In an exclusive interview to Network 18 Group Editor-in-Chief, Rahul Joshi, Reserve Bank of India Governor Urjit Patel talked about demonetisation, growth and why it is important for a central bank chief to develop a 'thick skin'.
In an exclusive interview to Network18 Group Editor-in-Chief Rahul Joshi, Reserve Bank of India Governor Urjit Patel discussed a number of policy topics. Read the full interview.
Q: My first question is related to the policy. In the run up to the policy, many commentators were expecting that you would go in for a rate cut given the low headline inflation rate. But you did not do that and you shifted the monetary policy stance from accommodative to neutral. What are your reasons?
A: The Monetary Policy Committee (MPC) resolution and statement that was published last week was fairly extensive in terms of the explanation that was given. To recap, since we have committed to move closer to 4 percent inflation because of the legislated and notified mandate of the government, we needed to look beyond the headline number to see where the kind of disinflation that is needed to take us towards 4 percent would come from and the committee felt that inflation, excluding food and fuel, is something that has been stubborn since September-October and has shown a little sign of coming decisively below 5 percent. That was the main reason why we had to look through the headline inflation.
The other reason is that the effects of the demonetisation and now, the remonetisation also may impact some of the commodities where we have seen disinflation, but we do not know to what extent and for how long. It is most likely going to be short-lived. For example, the disinflation in vegetable prices and therefore, the headline number needed to be looked through keeping in mind that we need to get closer to 4 percent on a durable basis, but in a calibrated manner. And that was the reason the MPC thought that we needed to have the flexibility going forward and therefore the shift of the stance from accommodative to neutral. That is the main reasoning.
We also find that internationally commodity prices have firmed up, the international food price index has gone up, the base metal price index has gone up, crude prices continue to be in the mid-50s and staying there for some time given the data of the past few months. So, the MPC noted that while inflation will be in the range of 4-4.5 percent in the first half of the next fiscal year, it then actually increases to 4.5-5 percent. That was one of the main reasons why we had to take the stance that we did, that while we will have some beneficial impact on inflation in the next few months, it then reverses itself mainly because inflation, excluding food and fuel, continues to be relatively high.
Q: How should we understand and interpret the neutral stance? Does it mean that there will no rate cuts in the next 3 months or no rate cuts in all of 2017?
A: The monetary policy committee could either keep rates constant, increase them or bring them down. There are three options possible compared to when it is accommodative. So, given how the inflation outlook changes, if at all, over the next few readings in terms of the data that comes about and our projections based on that for the next fiscal year, policy changes could either one of those three.
Q: Under what circumstances would you consider a rate cut? Is inflation the only thing or are there other factors in the mix as well?
A: We have been mandated by the government backed by legislation that we have to have an inflation target of about 4 percent - central tendency of 4 percent over the medium term. Therefore that is our main objective in terms of the policy of the central bank which is now determined by the monetary policy committee (MPC).
Q: Does this stance of yours mean that the economic recovery could be sooner and sharper than what most forecasters are predicting?
A: If you look at our projections that were published last week as part of the MPC, we expect growth to be about 7.4 percent in the next fiscal year which is about 50 basis points more than the projection for the current fiscal year. Therefore there is a recovery compared to this fiscal year going into next year.
There are some good reasons behind that recovery. One is that international trade, especially exports after a long time are now showing some life. We have had 5 months of positive export growth. I think the Budget has provided impetus to key sectors which has multiplier effects - realty-, housing, the rural segment. Over time we will see that some of the capacities that had been installed in the past will come up for expansion. So, private investment demand is something that maybe in the second half of this year will give a fillip coming from that source also.
So, our central estimate for next year is 7.4 percent which I think is a highly respectable growth rate under the circumstances.
Q: Your assessment of the economic pickup and GDP forecast are rosier than what has been predicted by the chief economic advisor and some others as well. What do you have to say about that?
A: We predicted a 7.1 percent growth in December for the current fiscal year based on the information we had at that time which was in the immediate aftermath of the withdrawal of the specified bank notes. We came up with a 7.1 percent number through the exercise that we had done internally at the RBI which was also a number very close to what two multilateral agencies at that time also came out with. Both the Asian Development Bank (ADB) and the World Bank came out with numbers of 7-7.1 percent. Then we have revised that estimate at the February policy as more data has come in.
While we give a point estimate, actually our statement has a fan chart which shows that there is uncertainty around these numbers. We could very well give a very broad range and that would be proved wrong. However we don't have that luxury.
Q: Today marks 100 days of demonetisation, a period which has been fairly turbulent for the Indian economy. Do you think that in your estimates, the economy will be able to shake off the negative impact of demonetisation?
A: Almost everyone agrees that the impact is going to be a sharp "V", that we would have a downgrade of growth for a short period of time. However the remonetisation has happened at a fast pace and that was part of the plan that subsequent to the withdrawal of the specified bank notes our production plans and supply processes would ensure that the remonetisation happened as quickly as possible, which given our capacity in terms of printing currency notes is at a high level.
Q: Looking back at the last 100 days of demonetisation, do you think that the principal objectives of the exercise have been met? Do you think that corruption has been reined in and counterfeiting as well?
A7: There were several objectives behind this. From the RBI side, the fake Indian currency note is an important issue that needed to be addressed. The other collateral benefits from this, in terms of greater accountability, better public finance, more transparency are by definition areas that take time to fully play out. We have also had financial re-intermediation, in terms of greater financial savings going into deposits, mutual funds and insurance. So, there have been a fair number of benefits. Even the impetus given to digitisation should be beneficial going forward.
But, I think in all these supportive policies and more work is needed so that these benefits are not only tangible but are long-lasting and durable.
Q: One must compliment the Reserve Bank of India (RBI) for managing the rupee despite the FCNR (B) outflow and demonetisation. Do you really believe the rupee is overvalued?
A: The exchange rate value of the rupee is broadly market-determined and the Reserve Bank of India, in terms of its long-standing policy, intervenes only during episodes of undue volatility.
Q: There is a feeling that if the rupee is overvalued, it could stunt growth because imports get cheaper.
A: Our current account (deficit) is low and has been low for some time now. It is at a level that is easily financeable. So, in that sense, the rupee is broadly where it should be.
Q: From your vantage point, how do you see the global economy given the momentous political changes that have taken place and its knock-on effect on economic policy and trade?
A: The change in policies from the largest economy in the world, namely the US, is something that the world will have to start getting used to because it is a major change in terms of openness to trade, in terms of trade barriers, in terms of the kind of fiscal policy that the new government may undertake, which against a backdrop of a tightening monetary policy stance by the US Fed has a real possibility of financial volatility going forward.
Some of these uncertainties may get resolved. For example, what the new government's taxation plan is going to be which will then impact the fiscal deficit in the US and some of it may actually add to the volatility going forward if there are too many flip-flops in terms of what is actually going to get implemented.
So, I think we are at an important juncture and the possibility of negative consequences for countries around the world is a possibility. Asia may come in for special treatment because almost two-thirds of the US trade deficit in goods is with respect to Asia. We just have to see how things evolve in terms of tangible policy changes which the US government so far seems to be fairly determined to carry through.
Q: How much of a cause for concern is it for an economy like India?
A: I think it is a cause for concern for the world. I think it is a cause for concern for emerging markets and in terms of creating financial volatility. I do not think anyone will be safeguarded from it and we have to manage this as it plays out. There are some things that are under our control and that is to ensure that we ourselves follow sound macroeconomic stability rules.
I think we are at a good place with respect to that. We have had a Budget where the fiscal deficit has been reduced, we have a central bank which has a mandate for flexible inflation targeting, we have reserves which are at over USD 360 billion and we have a current account deficit that continues to be modest. So, we need to look after these attributes of macroeconomic stability and that will allow us to withstand some of these sources of turbulence that come from the wider world.
Q: Fed Chief Janet Yellen has signalled a rate hike, possibly as early as next month. What would it mean for Indian financial markets and the rupee?
A: The Fed had indicated in December that there would be two, possibly three hikes in 2017. So, a fair bit of that is priced in. Given that financial markets are forward looking, from that source alone I would expect (and I would underline the word ‘expect’) the repercussions may not be that much as compared to when the Fed increased the interest rates in December and issued a hawkish statement. I think that was the news. I think subsequent to that, the Fed’s views on what it was going to do in 2017 has been fairly consistent.
Q: Taking the world economy question forward, do you see that there is some room for optimism as well? What would you advocate today for corporate India — a cautionary stance or an expansionary mindset?
A: It is not for the central bank to advise businesses what they should do. I think there are opportunities in each sector and they are best-placed to figure out how they want to both manage their risks while expanding their footprint.
Q: We have been fed on the virtues of globalisation for the past two decades. US President, Donald Trump is increasingly toeing a protectionist line. What does this trend mean for an economy like India?
A: I think we have had a sustained opening up of our economy since the early 90s. I don’t think that we should change our stance in any way because we do benefit from an open trade regime. I think India’s policy that the openness of trade should be carried through a multilateral process is the right one.
It depends on how the US carries forward the agenda that has been put out and how other major economies react to that. Because I think one issue that people are not realising is that there will be a reaction to what the US does. That could get messy. Hopefully, wiser heads will prevail and we won’t go down that road, but I think it is important that we should be on the side of keeping borders open with respect to trade and movement of factors of production.
Q: What in your opinion are some of the global worry factors that probably keep you awake at night?
A: The lack of a consistent policy enunciation from major economies is the main source of volatility. Clearer policies, policies that take into account what in terms of the externalities that they create, if those are not put out in a consistent, well thought-out manner then that causes financial volatility and given how fast financial flows happen, it affects us very quickly, as indeed it affects other countries.
In terms of the mandate of the RBI, etc. the hardening of some of the internationally traded commodities is something that we need to be worried about because that would feed into inflation. So, there is a real side to it and there is a financial side to it. By the way, most analysts expect in 2017 the world to grow at a faster pace than 2016. So, that is the good news.
Q: So, on the subject of growth rate, do you think we will be able to achieve 9 percent plus growth rates anytime soon?
A: These things, in terms of predicting what the sustainable growth rates are, are not easy to make. If very fundamental reforms take place, especially when it comes to factors of production like land, labour, then a higher growth rate is possible. Now, how much higher than the 7.5 percent that we are achieving so far is difficult to say. But the fact is we did grow at some point, faster than where we are now, but it could very well be that that was unsustainable and this is sustainable. So, 7.5 percent growth rate is not something to be disappointed.
Q: How do you respond to the recent criticism of the Reserve Bank of India? Do you personally feel upset about it?
A: No, I think that it is important that one grows a thick skin fast in this business and I think we have done that. We have gone about our work, we had undertaken major challenges during these past few months and valid criticism is something that we are open for and we take it in the spirit in which it is given and try to improve ourselves. But, everyone also agrees that not only the RBI, but the wider banking system has done a Herculean job over the last few months and over this period when there were many challenges. That is also important to keep in mind given the scope of the challenge, how far people worked to get over them.
Q: You spent a lot of time explaining some of the work that you have been able to do over the last few months. Do you feel sad that sometimes media tends to look at the negatives more than some of the good work that has been done? Even in the case let us say of remonetisation.
A: That has always been the case. What makes news is fairly subjective in this regard. I think that in terms of remonetisation, we are proceeding at a pace that is very quick. Therefore we have managed to bring the situation to normal along most of the dimensions after demonetisation.
In a way, this was part of the plan that we would be printing the currency notes to full capacity from day one and we would reach a threshold point in this process when things do become more or less normal. So, that is again part of the good work that has been done.
Q: It was part of the plan set into motion many months before the demonetisation exercise kicked in…
A: Given the currency replacement that was required, these kinds of plans and programmes are set in motion a long time back, in terms of supplies, orders, logistics and organising the distribution just in terms of the sheer number of notes that need to be printed in a new denomination to replace the older ones.
Q: Most finance ministers expect the RBI Governor to cut rates. Despite that, this time you have been able to maintain a mildly hawkish stance - just goes to show that your equation with Finance Minister Arun Jaitley is terrific…
A: The best way that a central bank can support growth on a durable basis is to ensure that the inflation is low, stable, there is financial stability and that is the role that the central bank plays. Very few countries grow at high rate, if inflation is high and volatile. I think, in a way, we are doing our bit to support a higher growth rate but on a durable basis.
With the constitution of the MPC, we have now diverse views on how the monetary policy is established every two months. I think that is a very important milestone in our economic history that the monetary policy is now determined through a committee process where there are both independent committee members and representation from the RBI.