India needs low interest rates, reforms to grow: Adi Godrej
Jun 20 2012, 17:40 | By CNBC-TV18
Adi Godrej - CII President and Godrej Group Chairman
The Indian economy needs both lower interest rates and government reforms to grow and lure foreign investment says CII president and Godrej group chairman Adi Godrej in a discussion on CNBC-TV18, along with HDFC vice-chairman and CEO Keki Mistry and former RBI governor, Rakesh Mohan.
Below is an edited transcript of the discussion on CNBC-TV18. Also watch the accompanying videos.
Q: The argument that both government and the industry are making is that investment cycle is a function of interest rates. The RBI has retaliated by saying that investment cycle is not merely a function of interest rates. Do you believe the logic that industry is giving and the explanation from the RBI?
Mohan: In the last few years, both the industry and the government think that investment and interests rates are like a hydraulic system where you suddenly decrease the policy interest rate from the central bank and then interest rates will automatically shoot down in the economy and therefore economy will start gaining.
The economy is a much more complex mechanism which I though we used to understand much better. Consumer price inflation is around plus 10%, that it's clearly very difficult for banks to reduce deposit rates. A large market borrowing programme is required to encounter large government fiscal deficit. Midium and long-term rates are determined by large borrowing programme.
Q: Can you blame the RBI for delivering a status quo policy?
Mistry: One can't blame the RBI for delivering a status quo policy. One would have liked to see some reduction in CRR more than a reduction in interest rates as the liquidity is running tight with Rs 75,000-80,000 crore negative in the system.
Easing of liquidity would have been a big boost to confidence. All this while RBI has been focusing on inflation. Inflation has not come down and is not even likely to come down because of constraints in supply side and second the currency.
In March, oil prices were USD 120 per barrel and rupee was 48. Today, oil prices is USD 97-98 per barrel and the rupee has depreciated, not appreciated. So, we are not getting the advantage of falling commodity price globally because of the weak currency.
Q: Industry is clearly disappointed with the fact that the Reserve Bank has decided not to move on the CRR or the repo rate. But the Reserve Bank's argument is that investment cycle is not merely a function of what it does to interests rates, it has to worry about inflation. Inflation is raging at over 10%. There was no choice for the Reserve Bank, but to not move on rates.
Godrej: No, I don't agree with that interpretation. I think the WPI is only around 7%. Inflation has come down. Most importantly, inflationary expectations are down because global commodity prices are coming down, especially crude oil.
We are very disappointed that RBI has not lowered the interest rate or the CRR because the lack of funding, especially for small and medium enterprises and the high interest rates are clearly coming in the way of investment and therefore, production and GDP growth.
Q: There is a ray of hope that capping of oil subsidies, perhaps partial deregulation of diesel etc will happen; they may perhaps move other crucial pending reforms as well. We heard from Kaushik Basu that the government could perhaps move on things like FDI in retail. But if that wasn't to be the case and if the inflation data, expected in July, was to look ugly, do you think the possibility of the RBI cutting rates on July 31 is pretty much ruled out?
Mohan: Given what governor has stated this morning, it would be logical. But I would still further add that there is excessive importance being given to such rate actions by the RBI. If the other actions are not taken, even if the governor takes such actions as he did indeed in April, there will be no effect on interest rates.
Q: As far as liquidity is concerned, the Reserve Bank says that they will use the OMO window and other appropriate instruments as and when required. They are pretty much going out and saying that liquidity continues to be an issue that we will manage.
Mistry: I think that will be very positive, if they continue with the OMO programme. If enough liquidity is injected in the system, it is going to enable our banks to cut rates. A mere interest rate cut by RBI would not really have helped banks in cutting interest rates on their own loans because at the end of the day there is a limited amount that we borrow from RBI.
But enough liquidity in the system will enable them to cut deposit rates and that would enable them to pass the benefit back to borrowers by reducing lending rates. So, through OMO operations, if liquidity can be injected in the system, I think it will be very positive.
Q: But if you look at the RBI's argument, it says that it is a front loaded rate action. It gave you 50 bps when no one expected it in April and even that wasn't passed through by the banking system, so would 25 bps really have changed the world for you?
Godrej: It's not a question of changing the world. The present position, which India is in, needs to be corrected. Reforms need to be brought in, interest rates need to be brought down and most importantly CRR should have come down. If the banks are not cutting interest rates, the CRR should be reduced.
Q: What about the possibility of another stimulus, QE3 is being talked about the in US at this point of time and the reserve bank as eluded to the fact that pressures of further stimulus in the global economy could mean commodity prices moving up and that could reignite inflationary pressures across the world and transport those to India. How significant is the possibility of another stimulus likely to impact our policy on July 31?
Mohan: This is a much broader issue that a possible QE3 in United States. Second thing that needs to be watched is what will happen in Europe post Greek election and the resolution or otherwise of the Spain crisis and possibly an Italian crisis.
The governor would advice over the next few weeks to really keep his eyes and ears open or what happens both in Europe and United States if difficulties do arise as a result of these issues.
Both in the Europe and the US then we are able to manage our economy with appropriate liquidity in the system to at least achieve the growth rates that are currently being expected. So I think the governor really has to be focus on these issues rather than the rate cut issue.
Q: Its clearly a wait and watch policy at this point in time, do you anticipate now that the RBI will move when it announces its policy six weeks later, do you believe if the inflation number continues to look bad its pretty much over and done with even on July 31?
Mistry: One should not look only at food inflation as people's food habits will not change whether interest rates are high or low. You need to look at commodity prices and core inflation. In the beginning of the year we said that, we believe that during the course of the year RBI would be able to cut interest rates by about 100 bps.
We already got 50 bps in April itself. So, remaining 50 bps cut is still on the cards. I believe in the H2 of the financial year one will see some action on the part of RBI hopefully if core inflation numbers reduce and currency becomes strong.
Q: The Reserve Bank says that inflation continues to be its number one problem and priority?
Mohan: We saw highest growth between 2003 and 2008 when the average inflation was around 5%, as long as inflation is in 6-7% plus area then regardless of what the central bank does normal interest rates will remain high, investment will be low and therefore growth will be low.
Q: Fitch has revised India's outlook, cutting to negative, similar to what S&P had done and the theme again seems to be lack of structural and policy reforms. It says it understands the predicament of the central bank, why is Indian industry finding it so hard to understand the predicament of the central bank?
Godrej: It is very important that the government acts on reforms and the central bank cuts rates if we want to get growth going. We have enunciated our position, and mentioned it, across the board. We expected rates to reduced, but unfortunately they were not.
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