RBI's mandate is to be practical, not theoretical: Rajan

Reserve Bank of India Governor Raghuram Rajan says given the weak state of the economy, there was a case against an overly reactive monetary policy action.  People who are saying you should raise rates because inflation is still very high even after taking out food, have in mind some kind of developed economy structure, Rajan tells Shyamal Majumdar and Manojit Saha in an exclusive interview. Excerpts.

How do you respond to the perception that you have simply delayed the inevitable by pressing the pause button on interest rate in the latest monetary policy review? 

It was not a pause, we were just waiting for data. Even before the latest inflation numbers came out, our sense was that we have bought some time by doing two hikes already. Let's see how things play out. Remember, the policy has effectively been tightened since July. Monetary policy works with long lags. So what we are doing now will affect the economy six to nine months from now. So you have to first have a sense of that before you press the button once more. The current inflation data is marred by noise, so we said let's wait.

But do you see the danger of the RBI falling behind the curve once again by this wait-and-watch approach?

It is interesting that nobody expected us to increase interest rate in September but we did. And in December, we are being accused of falling behind the curve. It’s a little funny how market expectations change so quickly. The point is that nobody should doubt our desire to fight inflation. Given the weak state of economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty. Don't judge me by whether I raise interest rates in every meeting.

We need to bring inflation down and keep interest above inflation to give people real returns, but how much above is something about which we have to take a pragmatic view.

Are you finding it difficult to manage the huge expectations?

I think there are two ways that we expect the monetary policy tightening to play out. One is through, what we call the negative output gap, that is, to bring down demand way below potential output to create disinflationary pressure. The second channel is the expectations channel, which is much less understood. You raise interest rates up to a certain level and then people start thinking that the economy has slowed down considerably which will earn you less in terms of wages, etc. I don’t know the strength of this expectations channel. People who are saying you should raise rates because inflation is still very high even after taking out food, have in mind some kind of developed economy structure. 

The criticism was also that RBI is doing the same mistake of pressing the pause button, as it did in the first half of 2011, and inflation came back in the later part of the year.

Remember 2010-2011 was a year of strong economic growth. That has weakened considerably now. So we have to be very careful while raising rates to take that into account. That is why I am saying there are disinflationary pressures and we have to see how they play out. And we will calibrate our response accordingly. In a situation of relatively high inflation and lower growth, we have to be a little more practical rather than theoretical.

We need not react to every spike that is temporary.  Our belief is as long as we reiterate our commitment to fight inflation, one should not doubt our commitment.

There is a view that you have ignored core inflation while making the decision to leave policy rate unchanged. Some economists see there is a momentum in core inflation.

Momentum in core inflation depends on how you measure. Different people have different way to measure. In our measure, the momentum is fairly flat. We will be satisfied if the WPI core stays flat at this level, because our target is 3 per cent and we are below that. But CPI core has to come down. 

Is there a case of shifting the anchor inflation to CPI (consumer price index) or core WPI?

I think for now we have to work with both WPI and CPI. Partly because we have a short history of the CPI index, we don’t know how the components of CPI will behave. There is also some scepticism about the quality of the data. We have more comfort with the WPI. But CPI is what the person on the street sees. So, I think we have no option but to look at the both. We have to bring CPI down because we are not comfortable with such levels but i am avoiding setting targets simply because I don’t know how the CPI behaves. The Urjit Panel committee will give its opinion on that.

RBI has a tradition of looking at WPI and that tradition will continue. But we are also saying CPI matters and we need to bring CPI down. We need to bring both these down and we will bring them down. 

Can the move to offer concessional currency swap to banks add to inflationary pressures? After all, it is cheap money.

What most banks have done is that they have locked-in the profits from such a kind of transaction by investing in similar maturity government bonds. So the FCNR (B) money has flown into three to five year government papers. I don’t think that is inflationary as it has gone into government debt market rather than fuelling credit growth which has been moderate. At times credit growth may look strong because firms are not going to the commercial paper (CP) market and all the demand comes to the loan market. Now that CP rates have come down, firms have again gone back to that market. 

While there is reason to be happy with the inflows via the FCNR (B) route, there was also a cost associated with it.

The FCNR(B) policy is not something that I jumped into with joy. It was many ways an option which given the circumstances of that time we had to embrace. There is no doubt that it is not cheap money in an absolute sense. We have given a subvention. On the other hand, if we have to raise money via sovereign bonds, for example, we would have got far less. With confidence in India falling very fast at that point of time, we had to try out the swap window. I think, the notion of how much did it cost us will be debated for a long time because opportunity costs are very hard to define. 

When will you restore the limit for dollar remittances made by resident individuals?

We should see it as countercyclical policy. At a point when the RBI was buying dollars because it did not want the rupee to appreciate, we let Indians take money out. At the same time, when e lack foreign exchange, we should have the ability to tighten somewhat with the proviso that if you are locked into long term contract, we will make an exception in your case. But let us follow a countercyclical policy. 

Earlier, we allowed to take out $ 1.2 million per family per year, which has been brought down to $ 3,000 per family per year. How many families in India take that amount of money out? Does it constrain anybody’s investment except the richest of the rich?  At a time when we are telling the poor household that you cannot invest in gold or you have to invest in gold at a cost because we think it is unnecessary import, can we tell the richest households that you can take money out no questions asked? It is a political economy issue also. We should accept that in good times, we will open up more and in bad times, we will constrain it a little bit until the time we are fully convertible. 

We have made significant difference over the last few months relative to where we were or relative to the fragile five countries (Brazil, India, Indonesia, South Africa and Turkey).  Of that fragile five, if you look at exchange movement in the last two months, we look a lot better. This was partly because the outcome of earlier policy action are playing out now. But in July, the constant analysts’ reaction was it was another band aid.  

But there was some element of luck as well...

Post September, I would be the last one to say that it was only because of good policy and there was no luck. We have benefitted from the postponement of tapering because that would have been a little early for us, then avoiding war in Syria. Then the postponement of the Fed tapering. And it (tapering) has come when our short term measures have been largely completed. The FCNR (b) fund raising, we have got the oil companies in the market, we have shown our ability to raise money, the market is reasonably stable and so it has come at a good time. But we have also taken action to contain the current account deficit and financing it.

If dollar inflows continue, will you be purchase dollar to beef up foreign exchange reserves?

I think it is too early to talk about such things. Overtime, oil companies have to acquire foreign exchange to pay us back. We have done the swap arrangement with banks. So we need the money to pay them back. Until they (oil companies) garner the required dollar to pay the RBI and until we have paid to banks, the issue of naked intervention does not arise.

Are you confident of meeting the January deadline for new bank licences?

A number of portfolios are largely complete and those have been put up to the Bimal jalan committee to look at. As we get more and more dossiers complete, they will also be given to the committee. A tremendous amount of work is going into it and the unit which is working on the issue, in working over weekends since last September.  

How difficult is it to be a central bank Governor? You were called a rock star in September. That idiom has changed to an "overly cautious" central banker in just three months.

I knew my popularity will go down with each passing day. It doesn’t matter what a few analysts say as long as I am doing what I think is right.

Courtesy: The Business Standard