 "Aim to manage CAD without any distortion: Raghuram Rajan")
At a press conference after the announcement of the central bank’s monetary policy review, Reserve Bank of India Governor Raghuram Rajan explains the reason behind the status quo on policy rate. Edited excerpts:
Rationale for pause
I think it is important to resist the labels of dovish, hawkish, etc. We are primarily trying to calibrate the monetary policy to target inflation in an environment in which the economy is weak. When we take action, we have to be convinced it is merited at that point. When there is lot of uncertainty, you wait for more data to come in, to get a sense of how we want to act. Any monetary policy action is determined by a variety of variables. A rate decision does not depend on a particular indicator but a variety of indicators… We need to see substantial softening in both headline inflation and some momentum in the right direction in core inflation.
Supply-side impact on inflation
Food inflation
What we are saying is we should not react to every spike that is temporary. Monetary policy operates with a long lag, about three to four quarters. So, whatever we do now will affect output a few quarters down the line. We’ve to be sure we are dealing with a longer-term phenomenon, rather than short-term spikes. The data we have access to, from a sample of metros, show vegetable prices are coming down sharply. In that sense, our view is it (the recent increase in inflation) is a spike. Our belief is as long as we reiterate our commitment to (fight) inflation, one should not doubt our commitment.
Concern on growth
We will look at the growth number. Our sense is even now, growth is below potential. The effect of a negative output gap can be seen in inflation numbers. If this is not seen and if transmission is not taking place, we have to query our assumptions… that will be an important factor.
We feel in the second half, growth will be better than in the first. The factors playing out are agriculture, exports, and stalled projects coming back in line. It is important, however, that everybody, the government and RBI, be vigilant o the growth scenario.
Monetary transmission
When RBI had reduced the rate, it wasn’t transmitted. There seems to be a lag in the system or a lack of response. I think we will have to calibrate policy to circumstances.
Fiscal deficit
The government has reiterated its commitment to contain fiscal deficit many times. My own discussions with government officials suggest they are very firm on achieving it (the March-end target). Given where we are, that will mean a certain amount of expenditure contraction in the fourth quarter. That will have some adverse effect on growth but that is a part of what they need to do, in terms of the numbers they have set out. An increase in disinvestment and greater revenues from state-owned companies will help meet the deficit target.
Comfortable CAD
The external environment is not something we should be complacent about. We are certainly focused on the external environment. As I said earlier, we are in a better position to withstand the volatility stemming from the US Fed’s tapering. Our current account deficit is significantly lower and we have shown the ability to raise money if we need to. Equity inflows have offset debt outflows by a considerable margin. All these suggest we are in a better situation. But I don’t think anybody in the world, including the Federal Reserve, knows the consequences when it announces tapering. I think at this point, the highest likelihood is of tapering-light, as some call it… I would be much happier if we had the current account deficit we have without curbs on anything, including gold. That is our aim — to have CAD without any distortion, removing the incentive for smuggling. At this point, we are very comfortable with the CAD.
Rationale for pause
I think it is important to resist the labels of dovish, hawkish, etc. We are primarily trying to calibrate the monetary policy to target inflation in an environment in which the economy is weak. When we take action, we have to be convinced it is merited at that point. When there is lot of uncertainty, you wait for more data to come in, to get a sense of how we want to act. Any monetary policy action is determined by a variety of variables. A rate decision does not depend on a particular indicator but a variety of indicators… We need to see substantial softening in both headline inflation and some momentum in the right direction in core inflation.
Supply-side impact on inflation
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There is an argument that supply-side is where the constraint is. Clearly, there are some supply-side constraints. Ultimately, inflation is a mismatch between demand and supply. If supply is not responding, you can’t keep postponing decisions, saying the inflation is due to the supply-side. That means you have to get demand closer to supply.
Food inflation
What we are saying is we should not react to every spike that is temporary. Monetary policy operates with a long lag, about three to four quarters. So, whatever we do now will affect output a few quarters down the line. We’ve to be sure we are dealing with a longer-term phenomenon, rather than short-term spikes. The data we have access to, from a sample of metros, show vegetable prices are coming down sharply. In that sense, our view is it (the recent increase in inflation) is a spike. Our belief is as long as we reiterate our commitment to (fight) inflation, one should not doubt our commitment.
Concern on growth
We will look at the growth number. Our sense is even now, growth is below potential. The effect of a negative output gap can be seen in inflation numbers. If this is not seen and if transmission is not taking place, we have to query our assumptions… that will be an important factor.
We feel in the second half, growth will be better than in the first. The factors playing out are agriculture, exports, and stalled projects coming back in line. It is important, however, that everybody, the government and RBI, be vigilant o the growth scenario.
Monetary transmission
When RBI had reduced the rate, it wasn’t transmitted. There seems to be a lag in the system or a lack of response. I think we will have to calibrate policy to circumstances.
Fiscal deficit
The government has reiterated its commitment to contain fiscal deficit many times. My own discussions with government officials suggest they are very firm on achieving it (the March-end target). Given where we are, that will mean a certain amount of expenditure contraction in the fourth quarter. That will have some adverse effect on growth but that is a part of what they need to do, in terms of the numbers they have set out. An increase in disinvestment and greater revenues from state-owned companies will help meet the deficit target.
Comfortable CAD
The external environment is not something we should be complacent about. We are certainly focused on the external environment. As I said earlier, we are in a better position to withstand the volatility stemming from the US Fed’s tapering. Our current account deficit is significantly lower and we have shown the ability to raise money if we need to. Equity inflows have offset debt outflows by a considerable margin. All these suggest we are in a better situation. But I don’t think anybody in the world, including the Federal Reserve, knows the consequences when it announces tapering. I think at this point, the highest likelihood is of tapering-light, as some call it… I would be much happier if we had the current account deficit we have without curbs on anything, including gold. That is our aim — to have CAD without any distortion, removing the incentive for smuggling. At this point, we are very comfortable with the CAD.