Return of flows to define rupee stability: C Rangarajan

Changing Repo rate is not the only rate market should look at and the RBI action was along expected lines, says PMEAC chairman C Rangarajan. The RBI has already raised to 10.25 percent to curb volatility in foreign exchange market. There will be an upward pressure on rates on account of squeeze on liquidity.

Also Read: RBI Credit Policy: Leaves key rates unchanged, reflects no hawkish stance These measures can be withdrawn only when the rupee stabilises and the central bank is the best judge for a rollback of its earlier liquidity-tightening measures.  He says it is imperative to work on reducing avoidable imports which will enable to tighten current account deficit. As an immediate measure, petroleum prices needs to be adjusted faster, in line with what is happening globally. When asked how ascertain stability in rupee, he said it will be defined by return of capital flows to Indian market.

Below is the verbatim transcript of C Rangarajan's interview on CNBC-TV18 Q: Do you think the Reserve Bank of India (RBI) was right in not hiking any policy rates and just keeping the arrangement of last week in place? A: The policy is along expected lines. Having squeezed liquidity only very recently, the RBI has decided to leave the other rates where they were. The repo rate is not the only signal that the RBI can send. The marginal standing facility (MSF) rate has been raised and the liquidity has been squeezed by various measures. All these are indications by the RBI that in order to curb the volatility in the foreign exchange market, they have to take appropriate action. Therefore, changing the policy rate in terms of the repo rate or reverse repo rate is not the only signal that we should look at. Q: What does the RBI mean when it says that the recent steps will be rolled back after stability returns to the foreign exchange market? A: Squeezing the liquidity really means pushing the interest rate up. You cannot act on quantity without having any faith on price. Therefore, it was expected and in 1995 or 1998, when call money rates really went through the sky as a consequence of the actions taken. Therefore, there will be an upward pressure on interest rates when liquidity will be squeezed. Initially it is on money market rates, but later on, it will spread to the other rates as well. The immediate trigger is what was happening in the foreign exchange market. Therefore, the withdrawal of these measures would virtually depend upon the return of the normalcy to the foreign exchange market. We cannot put a timeframe on it, but as and when capital flows return to the market or rupee starts stabilising, only at that particular point one can think of withdrawing these measures. Q: What does the RBI mean when it says that the government should introduce structural reforms to curb the CAD? Do they mean that they should increase the import duties on certain luxury items? Do they mean they should increase diesel prices by maybe Rs 1 to impact fiscal deficit and CAD? What do they mean by structural reforms during the period that they have given you a breather? A: The reaction to the CAD is twofold. In the immediate and the very short run, we need to find that the capital flows are adequate to cover the CAD. We all realise that running a CAD of the order of in excess of 4 percent of GDP is way above normal and reasonable. Therefore, over the medium-term and over the next 2-3 years, we need to bring down the CAD to manageable level which is 2.5 percent of the GDP. In order to do it what can we do? First on the export side, to some extent the depreciation of the rupee will act as an inducement for expansion in exports. This will happen particularly in the case of exports where the import content of exports is not very high. The service exports will gain particularly as a consequence of depreciation. On the imports side, we need to look at what can be done in order to reduce avoidable imports. One is gold. Second is coal. Whenever domestic production fell, we resorted to import from outside in order to compensate for the decline in domestic production, can that be done? The structural changes would also mean adjusting the domestic prices in line with what is happening to the global prices. This applies particularly in the case of oil, therefore, petroleum prices need to be adjusted much faster to what is happening in the global situation. Q: How long will it take to roll back 10.25 percent? A: It is difficult to say that. We really need to watch the situation as it evolves, but the signal is, when the capital flows return to the market.