Credible Policies Can Strengthen India's Immunity: RBI Governor Raghuram Rajan

Raghuram Rajan’s mission is not just bringing down inflation with an iron hand, but improving the entire financial system. In an interaction with select journalists, Rajan says why he would not target foreign exchange reserves, or currency levels, but work on building institutions. Edited excerpts;

ON INTERVENTION IN THE CURRENCY MARKET

If you look at the growth of central bank assets, which is a measure of how much liquidity is infused into the market, you will find it is about the same pace of growth as last year. Whatever we are doing is keeping a strict control over the expansion of liquidity in the market.

ON FOREIGN EXCHANGE RESERVES

Reserves will not buy us immunity on their own. They will prevent the second round. What will buy us immunity is strong credible policies. If we have a low fiscal deficit, moderate current account deficit and low inflation, people want to be here. As the rupee becomes more international and debt markets become more vibrant, liquid, we will reach closer to developed-country status. That’s when we get immunity. We will reach developed-country status before per capita income is developed to that level. But our constant focus will be to develop our domestic institutions and their credibility. That’s what will buy us immunity from international volatility. Reserves make sure volatility does not get converted into a sort of deeper mini crisis.

ON WHY HE IS FIXATED ON INFLATION

Inflation is a disease that we have to get rid of if we want sustainable growth. Moderate inflation is fine. High inflation close to 10% is detrimental in many ways. First, of course, with high rate of inflation, to keep people saving in fixed income, you need high rates of interest. Real interest rates may not be very high because they are nominal minus inflation, but because the business house that is investing, it has to invest at those high nominal rates. The possibility that inflation may come down creates a lot of fear about locking in at those levels, so it creates a dampening effect on investment.

It has an effect on external account, if inflation is high, there is a natural tendency for currency to depreciate relative to the rest of the world and these depreciations are rarely balanced and tempered. They come in bouts, they can be very sharp and they come with their own inflationary pressures as depreciation occurs. It also puts off foreign investors. They don’t want to invest in a country in which inflation differences are so high. It hurts the common man who does not have inflation-protected wages like the public sector. For all these reasons, if we want sustainable growth, we have to bring down inflation.

ON A TOUGH STANCE EVEN WHEN

PRICE PRESSURES ARE EASING The problem in the last few fights against inflation has been that every time we look like we are succeeding, the clamour arises — oh, we have had high interest rates, inflation is coming down, why don’t you cut interest rates? It is true that we don’t want higher rates for longer than we need to have, but we don’t want to keep fighting inflation for every two years and that’s what we have been doing for the last six years. So let us try and reliably bring down inflation. We completely agree it is not only a demandside defence, it has to be supply-side also. ON INVESTMENTS

Iwould very much doubt that it’s is the cost of capital that is the primary factor keeping back investment. Of course, lower cost of capital would help. If we cut the policy rate, it’s not clear if banks will follow suit in cutting the deposit rate until inflation comes down. So, to continuously say the policy rate is the problem is missing the overall picture of the other constraints on investment.

ON HEIGHTENED STATE OF POLICY PREPAREDNESS

There were some who had misinterpreted the June statement to suggest that there is a bias towards being more accommodative or, in your bird language, dovish. We were basically pointing to the fact that there is substantial uncertainty on both sides. Around 8%, uncertainty has become more balanced in the sense there was heightened risk in the upside last time, now they are more balanced. So there’s some improvement in the short term. Also, because time has passed and the medium-term goal, which was 6%, we should pay attention to as to how we are going to bring that down.

These are not two separate goals. First we meet the 8%, then we party for a few months and then we decide what about the 6%. It’s without all this confusion of base effects and so on, then we will have room to cut rates. The projection of inflation has to reach 6%. If early next year, given all that has happened, given government actions, if we think inflation will hit 6% before 2016, and stay that way, then we have room to cut rates even if at this point itself inflation has come down but is still above 6%. It is not that we have to touch 6% to cut interest rates, but have to project 6% to cut rates.

ON IMPLEMENTING URJIT PATEL PANEL RECOMMENDATIONS

We hope to talk to the government over this year and see what the government thinks. The whole idea behind the Patel committee is that we, as a central bank, have to rely on the government to set us an objective. Set an objective of what it expects inflation to be. And what leeway it wants us to have around that. That framework is what we have to discuss with the government after which it has to tell us that these are the things that you have to do beyond the two-year horizon. It is hard for us to imagine that the government would say — live with inflation above 8%. In the past, RBI has said 5%. If 5% is acceptable, then 6% should be acceptable. Then, let the government come up with its mind on what it wants in terms of inflation. But let us bring it down there and talk about what the next step might be.

ON IMPACT OF POSSIBLE US RATE HIKE

I am not going to predict the market. Any time the US sneezes, emerging markets across the world catch cold. Your main hope is that you do not catch pneumonia. Initial bout of volatility will happen, no doubt. But are we immune? No!