The Reserve Bank of India could consider narrowing the corridor of repo and reverse repo rates and raising the cash reserve requirement for banks if circumstances warrant, Deputy Governor Subir V Gokarn tells Sumit Sharma. Edited excerpts:
Banks didn't raise lending rates even after three earlier rate increases by the central bank. Bankers now say they don’t anticipate raising rates soon. Is it a worry?
We are now in a liquidity situation where the repo window is operational. The Reserve Bank is injecting liquidity. Credit growth has begun looking up and becoming more broad-based. Together, these conditions should translate into higher rates. From what we have seen and what bankers told us, an interest rate increase is on the cards. In the first half, on the other hand, because of excess liquidity it was perhaps a reasonable response. When cost of funds was not going up, why would you want to raise rates? But this is a different situation right now.
What can RBI do to see a more effective transmission of its measures by the banks?
We are trying various things. One is the introduction of base rate, a floor on lending rates, something the (earlier) BPLR (Benchmark Prime Lending Rate) was meant to do and did not serve the purpose. The base rate has to be sensitive to liquidity. So, to the extent we are able to manage the liquidity in a narrow boundary or keep it at a point where the system is more in an injection mode than absorption mode in the LAF (Liquidity Adjustment Facility), policy rates will translate into both market rates and lending rates. This is the situation we are currently in and would like to maintain, which would then make transmission stronger. But the two conditions we need are that the rates have to be transparent and liquidity conditions will have to be such where banks have no option but to pass on the cost of funds to the borrowers.
Is there a threat of the economy overheating?
When we look at the overheating in 2006, ’07 and ‘08, the global economy was also in the same mode. So, India was growing at 9-9.5 per cent and global economy was in a situation where capacities were stretched and commodity prices were soaring. All the conditions pointed towards runaway inflation. Today, the domestic drivers are very strong and the recovery is more robust but the global economy is still sluggish. The pressure on commodity prices and global capacities in tradable goods is still relatively soft. Thus, the domestic growth impulse is clearly comparable with what we saw in pre-crisis days, but the global situation is very different. This has allowed us some flexibility in terms of how we respond to domestic pressures.
You cited inflation as a key concern. Why is it that you have raised the inflation estimate to just 6 per cent from 5.5 per cent. What gives you the confidence?
It is a concern that is motivating our actions today. I would like to break up inflation in three factors. Food prices have been significant drivers since 2009. The bad monsoon of 2009 aggravated the pressure. This year, the monsoon has been reasonable. That should provide some relief for the rest of the year. Then, because of global factors, commodity prices are likely to remain easy. The third aspect is the lagged impact of the transmission of the monetary policy actions initiated. Convergence of all of this should lead to a moderation of inflation.
Besides inflation, is there any other risk or downside you see for growth?
The main risk is from the global side in terms of capital flows. The cushion may become narrower. Once the global situation stabilises, we will be in a better situation.
Could we see the repo corridor narrowing to 100 basis points?
The market is anyway familiar with such a band, as it existed earlier.
Since we have moved to the upper band, we want to make an effort to contain volatility. In case of surplus liquidity, the rate will move to the lower end of the range. We have set up a group to address the issue of what the appropriate width of the corridor is, as well as the instruments we must use. At the moment, it is quite likely we may consider tightening even further if circumstances warrant.
Is an increase in CRR (Cash Reserve Ratio) next on the cards?
An increase in CRR is always on the table. In case of a situation of surplus liquidity, we would want the system to operate at the top end of the corridor. That’s why we tried to extract liquidity in January and then again in April. An increase in CRR is not the best thing to do in a liquidity deficit situation, and if liquidity is being infused through the repo.
How much of a concern is the current account deficit? You mentioned about the risks from uncertainties or capital inflows and outflows.
We have pointed out that there is a risk of the gap between capital inflows, unlikely to go higher, and the current account deficit narrowing. If the global economy goes into another state of instability, inflows could grow weaker. But there is also the opposite risk of large inflows if the global situation stabilises and investors come into faster growing economies. We need to be watchful for both possible outcomes and respond appropriately, should either of these risks materialise.
