Be sensitive to emerging market climate: Rajan to Fed & Co

The Fed’s remarks on tapering of its monetary stimulus have triggered periodic bouts of volatility in emerging markets, India included, since May last year when the word ‘taper’ was used.

On the fiscal policy direction post elections, Rajan said that irrespective of which government came to power, the broader policies were likely to remain the same as they are at present.

“If there is a stable coalition in power post election, no matter which permutation it is, broad policies will continue. There maybe a difference in details, but they are all for passing the goods and services tax, they are all for a number of actions which the current government is taking,” Rajan said.

On the issue of inflation, which both the government and RBI continue to grapple with, Rajan said setting a target was the responsibility of the government.

“What kind of inflation target to have should be some thing set by the elected representatives of the people and should not be something that the central bank decides on its own.

We have certainly stayed away from setting our own inflation targets, that’s a process of discussion which the Finance Minister and the RBI governor as well as the Parliament might have going forward. There is no disagreement about the broader need to get a framework in place,” Rajan said.

On the issue of non-performing loans, Rajan said though much of the problem was at state-owned banks, solvency was not an issue because of the government's backing. He said that many projects which were stuck right now were viable once the economic environment improved.

“These are power projects which need coal and now the coal has been delivered or is being delivered, they can start producing. So I think a fair amount of it could turn around as growth picks up as projects get finished and to that extent the problem is contained,” Rajan said.

Below is the verbatim transcript of Raghuram Rajan's interview with Oriel Morrison of CNBC.

Q: What is your view on the global funds flow situation?

A: I think the comments were made in the context what I worry about in the longer run that we are seeing waves of capital flows first to the emerging markets then to the industrial countries back to the emerging markets and this time back to the industrial countries. I worry that this is creating instability in the global economy and we are not paying enough attention to this. In the shorter run context it was that now that the industrial countries were getting back into a more healthy growth situation there is a sense that emerging markets are on your own, figure out what you have to do, each one on its own bottom which I know is not the message that is intended or was intended by the monetary policy actions of central banks including the Fed. However, that was message that was coming across and the markets were taking.

So, it was an attempt to say look we all need to be in it together and we have a number of things that we emerging markets have to do and we will do them and we have done them. However, there are responsibilities on the side of the industrial countries also to make this a good recovery and now that you are recovering you can’t say look you are on your own or at least send the unintended message that is the case.

Q: What would you have Janet Yellen do?

A: I would think that all central banks, not just the Fed, have to recognise that their monetary policies have spill-over effects that have over the last few years led – the extremely easy monetary policy - to a build up of capital flows into emerging markets and a lot more leverage than emerging markets have typically been used to. Now, the reversal has to be handled carefully because that de-leveraging can create the same kind of destruction that happened with the de-leveraging in industrial countries. So, you have to be measured. Tapering has to happen, there has to be exit but there has to be a cognizance that these things affect the emerging markets also. So, a sensitivity, I think that is the right word to use – the sensitivity to the situation in emerging markets - alter the pace of tapering based on conditions there also, not exclusively, not even largely but be sensitive to that as you move forward.

Q: So where is the balance? What should tapering look like, what should the speed of tapering look like right now given the global economic situation today?

A: I would not alter the pace of tapering. USD 10 billion that was done in the last two Fed meetings is fine. What I would say is in situations where there is a lot of turmoil in the emerging markets (EMs), language that pays attention to it and the willingness – there is a lot of forward guidance that industrial countries’ central banks give on what happens if the domestic situation changes, some sensitivity to what happens if the international situation changes dramatically would be useful. We don’t know what will happen in the world. We have problems today in Ukraine, we had problems in Argentina a few weeks ago.

So, some sensitivity and certainly not the language that says that look you guys are on your own. We are going to do what we have to do and you pick the pieces. That language is not helpful. There is a realisation amongst many participants in the meeting that we have to be careful.

Q: Given the friction that we are hearing about at the G20 between the industrialised nations and the emerging nations what sort of tone do your conversations with Janet Yellen take?

A: Janet and I know each other. I respect her greatly. She is a very experienced, very prepared central banker. I don’t think we're talking about something that she doesn't already know. We are talking about how we should collectively address these issues and communicate with markets.

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Q: You were telling me earlier that there is some difference between the comments that you make and the way that is played out in international media. How would you then categorise the comments that have been made by some of the attendees here? For example George Osborne who essentially said that some emerging markets are blaming Fed taper for problems of their own that they should fix.

A: I don’t know what context he made those comments. At least from my perspective I wasn’t making the comments because India was particularly affected by the latest bout of tapering. India has been relatively stable since September. The currency has been very stable. We have brought down the current account deficit (CAD) from 5 percent to 1.5 percent through some dramatic moves over the last few months. Inflation is coming down. The fiscal deficit has come down and is sticking to the fiscal consolidation path. We have done all that we were supposed to do except we want to see more growth. We are at 5 percent, we would like to see more growth.

What we were trying to say is this is not about us, this is about changing a world where we have these gales of capital going back and forth and leaving destruction in their wake. If you don’t want a repeat once more which is emerging markets start building reserves once again because the message that has gone out is you are on your own. Nobody is going to come to your help if you run a large current account deficit, build your reserves, shrink your current account deficit, have a very competitive exchange rate, if that is the message that goes out we are setting in place the roots of the next crisis which is capital flowing back to the industrial countries, world demand being lower than it should be because the emerging markets are not spending as much as they should and you set in place the conditions for the global savings glut.

Q: Back in 2011 you were talking about the formation of an international monetary policy committee. Could this be part of the answer?

A: The first part is to recognize that there are these spillover effects and to then start taking that into account when we set monetary policy and not so much – you are setting monetary policy for the rest of the world when you are United States or the United Kingdom, but you recognize that there are feedback effects and you are sensitive to them. So, the first I would say is sensitivity.

In the longer run recognizing that we are a fully integrated world that capital transmits monetary policy instantaneously across the world, larger central banks have to model what goes on in the rest of the world and be sensitive to that because it does feedback but some times the effects are more than the feedback effects. What hits back to the United States or hits back to Japan or hits back to the United Kingdom may be a fraction of what actually happens out there. So, we need over time to discuss a broader view of monetary policy rather than just narrowly focus. It is difficult I have no doubt that setting monetary policy for your own country is difficult. Taking into account feedback effects elsewhere is going to be an order of difficulty that is greater but the fact that it is difficult doesn’t say that we should not try to do it because it does have these effects. We have to work. We already have discussions, we meet each other at the BIS but the problem so far as each country has its own mandate and that mandate precludes looking outside.

You will set monetary policy to maximize employment and get price stability in your own country but for an integrated world this is too narrow. We have to be broader than this. Again I emphasize it is because in the short run it may not matter as much but these crisis that we have had are not unrelated to the policies that we have been following both in emerging markets as well as in industrial countries.

Q: What sort of pushback are you getting on the messages that you are putting forward to the G20 or are you getting agreement?

A: Obviously it is different from what people have been saying but others have been saying this. Jaime Caruana of the General Manager of the BIS has been talking in this main for some time and certainly the BIS has been very forceful in pushing the idea that there are these cross border spillovers which we need to take into account. Remember they have credibility because they were arguing that this was important before the financial crisis and saying that this would lead to it. So, we have to have a continuous discussion. I think first recognizing the issue is the starting point and my remarks were intended to push for recognition of the issue that your actions have effects elsewhere, I know you recognize it but we need to talk about it more openly and be sensitive to these effects. Then over time we will at some point, may be 10 years from now get the recognition in Congress, in the Indian parliament elsewhere that monetary policy has to have a broader remit than the domestic economy.

Q: One of the Australian treasurers Joe Hockey's key objectives at the G20 was to put a number in terms of global growth targets. Is this the right thing to do?

A: There is a real concern that the G20 process is meandering a little bit. My concern is that we should talk about some of the areas of friction because that is where we can get some clarity and we can make some improvements in the way we behave. However there are also areas where each one of us can do better learning from each other and growth is one of those areas. No country is deliberately holding back on growth. We are trying to work as hard as we can to improve growth. The question is, is there some learning to be had for example from how Australia has improved productivity through the productivity commission, what changes it has made on labour laws for example. Can France learn something from that, can India learn something. These kind of discussions if we can focus on some of the experiences that countries have had and I think that is the Australian intent it will help us sort of learn from each other and push growth further. I do think that many of us are doing what we can on growth and being more ambitious is certainly good but a lot of the value added will come from learning from each other rather than anyone of us necessarily needing more impetus to push growth.

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Q: Do we need the G20 to agree to global growth objectives. Is that tangible enough?

A: I think it is good to be ambitious on growth and to the extent that we can put out credible numbers that we are trying to go towards, it is a good thing. However in terms of cranking up efforts in different countries, countries are working as hard as they can. So, really the value added to my mind will come from learning from each other in these conversations. If we can help each other, if we can learn from each other and perhaps also set up institutions that can help this process. I think that would be one set.

The other set is let's deal with frictions. By smoothing the frictions we can move forward.

Q: The IMF has essentially said that more monetary policy tightening is required in India. Essentially then inflation is going to remain higher than what your current forecasts are and in fact growth is going to be lower than what your current forecasts are, what is your reaction to that?

A: There is always a reasonable degree of disagreement between countries and the IMF. We are doing what we need to. We are undertaking a number of reforms. The IMF - understandably having been on that side myself is always going to say do more. Clearly there are places we could do more if we had the political consensus and the political certainty that we don’t have right now. We have elections coming, but post election hopefully on some of the areas where we need to make changes we will move forward. For example there is a goods and services tax which is in many ways a no brainer going to increase the tax revenues, spread the tax net, it is going to be a more efficient tax. All the parties agreed but we could not do it before the elections. So, post elections hopefully that will happen. If the IMF says you should have done that, well yes, but the politics did not allow, going forward we hope to do it. So, it is good to have an organization from outside that pushes you but we feel that on many issues what we are doing is reasonable and we are moving forward.

Q: Talking about politics I wanted to get to the difference of opinion which seems to be there – there are clear difference of opinion between the RBI and the government. If you look at some of the commentary from the finance ministry who actually said that the central bank policy should be subservient to the overall economic vision of the government.

A: I don’t disagree with that. I think that the overall objective of the central bank, what kind of inflation target to have, should be something that is set by the elected representatives of the people and should not be something that the central bank decides on its own. We have certainly stayed away from setting our own inflation targets. That is a process of discussion which the Finance Minister and the RBI Governor as well as perhaps even parliament might have going forward. We are not there yet, we have a committee which has suggested a target which is also consistent; the process that committee has suggested is consistent with the process of finance ministry’s committee. So there is no disagreement about the broader need to get a framework in place. I think in terms of how I see the process is that the government sets the objective and the central bank delivers on that objective. In India we have always had discussions between the finance ministry, between the Prime Minister and the central bank Governor and it is not as if the government is on a different page on what we have been doing on inflation thus far. So, they may have different views on what they would like to see done but there is a process, there is a conversation and it is not that what we are doing ultimately is saying is where they say over my dead body and we go ahead and do it – no, there is fair amount of coordination at the highest level.

Q: How would the landscape, the economic landscape in India change if in fact the government does change?

A: I hope the level of discussion, coordination will continue. It has always been that way in the past so I don’t see a reason why it should not. I believe it will.

Q: It certainly does appear though that if a new government is in fact put in place, a particular government is more pro-business.

A: It depends on which government comes in. Even within the Congress if a new UPA comes in, it could be quite different from the current government with a generational change. So, I think the jury is out on how it will change. My sense is that if there is a stable coalition in power post elections, no matter which persuasion it is, broad policies will continue. There may be a difference in details but they are all for passing the goods and services tax, they are all for a number of actions which the current government is taking.

Q: I just wanted to briefly touch on your five pillar policy. Clearly banking reform is one of your key areas of interest. Are you concerned about the increase that we have seen in NPAs?

A: Non-performing assets (NPAs) are going up, we need to bring them down. We have a framework in place starting April 1 to give banks more incentive to restructure the asset, to give the entrepreneur more incentive to restructure the asset and move on. I think the lesson of every crisis in the past has been cleanup. Before we get to a crisis I want us to cleanup. Let us cleanup and make sure we don’t get anywhere near the deep problems that other countries have. There are two things going for us here which I have to mention. One, a lot of problems are in public sector banks. Now, that is a problem but at the end of it there isn’t an issue of solvency because they are backed by the government. Second, that in the cleanup many of these are projects that are viable. This is not acres of housing built no where. There is a little bit of it but that is not the predominant. These are power projects which need coal and now the coal has been delivered or is being delivered they can start producing. So, a fair amount of these could turnaround as growth picks up, as projects get finished and so to that extent the problem is contained.

Q: It is fairly clear to the market at this point that the Fed is going to continue to taper at a measured pace. How are you in India going to manage the impact on your economy?

A: I think we are relatively well positioned. I actually welcome a measured pace of tapering. The only thing I have been calling for is that in the communication there should be some sensitivity to conditions in EMs. And this is not from our perspective this is broadly emerging markets some of whom have been in trouble in the last few months. However, I am fully prepared for a tapering that continues at this measured pace. We have built reserves; we are in a much better position as far as the current account deficit goes. So, I think the era of easy money has to end at some point and I would rather that it ends in a stable and a measured fashion. So, I think we are perfectly okay with measured tapering.

Q: How active are you prepared to be when it comes to managing the rupee?

A: The rupee has been very stable. My belief is that we should be focused on getting our fundamentals right and that has been our focus ever since the summer of last year. One of the main aspects of our fundamentals is the inflation rate. If investors have a sense the inflation rate is going to come down, both domestic and international investors, they would be more prepared to take a bet on the rupee and that is essentially what we are focused on.