Reserve Bank of India Governor Duvvuri Subbarao, who is known to have mind of his own, and has many times been at odds with the Finance Minister today voiced his discontent about the Financial Sector Legislative Reform Commission(FSLRC’s) recommendations regarding capital inflows.
In an interview with CNBC-TV18’s Latha Venkatesh, he stressed that taking away capital management from Reserve Bank of India is not advisable and that the central bank had made this suggestion to FSRLC when it was consulted.
“So we submitted but they have decided, the way they have decided. Now I believe the government will call for consultation and we will certainly not only put across our point but argue our point,” he said.
FSLRC which was set up to rewrite and update all the archaic Indian financial sector laws has recommended that the government and not the RBI should make rules with respect to capital inflows. This recommendation is irrespective of whether the inflows are FDI, FII, forex loans or NRI deposits.
This recommendation has been strongly criticized by many economic and baking sector scholars including KJ Udeshi and YH Malegam. Subbarao said that FSLRC’s argument on this is that external sector management with capital inflows has bearing on monetary policy, on financial stability and on bank regulation and hence RBI should not be handling capital inflows.
Also read: Barring FDI, RBI must control all capital flows: YH Malegam
On Friday, RBI cut the repo rate by 25 basis points and pointed that further room for monetary easing was very little. Upside risk to inflation and high current account deficit (CAD) were sighted as two key reasons by RBI for its hawkish stance.
Today, Subbarao said that CAD could come close to 5 percent in 2012-13 and stressed that any improvement below 5 percent would be a good improvement on CAD. He said although India was able to finance 6.7 percent CAD up till January due to higher liquidity in global system, we can not depend on mere foreign capital flows. “We must have low and steady CAD financed by stable flows,” he added.
Diesel price hike was seen as one of the key step in controlling the twin deficit-CAD and fiscal deficit, however oil retailers have declared on three prices hike since the fuel was deregulated. Subbarao also learned that diesel price hike was deferred on the back of fall in global crude oil prices, which gave oil retailers leeway to postpone the price hike. He however said that it would have been better if scheduled rise in April was taken by oil retailers.
On the recent cobrapost expose which involved leading private sector banks like ICICI Bank, Axis Bank, and HDFC Babk, Subbarao said that RBI was determined to take strict action against erring banks and will soon introduce systematic improvement in know your customer norms.
On the new banking licenses Subbarao said that RBI would constitute committee that will vet all applications only after June. He said that RBI would issue enough licenses to instill competition but would also make sure that they don’t outnumber the existing players.
Q: This is the last of your annual policies. Is there a personal satisfaction that even as you hang your boots, inflation will be finally at 5 percent?
A: I want to answer that question from an institutional perspective, not so much from a personal perspective. Certainly, there is sense of relief that after reining in near double-digits for more than two years, inflation has finally come within striking distance of our comfort level. However, at the same time, as we said in the macro document on Thursday and then the policy statement on Friday, there are upside risk factors both to growth and inflation and we cannot let our guard down. There is a real possibility that inflation pressures will reemerge and we got to be very cautious about that.
Q: Yet you cannot unplug your personal journey for five years in the RBI.
A: I certainly cannot.
Q: Is there some regret or rethink that perhaps you could have done more to get this inflation beast lower earlier? There was this paper from Mohanty, which pointed out that if you applied the Taylor Rule, the RBI actually was at negative real interest rates, which perhaps allowed inflation to persist or even exacerbated it. Is there regret that you could have done more at some point in time?
A: I don't believe so part because I am not so model-driven and part because I believe that we did what was necessary at that time. And looking back, I don't think we would have done a different trajectory. With a benefit of hindsight a lot of people say this but what we did was the most appropriate thing.
Q: You have spoken about very little space being available going forward and yet you gave us a window of hope in the sense that if inflation were lower than your trajectory and current account deficit (CAD) improved more, the space would open up. We have your inflation trajectory of 5 percent by September and may be 6 percent by March. We don't have your expectations on CAD. What in your opinion would count as an improvement in CAD?
A: I am wary of putting numbers on this because they are quite sensitive but last year the final CAD number is not yet available but it might be close to 5 percent. If provided the Q4 number a substantial improvement over the Q3 number but the most probable outcome would be that it will be close to 5 percent. So any improvement over 5 percent would be an improvement. However, we must recognise and evaluate in the CAD number that our sustainable CAD is 2.5 percent. So, year-on-year for three years, we will be above 2.5 percent and that is something that we cannot afford both from external payment situation point of view as well as monetary policy management point of view.
Q: Just a point on you repeatedly saying that interest rates really can move either ways depending on global factors. Are you privy to something? Are global central bankers or central banking experts wary of some kind of an asset bubble because in recent days asset prices have flared up although economic fundamentals are coming down across continents?
A: I don't think RBI is privy to anything that is not in the public domain. We are privy to the same knowledge, same perceptions as everyone else. I do attend international conferences, I do get a chance to meet other governors especially governors of advanced economy central banks who are now in the easing mode. But it is not as if we are seeing a bubble building up. However we do recognise that there are upside risk factors unwinding of the quantitative easing (QE) both about the timing and about the trajectory of unwinding. We must recognise that advanced economy central banks are in clearly uncharted territory and therefore it is new even for them and new even for us. And we have to be alive to the implications for our external sector management of their policy trajectory. And that is the caution we were trying to communicate yesterday, not that we have any further knowledge than the public.
Q: Let me come to the financing of the CAD. The withholding tax has been cut from 20 percent to 5 percent in the hope that debt flows will come. But we have financed 6.7 percent without so much of debt flows. As it is various documents from the RBI and other places point out that the percentage of short-term debt, the percentage of short-term residual maturity debt as a percentage of total reserves is going up and that is not a healthy situation. Why did you allow it? After all we have financed 6. 7 Percent, why do you have to allow another 35 billion, attract it with 5 percent taxes? Are we that desperate, isn’t this a dangerous game to play?
A: First of all, all our external sector vulnerability indicators have deteriorated. They are inferior today than they were a year ago. Our external sector there are strains, I don't want to convey that it is alarming or disturbing but certainly the strains on the balance of payment situation have accentuated.
We financed 6.7 percent of CAD in Q3 of last year because there was lot of liquidity in the global system. That is a one off situation, we cannot depend on that. It is of course the RBI’s policy and the government’s policy that we must have low and steady CAD and that we must finance that low and steady CAD through stable, non-debt creating flows. However we cannot completely eliminate debt flows. So to the extent that we have external commercial borrowing (ECB), to the extent that we allow Foreign Institutional Investors (FIIs) to invest in corporate, we have tried to streamline that.
Q: Year after year we keep saying that we won't allow ECBs more than this, quite clearly meaning that this is not a very welcome source. And suddenly we make it attractive, we cut the tax on it. It seems like a sea change in policy actually. Was the RBI with its back to the wall you argued your best and then you had to give in?
A: I don't think you should see it that way. It is not as if we want to eliminate ECB altogether, we want a restrained ECB. And to the extent that there are non debt flows coming, to the extent that FDI comes in we would of course like to restrain ECB. However if you have a high CAD you cannot make an adjust on the CAD in the short-term. Therefore you have to finance it and therefore you have to look for ways of financing it. But as we said several times before, our challenge is to bring down the CAD but that is a medium term policy objective, it cannot be done overnight, it cannot be done in one year. But meanwhile we have to be financing the CAD through stable flows.
So one thing we must be focusing on in the short-term is to make India more attractive for foreign direct investments so that our reliance on other avenues of financing comes down.
Q: At the moment you are the boss on capital control so this is your decision. Your hand may be forced but it is still your decision, the withholding tax.
A: Tax matter is the government, I don't want to say that I have any view, any authority on that but certainly we have been consulted and we agreed that this needed to be done at the current juncture given our CAD and given the need to finance it.
Q: Very soon it could be that capital controls will not be the realm of the RBI, you perhaps are going to be consulted but the decision may move to the government if the Financial Sector Legislative Reforms Commission (FSLRC) has its way. Have you responded to that recommendation? As a central banker would you say that this is a dangerous development if it happened?
A: I am a little uncomfortable about answering specifics of the FSLRC because I want to do that in a more considered way at a preannounced platform. Regardless since the question has come up I want to say that we had submitted to FSLRC and to Justice Srikrishna, our position on all the issues that were on their agenda. And certainly we had submitted that taking away capital from management, all of it from the RBI is not advisable. What the FSLRC recommended is that inflows should all be with the government. We said that is not advisable given that external sector management through capital inflows has a bearing on monetary policy, has a bearing on financial stability, has a bearing on bank regulation. But the FSLRC decided the way they have decided.
Now I believe the government will call for consultation and we will certainly not only put across our point but argue our point of view.
Q: Let me come to the other issue of liquidity. A large part of the lack of liquidity in the inter bank system is because the governments cash balances are accumulating with the RBI. There was a suggestion that that should be deposited with banks. What is happening to it, that will solve your liquidity problem isn’t it and not too much of downside I would assume?
A: That suggestion is still under consideration. The second part of the answer is I am unable to understand how it might solve the liquidity problem because if you take the balance sheets of the government and the RBI together it does not make any difference. And you are transferring some money that is locked up with the government to the banks but banks could always take that money from the Liquidity adjustment facility (LAF) window. So you are transferring some securities from here, some money locked up with us, taking securities from the banks. So it is another window for making the same transaction.
Q: No it is not quite the same because when they borrow from the LAF window there are a lot of restrictions. This is overnight money, you cannot lend it in the form of loans. There are a series of guidelines that you give banks that you cannot have longer term assets on the basis of this overnight liability. If it was a deposit with them it will behave like any other deposit. So technically the bankers will not keep coming and complaining that there is liquidity tightness and that is why we are not passing on. Perhaps it will help transmission. It could be healthy, why is it getting held up?
A: First of all I don't want to leave that issue at that open ended position. I think there is not going to be much of a liquidity improvement. Even if we auction those securities to the bank it will still be short-term money. It will not be long-term money that they can take long-term positions. This is in discussion with the government and hopefully we will resolve it soon.
The other issue that I want to say about disclosing the government cash balances in the public so that all stake holders can make an informed assessment that there is no additional knowledge with us that the market players don't have. Again we have been engaging the government on that. As soon as they give clearance to that we will disclose the cash balances.