Inflation stability a key for long-term growth: RBI

Excerpts from Reporter's Diary on CNBC-TV18 Watch the full show »

In a surprise move, the Reserve Bank of India (RBI) cut the cash reserve ratio (CRR) by 50 bps, signaling a shift of focus from inflation to growth.

Dr Subir Gokarn, Deputy Governor of RBI says, inflation stability is a key for long-term growth. "If you want to talk about sustainable and stable high growth over a period of time, the requirement for that is inflation remains low and stable over a long period of time," he adds.

According to him, inflation is showing signs of softening. "Impact of 'imported' inflation will be muted over next few months," he adds.

Today, the bond markets actually acted in reverse. The bond yields went about 15-16 basis points higher. That's because they are worried that the CRR will perhaps replace the open market operations (OMO) and there will be no open market purchases of bonds by the RBI.

Gokarn says, the central bank didn't announce OMO this week to check credit policy impact. "We are certainly not ruling out continuing with OMOs over the next few weeks," he adds.

Also read: Bankers laud RBI's growth stance, say rates to soften ahead

Below is the edited transcript of his interview with CNBC-TV18's Latha Venkatesh. Also watch the accompanying videos.

Q: You all have not announced an OMO today, how should the market interpret this? Will there be future OMOs regularly?

A: We didn't want to announce one this week because we had the policy and we want to see its impact plays out. The motivation for OMOs has been and will continue to be the perception of persistent pressure on liquidity. To the extent that this pressure remains in the system for the next few weeks, we are certainly not ruling out continuing with OMOs over the next few weeks.

Q: If you have a M3 growth of close to 16%, the calculation on the basis of the current rate of growth would be that about Rs 2 lakh crore of reserve money will have to be created. Clearly, on the FX side, at the moment the RBI is forced to drain out liquidity. So, should not there be a structural announcement in terms of how to create reserve money, may be buying bonds from the market, any thoughts on that?

A: Let's keep that larger structural issue to the annual statement. I don't have any immediate views on this because that's not been the focus of our policy discussion in this quarterly review. We pay a lot more attention to the integrated view of monetary and market developments in the annual policy and then in the half yearly.

I think the limited objective of this policy was to act on the overall liquidity and growth, inflation dynamics, keeping in mind that the problems are there. We have been certainly seized of this apparent mismatch in terms of the sources of liquidity whether it is through the accumulation of foreign assets or whatever expands the RBI balance sheet. So, let's save this discussion for April.

Q: There is a lot of discuss on this policy itself. You just spoke about the growth inflation dynamics. If one took three-month rolling inflation index, as you took it for core inflation even then core inflation is not falling. If you just look at plain month-on-month numbers, the December number has indicated that core inflation is rising at a rising pace. Can't you be accused of having acted in haste?

A: When you look at month-on-month numbers, you have to do seasonal adjustments. You can't just take the raw numbers and draw any inferences because seasonal effects are quite significant.

The indicator that we have used in our report essentially has taken the seasonal effects out and is then looking at the trends that are visible. Now, on that score, the line that we show in the graph, which you referred to, is quite flat essentially indicating that there is no disenabling downward trend.

In the last three months, the impact on inflation, particularly inflation that has transmitted through energy and commodity prices, is partly the result of very significant depreciation. We have seen somewhere 15% impact of depreciation on prices.

Now, as we go ahead, we don't expect the same impact to felt. Ofcourse, there could be a risk scenario, which might change. But our base line projection is that the impact of imported inflation, that is the impact of currency depreciation, will be significantly more muted over the next few months than it is. So in that sense the adjustment of core inflation to the growth deceleration is going to start becoming visible in a way that we expected it to become visible in the previous quarter, but it got delayed by or postponed by the depreciation.

The other risk, which we pointed out, is that there is a suppressed inflation, fuel prices, coal prices need adjustment. That might take the number up a bit. That again might transmit through into higher overall rate of inflation. That is something we will have to wait and watch out for.

Given these two factors or keeping these in mind, particularly the depreciation impact, we are reasonably confident that this particular indicator will start to move down. We don't expect it to drop dramatically, but certainly show sign of softening. That is really the basis for our continuing guidance that the cycle has peaked.