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Excerpts from Reserve Bank of India Governor Raghuram Rajan's interaction with the media and analysts on Tuesday:
On the rate cut
We have done what we think is appropriate, given the data. We have always said we are data-contingent. There are possibilities that if the monsoon turns out to be better than forecasts, there might be more room that emerges or if there are actions by the government such as to contain the possibility of an inflationary aspect.
On government pressure
I don't think the premise is right that the government has been putting pressure on RBI to prop up growth. I think the government has been trying on its own to reduce bottlenecks and create new pathways for growth. I think we both play together. As far as today's rate cut goes, it is a way to ease the way for further investments to reduce medium-term supply constraints.
Monsoon
Clearly, the biggest uncertainty at this point of time is the out-turn of the monsoon but also the policy reaction. As you know there have been El Niños (the problematic weather condition) in the past with reasonable rainfall. Poor rainfall has not (necessarily) led to a fall in production and (there has been) a fall in production which has not led to an increase in inflation.
The point we have always made is that we have to be on the disinflationary path that has been set out.
On the cash reserve ratio
It should be recognised that CRR is primarily a monetary instrument. If we want to reduce the cost of capital and lending rates, the more direct instrument to use is the policy rate, which we have used.
For bankers, CRR represents the uncompensated reserves they hold with the central bank. It is absolutely necessary that it is kept uncompensated because that is the way we essentially drive monetary policy transmission through the credit multiplier.
There is the notion that cutting CRR will reduce the cost of funds. It will. But that is back-door policy. The direct way of cutting the cost of funding is to reduce the policy rate. Also, if you estimate the effect (of a CRR cut), it is quite small. A one per cent cut in CRR will reduce the cost of funds by seven to eight basis points. Today, we have done a 25 bps cut in the repo rate, which over a period should reduce costs by 25 bps as their (banks') deposits and liabilities adjust.
Asset quality
Banks are aware of the asset quality issues. They have been sitting on these for a number of years. What we are doing is unearthing cases where asset quality issues are being suppressed. What we want is a quick clean-up of the balance sheet and restructuring of cases where assets can be put on track. We also advise further capital infusion, so that banks can fully recognise the problems and make provisions accordingly.
(Public sector) Banks' capital raising
I don't think anyone needs capital immediately. Going forward, they need capital to both absorb some of the provisioning and also as the economy picks up. Capital can be raised in many ways. One way is to issue new shares, if they have access to the market. The other is the government putting in more money. The third possibility is reducing dividends, in case the bank is not in a very healthy position.
Monetary transmission
The repo rate has been reduced by 75 basis points so far. If you look at the commercial paper or certificates of deposit markets, you see the effects of the cut. If I look at bank fixed deposits, the rate has come down from nine per cent to eight per cent. It has to be passed on to the lending side.
Base rate
One of the things we are working on is to revise the base rate structure, so as to reflect the marginal cost of funds. We have a framework, so we are discussing with bankers to get their feedback. Soon, we will be in a position to have a revised base rate framework. Ideally, we want to migrate to a situation in which there is the benchmark rate at which loans are priced and market-linked. That is the medium-term objective.
Growth
It is a discrepancy in the eyes of the world as to why we still think the economy needs great cuts when it is growing at 7.5 per cent (annually). We still have very weak investments. Corporate results have been quite weak, suggesting that final demand is yet to pick up strongly. Those are reasons why we feel the economy still is below potential; the output gap is somewhat negative. Even with 7.5 per cent growth numbers, there is some discussion on how much of it includes special factors, including excise taxes and subsidies. When you subtract that, growth does not look as strong as before. So, growth is weaker than what the headline numbers suggest.
Stressed projects
There have been signs that these stressed projects have been coming down. But, the level of these projects that are stressed is pretty large. This is ongoing work and will take some time to clean up.
Relationship with the government
If I cut interest rates, it means I want to please the government. If I don't cut interest rates, it is because I want to have a fight with the government. Why can't you make up your mind? There is a misimpression that we want to keep interest rates really high because our primary objective is to look really strong and firm. There is no point in looking strong and firm if you kill the economy in that process.
Public Debt Management Agency
Both the finance minister and I have agreed that there is a reasonable case for an independent PDMA, which will be relatively small and run the front and middle office that in the past has been done by RBI. In fact, the middle office is now largely sitting in the finance ministry. I don't think that will create a huge disruption. There is a broader agenda of moving a whole lot of other things away from RBI and we have agreed that would not be wise without much deeper dialogue.
Bond market regulation
Today, exchange-traded bonds, government or corporate bonds, all are with Sebi (Securities and Exchange Board of India, the capital markets regulator). There is somehow this misapprehension that it is not already being regulated by Sebi. What RBI does regulate is over-the-counter trading. Given that especially for short-term money market instruments, there is a much stronger link to monetary policy, it is important to consider how those things are regulated. We have been in complete agreement with the finance minister in that what is functioning well does not need to be disrupted for some hypothetical gain. Let us make sure that we have a well-laid path, based on tangible progress and tangible value, before we intervene.
Banks' margins
As interest rates come down in the commercial paper market, firms are going directly to CP. This is putting pressure on banks to actually cut rates. Interest rates were coming down even before the first rate cut because of pressure from these other markets. I have no doubt that over time, competition will play a role. Banks will have to figure this out. Do they keep the margins right now and lose market share or do they cut their margins and keep the market? That is an age-old problem that they will have to address.
Bond yields
I don't think we can argue that government bond yields have not been coming down. They have come down. Today's 7.65-7.66 per cent is way down since the level we saw at some point in 2013. If you look over the longer period, they have been coming down. If you look over one month or two months, there are so many (other) factors. Remember, bond yields are also influenced by international yields. US bond yields have come up 40-50-60 bps.
RBI's role
RBI is not a cheerleader. There are other people in the economy who can play that role. Our job is to give people confidence in the value of the rupee, in prospects of inflation, and having established that confidence, create the longer-term framework for good decisions to be made.
