Fiscal actions shouldn't undercut macroeconomic stability: RBI MPC

Interview with Urjit Patel and other top officials

After the Reserve Bank of India’s (RBI’s) fourth bi-monthly policy review for FY18, Governor Urjit Patel and other top officials spoke to the media on the central bank’s decision to hold the repo rate, increase inflation projection, and reduce its growth forecast. Edited excerpts:

There is some discussion about a fiscal stimulus package from the government. What’s the RBI’s take on this?

Urjit Patel: Given that the general government fiscal deficit — in other words of the states’ and the Centre’s combined — is already in the region of 6 per cent of the GDP, our national fiscal stance can hardly be described as tight. We should be very cautious, lest fiscal actions undercut macroeconomic stability.

Does the higher inflation projection mean that there’s no scope for a rate cut going forward?

Patel: Our projection has gone up compared to August and the range is now 4.2-4.7 per cent. It includes the HRA (house rent allowance) adjustment, which is a statistical top-up on the housing component of CPI (Consumer Price Index). What the MPC (Monetary Policy Committee) has said is that we will be watching the incoming data carefully. There are upside risks which we have enunciated. There are some things which may mitigate these risks. So, we will basically have to wait and watch on how the evolution of inflation takes place over the next six to seven months in terms of what happens and have projections. But as you know inflation has been volatile. Within two months it increased by two percentage points. So, we will see what happens.

You expect inflation rising by 100 basis points over 18-24 months if states implement the Seventh Pay Commission award. Is the rate cut out till March 2019 irrespective of the growth rate?

Patel: As we have indicated this time and in the past that there is an uncertainty bound around all these. While there are upside risks there are also downside risks. There might be some reversal of commodity prices, which is a possibility. Food inflation continues to be kept under control. It is equally wrong to pre-judge either way how these things will evolve. What we have done is to lay out the risks which could materialise with varying probability.

What will be the main triggers for improvement in growth in the second half?

Patel: There are factors that have affected growth in the second quarter of this year. Some of those will dissipate. In recent days, many of the high-frequency indicators suggest that there is an uptick in growth. The core IIP that was released yesterday (Tuesday) was at 4.9 per cent. In the second quarter, the services sector has been showing a healthy growth rate. There’s a possibility that cyclical upturn will happen in the next two quarters. But overall the growth this year has been reduced from 7.3 per cent to 6.7 per cent.

What are the findings of the internal study on rate transmission? 

Viral Acharya: An internal group was set up to ensure that the base rate and MCLR (marginal cost of funds-based lending rate) — which are used as benchmarks for the floating rate loans by the banks and non-banking finance companies — are in line with the monetary policy and changing yields in the Indian bond markets. The primary recommendation of the report is that it’s going to propose three possible benchmarks to which such lending could be tied going forward. We think that the internal benchmark such as the base rate or MCLR seems to give banks a very high amount of discretion. A lot of factors give them flexibility to keep lending rates high even if the monetary policy rates are going down and is on (an) accommodative path. To address this, we think it’s time to move to what most countries follow — to have these rates tied to external benchmarks, which will create transparency for borrowers. They can just compare two loans and see which is at a lower spread because the benchmark would be the same. 

The second important point I would stress is that interest rate resets, which are right now at annual frequency, should be changed on all floating rate loans to quarterly resets. So, the transmission would be much faster once monetary policy changes. The last thing I would say is that the report proposes that this happens in a fairly time-bound manner so that monetary policy can have its impact on the economy.

Can you throw more light on public sector banks’ (PSBs’) recapitalisation? 

N S Vishwanathan: The discussion on the capitalisation of PSBs is an ongoing one with the government. The need for capital for all requirement, including minimum capital required for growth, has been underscored. As far as instruments are concerned, all instruments will be considered.

When do you see private investments picking up?

Acharya: It’s a little hard to precisely project this. One has to rely a little bit on evidence in other parts of the world where such significant deleveraging of corporate and banking sector balance sheets have taken place. What history seems to suggest is that you need both deleveraging to take place. It’s important for the heavily indebted borrower to deleverage. But it’s also important for financial intermediaries to have the capital both for financial stability and for growth. We are working quite hard on getting some traction on the second front. On the first front, we are directing cases to the Insolvency and Bankruptcy Code to push through that resolution. My sense is this whole process could take anything from 12 to 18 months as a whole. Of course, investments may revive even earlier along the way. Once deleveraging takes place, some consolidation might take place in some of the indebted sectors. Capacity utilisation might improve. When exactly that takes place is a little hard to predict, but what we can do is to structurally set the stage right. So, when the growth impulses are there, the economy is in a position to amplify those correctly. 

Patel: It’s not that all sectors are suffering from over-leverage and poor balance sheets. In those sectors, as capacity utilisation picks up, we would see investment proposals come in.