 "\"RBI should already have started cutting rates\"")
Bank credit which continues to be sluggish may see some pick up if the Reserve Bank of India (RBI) decides to cut interest rates, believes Ashima Goyal an external member of RBI’s technical advisory committee and professor of economics at the Indira Gandhi Institute for Development Research, Mumbai. In an interview with Neelasri Barman she discusses about a range of issues that surrounds the economy.Edited excerpts:
Do you think there will be some upturn in inflation once the base effect vanishes?
The glide path for retail inflation is 8 per cent by January 2015 and 6 per cent by January 2016. That is the RBI’s target. We do not have formal inflation targeting yet. That is still being discussed with the government. But now the economy is overachieving on the glide path. The RBI’s own March forecast has also come down to 6 per cent. Due to this there is some room to cut rates. The inflation has come down because of the reduction in oil and other commodity prices. Even if there is some upturn due to base effect it will not be large enough to raise inflation above 6 per cent. There is very little risk to the 6 per cent inflation target.
Do you think RBI may defer interest rate cuts due to volatility in the currency.
I do not think it should do so in the Indian context because of a number of reasons. We have some real appreciation in the rupee in the past because of which we can take some depreciation. The RBI is comfortable with the foreign exchange reserves and inflows are also large enough to protect against any severe depreciation. So I do not think rupee depreciation will be sufficiently large to require any interest rate defence kind of action. This is aimed at retaining debt inflows. Our experience of 2013 is that when RBI raised short-term interest rates by 300 basis points it did not work much because even after 4-5 months debt outflows continued. So it is better to focus on the domestic cycle. Higher growth will attract better quality inflows. Moreover, debt inflows are still capped, although these caps have been relaxed.
When do you see the rate cut cycle to begin?
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This is a decision which the governor of RBI will take. I will not predict what will happen. But in my view the RBI should already have started cutting rates. The aim of a glide path is to reduce the output sacrifice of disinflation. If trend inflation is already under the glide path, output is much below potential, and industry is hardly growing, it is possible to think of stimulating demand. Household inflation expectations are most affected by food inflation. That should come down because internationally also food prices are softening. If all this is helping to anchor inflation then you can reduce interest rates. The rate cuts should however be very gradual, to continue the focus on inflation expectations. The path should be data dependent and steep cuts such as occurred last time oil prices fell in 2008 and led to over stimulus avoided. The rate cut cycle should have begun in October. May be by 25 basis points cut the cycle could have started. Then there is no need to cut every time, however, as the signal itself, and future expected cuts, have a positive impact. Probably RBI is waiting to see what happens after the base effect wears out.
Do you think concerns on Current Account Deficit (CAD) may be back in 2015 considering gold imports have risen? And was it prudent to remove the 80:20 restriction on gold imports?
CAD is not seen much above 2 per cent of GDP because reduction in oil prices will help CAD. Some increase in gold imports rise should taper off in the long term. If it doesn’t then government may impose some restrictions. There is one view that 80:20 kinds of restrictions encourage smuggling. Unfortunately the restriction was removed during the festive season and at that time consumption of gold increases. What we are hearing is that since prices of gold had fallen people had just stock piled gold. Let us see how it works out now.
When do you see the US Fed hiking interest rates? Are we going to be vulnerable?
Sometime in the course of next year the US Fed will hike rates but it will be a very slow approach. I think they will learn from the tapering episode and not surprise the market. Their domestic economy is doing much better so they are ready for some kind of normalisation. I think the steps India has taken in the last one year has made it one of the least vulnerable markets. US Fed will go very carefully. Even if global markets are in trouble we should not see so much of outflows because we have much better growth prospects.
What is causing the fall in foreign exchange reserves? Do you think the rupee depreciation will make it worse?
The fall in foreign exchange reserves of RBI is due to valuation effects as the dollar is strengthening, not due to any large outflow or intervention. It is a problem that firms have not hedged their foreign exposures. Due to that some volatility in the rupee is good because it reminds firms they need to hedge. Now you see a lot of firms coming forward to hedge their exposures.
Are we going to see a slowdown in foreign flows in 2015?
The quantitative easing of US is over but Japan and European Central Bank (ECB) has continued, so there is still a lot of global liquidity. Continuing inflows depend on whether India delivers in terms of higher growth along with macroeconomic stability. But over a longer period of time there should not be over dependence on foreign flows. We need to increase our own manufacturing capabilities and increase domestic savings. A sustainable CAD is about 1-2 per cent of GDP and that much of inflows should not be a problem. The government’s moves should attract need more Foreign Direct Investment (FDI), which is a better quality and more stable type of inflow.
In the absence of rate cut what will happen to Gross Domestic Product (GDP) growth?
Agriculture has helped sustain growth but industry and services are not doing very well. On some aspects we seem to have bottomed out and so are climbing out from the sub-five per cent we had reached. I think GDP growth should be at least 5 per cent.
What are the five key factors which will have an impact on domestic markets?
Five factors are the impact of US rate cuts reversal; the size of growth in emerging markets like India and China; the slowdown in Europe and Japan; softer oil prices; possible co-ordination across central banks so as to minimize global shocks and spill overs.
Bank credit continues to be sluggish. Do you think we need rate cuts to drive it?
Some reduction in interest rates would help. In the present rate structure deposit growth is higher than loan growth which shows banks are flush with funds, implying the price of credit needs to adjust. But easier restructuring, as has been allowed at least for large projects, will also help. Infrastructure needs long term loans, but what banks are allowed are short term loans. This leads to some mismatch. Reviving demand and improving the ease of doing business will also help credit growth.