Must control CAD; core issues a challenge for Rajan: Gokarn

Former Reserve Bank (RBI) deputy governor, Subir Gokarn feels that Raghuram Rajan's biggest challenge as RBI Governor lies in convincing the policy makers to address the core problems of deficits. Rajan succeeded D Subbarao as the central bank Governor on Wednesday.

The question remains whether the RBI wants to focus on growth, currency volatility or inflation. Rajan may not change the central bank’s stance completely, Gokarn, director of research at Brookings India told CNBC-TV18. The new Governor may look to increase dollar flows via sovereign bond issues, he adds. Stressing on his point to address structural problems, Gokarn says that the RBI’s short-term measures will hold significance if they supplement long-term steps. “We have to deal with is the current account deficit (CAD)”, he says. Also read: Larry Summers the next big risk for emerging markets? Below is the edited transcript of his interview to CNBC-TV18. Q: Do you foresee anytime soon that the new Reserve Bank of India (RBI) governor will be able to trim this 10.25 marginal standing facility (msf) rate? A: The question is how committed is the RBI to this new regime, which they went into in July. They moved from a growth-inflation management strategy to an exchange rate and inflation management strategy. The two are consistent because if you worry about inflation pressures from the depreciated rupee, then raising interest rates to address the rupee and inflation set are internally consistent. However, in the process the growth objective is being obviously put on the backburner as higher interest rates would impact directly on growth. Those risks have been pointed out in the discussion following these actions. The question is; do you stay with this regime as you believe that it is ultimately going to help to stabilise both the exchange rate situation and the inflation situation or do you say well this was temporary. This is one signal that has come out of this system and at some point we have to go back to worrying about the growth inflation dynamic. It would mean going back to easier liquidity conditions and consequently bringing the call rate down to the middle of the corridor as opposed to the top-end where it is now. So that decision is a critical one and obviously Dr Rajan is going to have to decide fairly quickly on whether he is going to use the first few day of his term to signal very categorically a return to the more traditional management or objectives that the RBI is trying to manage. Q: One pressing concern that the market has is whether Raghuram Rajan plans to dismantle any of these mishmash of measures including the hike in short-term interest rates? What is your view on whether there will be any reversal of that? A: I don’t see it so much as a question of whether the new governor will use this as an opportunity to dismantle anything. Each measure has to be seen in terms of what it was expected to do and whether it has done that. If you look at the entire series of actions, taken whether liquidity tightening or the restrictions on capital outflows by residents both individuals and companies, what have they achieved needs to be asked. Have they helped to stabilise the rupee? That was the primary objective of all of these things. Have they helped to achieve that? If they haven’t, then does it make sense to roll them back and either look for other ways to do this? Or to say, let us stop worrying about the currency and let us focus on other things. That is also an option. The point I have been making right through this period is that all of these short-term measures have meaning and significance only if they are used to supplement long-term structural measures. We have to deal with is the current account deficit (CAD). Without making any concrete moves to address that, you can keep experimenting with short-term measures to stabilise the currency and some of them will work for some period of time, others will not work. At the end of the day, we are not going to get the robust enduring solution to the problem because the pressure is not being addressed. So if you look at a combination and this is perhaps the new governor’s big challenge. How do you persuade the rest of the policymaking establishment that unless we address the CAD forcefully and quickly, anything that the RBI does for the currency is going to have short-lived benefits, if at all. That needs to fall in place. I hope that things move quickly on this. _PAGEBREAK_ Q: You know Dr Raghuram Rajan and RBI very well. What difference is he going to make? Is he market oriented man? Is he dovish? How will he change the thinking in the cream of RBI? A: I don’t see him as somebody who is fundamentally going to change the inflation priority that has emerged during Dr Subbarao’s regime. To the extent that people are expecting sort of 180 degree switch to now forget about inflation because its supply side and let us move on to worrying about growth. I only don’t read that kind of switch in anything that he has said on the issue. So that would be my take those in terms of inflation management. Continuity is more likely than any dramatic change. But we are talking about unusual, abnormal circumstances today when it comes to dealing with the multiple pressures, the exchange rate and the consequences that has on the basic objectives, growth and inflation. There is obviously room for trying different things and my preference in this situation would always be to go for expanding the inflow of dollars. I have spoken about this as opposed to reducing the supply of rupee, which is what was done. If those liquidity measures are found now to be not doing the job and some rollback is done. The problem doesn’t go away. You still have to worry about this freefall of the currency and that means going for expanding the dollar pool. We have had talked about sovereign borrowings and other ways to do this perhaps that opportunity or that channel will start to get a fresh look since so far there seems to have been reluctance to go down that route. We will have to look for somewhat different perspectives on deal with the immediate situation but in a more normal situation assuming that emerges at some point, his views are basically that the central bank should be primarily focused on managing inflation and maintaining as often been said low and stable inflation rate.