RBI's forecasts, initiatives depend on govt policy: Gokarn

Below is an edited transcript of the analysis on CNBC-TV18

Q: Do you think it is going to be a little difficult to expect the RBI to start moving on rates in January and that expectations should be postponed to perhaps March?

A: There are two factors to consider - one, when the RBI report mentions the fourth quarter, it is referring to the entire quarter and not about a specific date.

Second, I think it is important to keep in mind that a monthly inflation data is fitted into a projection model to check if it is consistent with our overall projection. And if it does, that allows the RBI to announce a three or six-month forecast which then gives the central bank some thing to act upon. None of the RBI’s decisions are taken only on the basis of historical readings.

The RBI also assesses and attempts to forecast what the next few months are going to look like before a decision is taken and today’s decision is to be viewed in that context. The RBI does expect that over the next three months, as mentioned in the policy document, inflation will actually go up as some of it is due to the pass-through effects of the changes in administered prices. Now that is important as it offers an overall sense of the momentum not having completely slowed down.

The RBI does expect this scenario to reverse beginning January and if the forecasts are on track, it will allow the central bank the time to take initiatives.

The other factor which I want to emphasise is that growth which has been at below-trend for a long period of time does have an impact on inflation and that is actually affecting our inflation forecast as well.

Q: When the RBI meets on December 18 for the mid-quarter review, will the low GDP growth in the second-quarter add significance to the mid-quarter policy?

A: That will be taken into consideration along with other factors such as the global scenario along with the inflation data of November and December which will give the RBI if its overall projections are on track or not. Add to this the IIP data for two months, the currency data and other financial market dynamics. So an enormous amount of information will be at our disposal to take a decision.

Q: Do you see more elbowroom in terms of cuts in CRR? If growth data is weak, will it warrant more CRR cuts?

A: The traditional limit is probably at 3 percent. In mid-2000, the RBI stated an intent to reduce the CRR limit and keep it at 3 percent. But after a few years of holding steady, the limit was removed and it allowed the RBI an extra instrument at its disposal which has been used quite extensively over the last several years. But in addition to the CRR, if liquidity pressures turn out to be more significant than anticipated and exerts disruptive influence on credit, then the RBI still has the OMO option.

Q: During the year, is the CRR is a useful instrument if the conditions warrant?

A: Within the overall goal of keeping liquidity in a situation which does not aggravate the pressure of interest rates, any instrument that is likely to have an impact will be used .

Q: The payment of advance taxes in September allows the government to deposit a huge cash balance with the RBI in October. But the festival season drains liquidity out of the economy. When is this expected to ease?

A: The underlying structural factor that has been pushing the RBI to increasingly use the CRR this year is the persistently increasing wedge between deposit and credit growth. Though both are slowing down, but deposit growth has been at levels significantly below credit growth.

In early 2011, the wedge was 9-percentage points- 24-percnet credit growth and 15-percent deposit growth. Though the wedge has narrowed definitely, its size and persistence has begun to have an adverse effect on liquidity conditions. To deal with the problem, the CRR is an ideal instrument because it ensures a permanent change in the credit regime. The other factors such as the effects of the seasonality of currency demand and government balances are likely to be more transitory.

If the transitory problems persist then the RBI will plan to use the OMOs as the effect will wear out at some point. So, the ultimate goal is to keep liquidity at as comfortable a level as possible within that boundary of the deficit and use any instrument that will achieve that objective.

Q: Normally, when does liquidity ease? What is the RBI's plan to reduce the deficit of Rs 1 lakh crore in six-to-eight six weeks’ time?

A: Typically, the RBI forecasts for four weeks as any projection beyond that is subject to errors .The current four-week forecast states that there time at hand to take an initiative apart from the immediate festival impact which is over the next two weeks and that the situation will be lesser than what has been observed over the last few weeks.

But the RBI doesn’t have a clear picture of how the government is going to drawdown balances and the tax payment in December. These two factors add some uncertainty to the RBI’ projections and that's why the RBI watches the government's policies daily and whenever to the extent the RBI has observed pressures building up, either a short-term initiative like an OMO is contemplated or in this case that given the overall macro situation, a cut in CRR was seen as an appropriate response as it also fits into the larger macro-economic assessment.

Q: Do you think inflation will peak at 8.5 percent or do you think it will go higher?

A: The RBI's chart is within a range. So you can look at the top of that range and at the probability associated. But psychologically, the base line is what the RBI would work with and at this point, the level of 8- 8.5 percent is the most likely range within it is going to be. But that’s quite a leap from the current level and that’s a very important factor in our decision of not announcing a rate-cut today.