They felt that the government borrowing next year is large and may put pressure on resources and interest rates as credit is expected to pick up significantly.
You significantly raised your GDP (gross domestic product) growth projection. Do you think this can be sustained post the removal of some monetary and fiscal measures?
I cannot make an absolute and unconditional assurance. But we have made some assumptions about the fiscal stance of the government. We have also made a comment that the government must begin the process of fiscal condition.
In the last policy, we had pointed out that growth was driven by fiscal stimulus. Since then, we have more recent numbers. Starting with the second quarter, private consumption and private demand have started picking up. So, we are not so much dependent on fiscal stimulus as we were six months ago.
How much rollback of fiscal stimulus did you assume when you made your growth projection?
On the fiscal stimulus package, what we have said is that there is a transient component and a structural component. We have said that the government must begin a phased withdrawal of the transient component. On the structural component, there is the Sixth Pay Commission. Even as the central government has paid the arrears, Subir (Gokarn, RBI deputy governor) keeps telling me that state governments and public sector enterprises will now align their compensation structures with the commission’s recommendations.
What kind of government borrowing do you expect next financial year?
If we assume fiscal deficit at 5.5 per cent of GDP, the borrowing programme in net terms will be roughly equivalent to this year’s in absolute terms. In gross terms, it will be slightly higher because of redemptions coming up in 2010-11.
By all accounts, all of us know that the government borrowing next year will be more challenging than it was this year, for several reasons. First, private credit demand will pick up and threat of crowding out is going to be real. Second, we had taken several active liquidity management steps this year such as OMO (open market operation) sales and MSS (market stabilisation scheme) de-sequestering. These options will be limited going forward.
Third, inflation pressures are going to be stronger in 2010-11 than in 2009-10. So, government borrowing is going to be more challenging.
You people (the media) evaluate the movement in yield rates. While doing so, please reckon what would have been the rate on 10-year g-secs (government securities) if RBI had not done active liquidity management. It is true that in March 2009, yields were at 6.6 per cent and have gone up to 7.6 per cent today. We are going to manage the liquidity situation, we are going to calibrate our monetary policy to manage the borrowing in 2010-11.
When do you see demand pressures acting on inflation? Will that be the tipping point as far as interest rates are concerned?
It is difficult to say because we have a number of factors. We have said that inflation will start moderating from July 2010 onwards. We are hoping that we act appropriately in the next six months. But we must be supportive of growth till investments pick up.
RBI had cautioned about teaser rates. Is there any additional NPA fear from that side?
In our discussion with banks, there was no talk of teaser rates. Neither did banks feel that there will be a rise in NPAs due to this, although in some retail portfolios, there has been an increase in NPAs. As far as restructured accounts are concerned, there was some discussion. Overall, the view was that restructuring has helped prevent NPAs.
Banks said NPAs would come under pressure, but not (under) unmanageable pressure, and mostly from export-led SMEs.
RBI has expressed concerns over capital inflows. How will you tackle this issue?
So far, capital inflows are roughly corresponding to our current account deficit. As many of you know, we have not intervened in the market because it is our policy not to intervene unless there is volatility in exchange rates.
It is expected that capital flows into emerging market economies, including India, will increase. It is not clear what policy measures we will take to manage capital flows. As in the past, we will manage the capital account in a manner appropriate to the size and expected volatility of the flows.
What are bankers concerns’ on funding to the infrastructure sector?
Banks have significantly increased their exposure to the infrastructure sector. As a percentage of total banks advances, this has gone up from 3 per cent a few years ago to 10 per cent. And of that, 46 per cent exposure is to the power sector.
There is need for infrastructure financing but the whole risk cannot be taken by the banking system. So, we need to look at much more syndication, much more corporate bond market, etc.
What measures are banks taking to deal with asset-liability mismatches in lending to the infrastructure sector?
The banks have made certain suggestions. They way they are doing it right now is resetting the rates every year. But what they have asked for is long-term bonds which are tax-free. The government has to take a view on this.