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Jul 27, 2013, 03.27 PM IST | Source: CNBC-TV18

Bringing stability to rupee key; bond yields to fall: Rajan

The Indian currency seems to be on firmer ground this week, but the currency still remains vulnerable despite the Reserve Bank of India’s (RBIs) second salvo. This peace has been bought at a huge price on the rates front.

The Indian currency seems to be on firmer ground this week, but the currency still remains vulnerable despite the Reserve Bank of India’s (RBIs) second salvo . This peace has been bought at a huge price on the rates front.

Bonds have fallen by Rs 5-7 on the long end, the ten-year bond yield shot up to a high of 8.5 percent at one point and the AAA banks have had to borrow at 11-12 percent within a one-year period.

And all this is happening at a time when growth is still sliding. The government's chief economic advisor Raghuram Rajan speaks on these issues.

Below is the edited transcript of his interview with CNBC-TV18

Q: There is some temporary peace on the rupee, but what is the end game of the steps unleashed by the RBI? Is the government waiting for the rupee to go to 57? When do you think the steps can be rolled back?

A: The key issue is not targeting a particular level for the rupee, it is bringing stability and creating some comfort. Neither the government nor the RBI is happy seeing the rupee continuously depreciate and remain volatile. The end game is more stability.

Q: We are in an unstable global environment plus we are also in a structurally difficult domestic environment where imports are much higher than exports. So, can you buy stability on the rupee with these factors?

A: Stability doesn’t mean we want to fix the rupee at some exchange rate; that is clearly not the intent. However, in a situation where there is a sense amongst the analysts that the rupee can go anywhere, that would hurt the economy as a whole.

It is better in such a situation to bring some calm to the market, to bring some stability to expectations by saying that at such times we will come into the market, take the necessary policy measures to bring some stability to the rupee.

Again, let me emphasise that this is not an attempt to say that the rupee will stay fixed at some number forever. That is not the intent at all.

What we want to do is give investors some sense that they can be comfortable about the rupee not going into a freefall, and that there will be some push back if there is too much volatility.

They should feel comfortable entering the equity or debt markets. There is absolutely no intent to kill growth. We hope that this way of stabilising the rupee is going to be substitutes for other more damaging ways of doing that like for example, a programme of interest rate hikes over time.

Q: Why should not the RBI or the government use the opportunity to actually kill some demand? After all the persistent increase of imports over exports to the extent of trade deficit which is 10 percent of GDP and CAD that is 5 percent of GDP indicates that there is an inherent demand that needs to be killed. Don’t you think that some of this should be used to reduce that demand?

A: I don’t believe that our problem with the CAD is primarily one of excess demand. Some demand is at play but I don’t think it is excessive because consider a place where there has been a large burgeoning of the current account deficit we can’t do much about the price of oil. Gold is something that has picked up in the last few years, but I don’t see gold as being an expression of excess demand.

It is more an expression of the investment habits now finding their way into gold rather than into financial instruments. Similarly, when you look at the items that have propped up in recent years, iron ore exports have come down, scrap imports have gone up and coal imports have gone up. These aren’t necessarily an expression of excess demand that is people buying a lot of consumer goods, this is more an expression of supply constraints in the economy.

Q: How long will this decimation of debt paper going to persist? People are sitting on real losses and you are giving a timeline of stability on the rupee which is not a very clear indication when this game will end. How much time will you give it?

A: You should see the measures trying to constrain liquidity for little while, push up the cost of speculating against the rupee which means pushing up interest rates at the short end. In that process, as you tighten liquidity some entities that are liquidity short have been selling bonds longer term bonds and as a result bond yields have gone up, bond prices have fallen. This will largely be a phenomenon that is temporary.

Money will start coming in as they see these attractive bond yields and overtime these yields will come down. So, even if the liquidity tightening measures are in place I don’t see that necessarily bond yields should stay as high as they have been. Even today we saw substantial reduction in bond yields. As the initial liquidity shock gets managed, I would see bond yields coming down. So, I don’t usually give investment advice but one should think about waiting out the period because as the yields come down some of those paper losses would go away.

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