Time right to withdraw monetary stimulus: Raghuram Rajan

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Noted economist and economic advisor to the Prime Minister, Raghuram Rajan's is in India for the launch of his new book 'Fault Lines' which talks about how hidden fractures still threaten the world economy.

CNBC-TV18's Latha Venkatesh caught up with Rajan to find out his outlook on the Indian economy. Talking about RBI's recent move on the interest rates, he said, monetary tightening was certainly warranted at the moment.

"One should not have sustained negative real interest rates, except in a moment of panic. We have left panic behind and it is timely that we get back to positive real interest rates at the short-end," he added.

Below is a verbatim transcript of the interview. Also watch the video.

Q: We have just had a credit policy that has raised rates by about 50 basis points on the reverse repo and 25 basis points on the repo. But we are struggling with an inflation which is in double-digits for quite some time now. The CPI is in double-digits for 24-months and the wholesale price index is in double-digits for the past 5-6 months. Don't you think the RBI's loose money policy is some way responsible for the situation?

A: Eventually what happens is even if something is supply side because of either tight food supplies in the world, bad monsoons or mismanagement of imports, eventually that tends to, if not controlled, tends to feed into inflationary expectations. There is only so long that you can keep telling households, "This is temporary; this is a supply side shock."

If they see food prices going up, the visibility of food prices makes it particularly important part of the consumption basket. A householder sees that every day when they go out to buy food. So eventually that affects both inflationary expectations as well as potentially waged demands.

I do not think you can just dismiss and I have never been one in the camp to dismiss supply side shocks as unworthy of worrying about and just focus on the demand side-increasingly the two become intertwined in a way that you can not tear the two apart.

We see inflationary pressure building in other ways. You also have to argue if there is an economy, which is growing at 8-8.5% and we have the kinds of bottlenecks on transport, infrastructure etc, that we have, then at some point you are going to reach the growth potential of the economy.

Certainly, monetary tightening that we have is something that is warranted. You have to be careful about not moving it too rapidly, too quickly because there is still some uncertainty about the global economy. But given that the concerns about the double-dip are abating in the global economy, it is timely that we withdraw stimulus on a steady sustained basis.

Q: A lot of Indian companies today have and have been able to raise prices say by 10% quite easily and the cost of money for any company is not more than 7%. Clearly, we are living in a situation of negative real interest rates for some time now. Would you believe that Reserve Bank even after all the tightening of the last 4-5 months is still seriously behind the curve?

A: Certainly, one should not have sustained negative real interest rates, except in a moment of panic. We have left panic behind and it is timely that we get back to positive real interest rates at the short-end. How we achieve that; what pace we achieve? It is certainly for the Reserve Bank to decide.