'Growth rate could shift to higher trajectory'

Q&A/ Y V Reddy

It was certainly not the right day for the Reserve Bank of India governor to discuss monetary policy and the outlook on interest rates "" a bigger drama was unfolding in New Delhi, with Sonia Gandhi declining to become the prime minister.

In an ante room on the 18th floor of the Reserve Bank of India's (RBI) towering headquarters in Mumbai, the TV was on in silent mode. RBI governor Yaga Venugopal Reddy was looking at the news while answering questions on the RBI's annual policy, on the disinclination of banks to lend to agriculture and small and medium exterprises, and the RBI's differing views with the finance ministry on bank dividend payouts.

You did not have a budget and a government borrowing programme in front of you before announcing the policy. Was this a handicap?

We have had an interim budget. The budget is the starting point and we need to respond to it based on the evolving circumstances. Just like any market player needs to have the resilence to be able to handle many changes that happen in the market place, as a a public policy maker we also have to respond to evolving circumstances. One important aspect in this situation is that in totality, whatever changes occur, the Indian institutional set up is such that, under normal circumstances, it seldom goes out of the realm of manageability.

How much weightage have you given to the change at the Centre which will have a bearing on the status of the fiscal deficit?

Analytically you have the structural factors, the overall macro parametres and the composition of expenditure. Some of them have an immediate relevance. We focus on those elements which are most closely associated with monetary policy. In capturing those, we have to take into account -- firstly, what the institutional set up in which these policies are framed is, and secondly, what our experience in the past has been because there is an element of continuity. That is an indication for us about the possible qualitative assessment. It is never based on quantitative reasons.

What is the central message of your policy?

The first message is that we could be continuing with the growth rate or there could be a upward shift in the trajectory -- a structural shift owing to the competitive strengths of the economy. Secondly, in terms of inflation there is an element of pass through of international price trend to the domestic price level but we have enough cushion to be able to give more weight to domestic considerations. I do not place any upward bias on the inflation target of 5 per cent. Thirdly, the Indian banking sector has gained in strength and in efficiency relative to most other countries.

Fourthly, while there will be an impact of the movement in interest rates and currency fluctuations on emerging countries, there is always a special emphasis on trying to avoid excessive undesired volatility. That has paid off in the past and it will pay off in the future. Fifthly, there are signs of credit pick up. And, finally, the external sector will continue to be comfortable.

Do you concur with the view that central banks are essentially risk managers of the economy -- managing the risk of rising prices and growth?

Yes. The central bank essentially focuses on growth and price stability while the relative emphasis will depend on the context. The additional factor that has come in the last few years is financial stability "" the stability of the domestic financial sector and the relationship with the external sector and its impact on the financial markets. Another relevant point, also a challenge, is the management of the fisc.

How concerned are you about the equity markets?

Equity markets by nature tend to be volatile, but as a central bank we do not want huge volatility to be transmitted to other markets. So we kept a watch on money markets. There was no impact on the government securities market. But in the foreign exchange market there was uncertainity owing to a particular category of participants in the equity markets buying dollars. So we created a situation to enable them to buy dollars. A month back, on the supply side there were lumps and RBI was buying dollars. We are just reversing the trend now to ease out the lump in demands.

Are banks giving credit to small and medium segments?

For the past 50 years we have been trying to meet agriculatural credit, but the percentage of credit through the formal system vis-a-vis the informal system has not improved in spite of any amount of institutional intervention. We have been able to sensitise them and there is a shift in banks' attitude. In terms of the procedures and policies, there are still constraints. We are addressing it.

What about loan rates? Are the SMEs getting loans cheap?

A beginning has been made.

What's your call on interest rates in medium term?

In the medium term, I want banks to reduce their spread and bring down lending rates.

We are talking about general interest rates

We will have to wait and see

Why do you want to cap foreign banks' ownership in local banks at 10 per cent?

This is not part of the policy document...

Are there differences between the finance ministry and the Reserve Bank on banks' dividend payout? While the ministry wants to banks to pay 20 per cent dividend, RBI is not allowing all banks to pay dividend.

We have prescribed certain norms and if the banks fulfil those norms they can pay dividend. These norms show the health of a bank. Even if a bank does not fulful those norms, it can put in an application (to the RBI) for dividend payment but the fact is, once you have the norms in place you know which banks is healthy and which bank is not...

The prices of bank stock are falling like nine pins. Are you concerned?

We want banks to be healthy to enter the capital market. We don't look at the price in the stock market.

Will the new norms on a capital charge on market risk impact banks' capital adequacy ratio?

Not really. We have analysed it. There may not be any major impact on banks ' capital adequacy ratio.