Rajan calls LPG cap hike `misdirected subsidy'

“A monetary policy committee would create an institutional structure that would help take good decisions and would send a signal that the RBI is working on its mandate,” he said.

The panel had suggested the central bank should look at inflation as the goalpost around which its decisions on interest rates should centre, rather than its current dual objectives of balancing between growth and inflation, and had recommended setting up an independent monetary policy committee in this regard.

The committee had also outlined a target for the central bank to bring down the consumer price index to 8 percent in a year and 6 percent in two.

In the US, for instance, the Federal Reserve has a dedicated body, the Federal Open Market Committee, headed by the Fed chairman that takes decisions on interest rates.

Rajan, however, admitted that some proposals of the committee would require political discussions and that he would call for a broader debate on the MPC structure.

Trasnscript on the next page

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Below is the verbatim transcript of RBI governor Raghurm Rajan’s interview with Karan Thapar on CNN-IBN’s special show Devil’s Advocate

Thapar: Let us come to the Urjit Patel report which is accepted which significantly changes the way the RBI sees its role and how it functions. In comments that you made on Tuesday many people got the feeling that you were inclined towards accepting it. Have they correctly understood you or have they misinterpreted you?

A: The Urjit Patel Committee report has had the remit of looking at our entire monetary framework and suggesting changes. Some of those changes can be done immediately because they give us some technical support in what we are trying to do, some of those changes require a broader political discussion with the government, with parliament etc.

So what we think is variable to what we are doing now, we can take on which is what I did when I said they have given us a glide path to bring down inflation. Our mandate is to bring down inflation. So they have told us you can do it comfortably over a couple of years, bring it down to 8 percent at the end of this year to 6 percent at the end of next, that seems to me something which has been done with a fair amount of analysis, well within our grasps, let us pick that up.

There are more detailed recommendations on the structure of monetary policy committee who sets the inflation goal, what that should be, whether we should be moving into inflation targeting. Those are issues that we need broader debate on.

Thapar: Broader debate within the bank or broader debate with the government as well?

A: With the government as well. Some of these things require political buy-in and we have to have that debate.

Thapar: Let us for the moment first talk about the Urjit Patel's recommendations about inflation. It says that the RBI's main focus should be on inflation rather than a mix of inflation and growth. At a time when the US Federal Reserve and perhaps the European Central Bank (ECB) are increasingly focusing on both, do you agree with this recommendation or do you have certain doubts?

A: No, the reason the US Federal Reserve and the ECB can focus "on growth" is because inflation is very quiet. Part of the reason inflation is very quiet is because over the years they have built credibility that they will fight inflation and keep it within a low band.

Thapar: Here inflation is the problem, so it has to be the central focus.

A: Exactly. First make it the central focus. Once inflation comes down then in circumstances like the current one when growth is very weak we will have the room to cut interest rates sharply, so as to create the conditions for growth without worrying about inflation.

Thapar: So Urjit Patel is not tying your hands down forever and a day on focusing on inflation. It is simply saying to you for now and until you correct the problem of inflation, inflation is our central focus, but once you have brought inflation down to acceptable levels then the bank probably will have to focus on inflation as well as growth. Growth is not ruled out thereafter.

A: What you want to do is maximise growth given tolerable levels of inflation. What people do not understand about inflation targeting and that is where the terms have gotten overly complicated in public. People do not really understand what it means. All it is saying is the best way I as a central bank can help the economy grow is by keeping inflation low. That then allows me to set interest rates, which lets the economy grow.

Thapar: On inflation itself specifically the report says that the consumer price index rather than the wholesale price index should be the main inflationary guide that the Reserve Bank of India (RBI) follows. However many people point out that the consumer price index (CPI) has too much weightage to food prices and perhaps too little to non-food components. If you accept that CPI must be your main guide would you at the same time also redesign CPI?

A: It is an evolving process. We will have to look at the components of CPI and how that behaves over time.

Let us put it this way it is a much better gauge of the inflation that you as an individual citizen experience than the wholesale price index (WPI).

Thapar: But not perfect still.

A: It is not perfect. The point is you focus on something which is imperfect but captures a lot of what you experiencing or look at something which we have lot more experience about – It is little bit like the economist looking under the lamp because that is where the light is instead of where the stuff that he lost fell.

Thapar: What I read in that answer is you still keep open the option of redesigning CPI to remove its imperfections?

A: That is an evolving process. In fact as our consumption basket changes CPI will change.

Thapar: Something else that is in the Urjit Patel report is that it says that over the next 24 months CPI inflation which is presently a worrying 9.87 percent must be brought down to 6 percent and thereafter it suggests that your target should be 4 percent within a band of 2 percent on either side. If you accept that recommendation doesn’t it therefore almost automatically follow that for the next two years the bank is going to be fighting a pretty relentless battle to bring down inflation?

A: What we have said is over the next two years we want to bring inflation down to 6 percent. That to my mind is a feasible target, it is a reasonable target. 6 percent is neither extremely low nor is it extremely high.

Thapar: Coming from 9.87 percent you are coming down almost 4 percent, so it does mean a pretty relentless battle.

A: It means bringing down inflation in a serious way. We will need help from the government. We believe that the government is going slow for example on agricultural support prices over the last few months will help, because it will reduce the price at which food increases and remember you just said that food is the big part of the CPI index.

Thapar: As you do that part will shrink and so your advice to the government is please go slow on agricultural support prices?

A: Please go slow on support, but give aid to agriculture so that we have more supply coming in.

Thapar: Urjit Patel report says that future decisions should be taken by a monetary policy committee rather than by the governor alone. Are you happy to see your powers diluted, even though you would be chairman of that committee?

A: It is a big responsibility, so I am happy if a committee is willing to share it, but the more important point is can we create an institutional structure that over time makes better decisions. I do not care about the decisions I am going to make over the next few months or years.

Thapar: But thereafter you want an institution.

A: I would be pretty happy to let it go to an institution before then, but we need to think about what institutional structure will give the central bank credibility and also allow it to make better decisions. So it is not the wins of one person but the considered view of a group of people, all of whom are experts which brings together the best policy structure.

Thapar: Urjit Patel also says that the decisions taken by the monetary policy committee would be on the basis of a majority vote and no member would have the right to abstain?

A: Those are details. My sense is we can work out over time what seems reasonable. Those can be debated. But really the whole concept of a monetary policy committee is the big advance and do we want to go there, do we want to go to a place where the rest of the world is, that is really the question we need to ask.

Thapar: One of the comments made by the Business Standard on this concept which you call a big advance is that it would change the nature of the relationship between the bank and the government and if sometime in the future there were to be differences over monetary policy between the government and the Finance Minister in particular, and the RBI then you could see a certain measure of tension between the two because the monetary policy committee would not allow the RBI and the governor the flexibility to heed a hint from the minister?

A: I do not think it is secret that there have been tensions in the past. It is not that having an individual resolves the problem of having tensions. What is true is that there is constant discussion between the RBI and the Finance Ministry in the same way as the chairman of the Federal Reserve has breakfast with the treasury secretary. There is constant discussion. We talk about a lot of things and there is some give and take in those discussions.

Thapar: Urjit Patel recommendations would give you a red line of protection as well, which may some times be missing at the moment?

A: It may be useful under certain circumstances, absolutely.

Thapar: That would be a positive because it would underline the autonomy of the RBI?

A: It would send a strong signal to the outside world that the policies that the RBI is following are according to its mandate and not according to something else. That said, there will always have to be some amount of dialogue between the RBI and the government.

Thapar: When will you formerly announce as governor your reaction and response to the Urjit Patel report and which bits you ate accepting immediately, which bits you need to debate and discuss with the government, which bits you need to debate, analyze and discuss internally? When will we have a formal announcement?

A: You know the history of committee reports in this country. There is some debate that takes place, people express opinions, then you pick-up pieces that are right to take up and you start talking about them with the relevant people. I don’t think there is a special date on which we will say we accept clause A, B, C, D and reject clause E. We will debate with the government pieces of it and as time goes on and start implementing.

Thapar: In other words bits and pieces will be accepted as you think the time is right and when you accept them you will also let the people or the public know it has been done? It will happen from time to time.

A: Yes but it will be debated. Nothing is going to be done by stealth.

the interview continues with more discussion on state of economy and economic growth on the next page

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Thapar: Let us start with the state of the economy as it is today before I ask you about how the bank sees its future and lets us begin with economic growth. For the first six months of this financial year it has been just 4.6 percent and on Tuesday you readily accepted that it will be under 5 percent for the year as a whole. How worried are you by the declining growth the country is experiencing?

A: It is stabilising at a low level. I don’t think we will see significant further declines at this point. Question is when it is going to come up. The hope is that with rest of the world starting to pick up more strongly, with our agriculture doing well and with our big projects starting to slowly come back to life that we will get stronger growth.

Thapar: You say it is stabilising at a low level but where do you think it is going to actually stop because independent institutions like Fitch, Crisil, World Bank, IMF put it for a year as a whole between 4.2 and 4.8 percent. 

A: The precise number is ….

Thapar: Above 4.5 or around 4.5 percent?

A: As we said in the report slightly below 5 percent but for the year as a whole we will be between 4.5 and 5 percent but where precisely depends on so many imponderables.

Thapar: Within that overall figure how worried are you about industry and manufacturing in particular because the index of industrial production (IIP) for the last 8 months has been in negative territory and in November it sharply fell by 2.1 percent. Does industry face a particular problem?

A: Industry is weak, manufacturing especially is very weak. Weakness eventually creates a source for rebirth.

Thapar: But you may have to fall a lot before that happens?

A:  I think we have fallen quite a bit. So, the conditions are getting into place for a stronger growth.

Thapar: Is that a hope or is that based on some factual analysis?

A: We have had hope for quite some time that we are stabilizing, we are starting to pick up. The magic impetus which creates the kind of activity – I start doing stuff, I start investing which then creates demand for your stuff which makes you invest.

What is missing really is investment. Investment is based as you know on animal spirits. When those animal spirits start picking up I am hopeful the revival of the large projects, which we see some emergence of.

Thapar: Have you knocked that investment and the revival of animal spirits by hiking interest rates at a time when most people thought you might just maintain the status quo. Industry as you must be aware is very depressed by your hike?

A: If you talk to the bankers the hike is sort of infra marginal. To put it differently, in layman's language they already see that depositors are demanding a higher rate of interest, much higher than our policy rate because inflation is high.

Thapar: In other words you are bringing the interest rate down wouldn’t have brought the rate down that they borrow at? But have you sent the wrong message nonetheless?

A: No. What we have done is we sent a signal that we want to bring inflation down. The key problem for them is not the interest rate, it is inflation. Unless we bring inflation down deposit rates are not going to come down, bankers are not going to reduce the cost of funding.

Thapar: Let us then come to inflation. The wholesale inflation index has admittedly come down to 6.16 percent, but the consumer or the retail price index is still at a fairly worryingly high 9.87 percent and yet on Tuesday you seemed to suggest that there may not be an immediate need for further interest rate hikes. So are you confident that inflation is actually on a glide downwards or once again is this hope?

A: First you asked me why I raised rates and now you asking me why I have not raised rates enough.

Thapar: If I am picking up on your optimism then I am actually questioning the optimism.

A: What we have done is taken into account that there is some disinflation in the system, that what was 9.87 percent is going to come down further next month, probably little further into March. We setting rates at a level that we think is consistent with that disinflation for us to get some byte and for the inflation system to come down to about 8 percent at the end of the year.

Thapar: Was your heart in that sentence which suggested to people that in fact another interest rate hike may not be necessary, may not be foreseeable, because a lot of people took heart from that despite the hike that you did?

A: Our statement was we have done what we think is necessary at this point and hopefully no more.

Thapar: So it is the hope?

A: It is the hope, absolutely. I am not clairvoyant. There maybe reasons to do more, there maybe reasons to do less.

Thapar: At the moment you are hoping you do not have to do more.

A: At the moment I think I have done enough.

Thapar: Let us come to the fiscal deficit. Given that this year growth is going to be way below the Budget target of 6.4 percent, given that fuel and fertiliser subsidies are likely to rise perhaps substantially above the Budget target of Rs 65,000 crore because of the depreciated rupee and given that Rs 14,000 crore disinvestment target would be missed by a long margin, do you think finance minister Chidambaram can actually meet his 4.8 percent fiscal deficit target?

A: I think they will get close. From what I hear there had been substantial amount of spending cuts that have been put in place. I think whether it is 4.8 percent on the nose or not it will be very close, close enough not to matter that much.

Thapar: Close enough not to matter, but the problem is if he misses 4.8 percent having said repeatedly, more often that anything else that he has ever said that he is going to meet that red line, missing it even by 0.01 will actually worry people, won't it?

A: I think the government will make every effort to meet it. I think there is a high probability that it will. What I do want to emphasise is even if it doesn’t, there has been a substantial amount of fiscal contraction, so much of the heavy lifting will have been done.

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Thapar: You said even if it does not it will not really worry people. I will tell you one reason why people are getting worried is because the cabinet at Rahul Gandhi's behest is raising the cap on subsidised LPG cylinders from 9-12. That will add several thousand crore more to his subsidy bill and if he is anyway missing it, this will make sure he misses it substantially.

A: I was talking about everything included.

Thapar: This was included?

A: What one should be careful about is expanding the misdirected subsidies in the system. We have to be very careful. We need to spend on very important things we are not spending on.

Thapar: Is an increase in LPG cylinders expanding the misdirected subsidies?

A: I believe that there is a certain amount of the population that perhaps can benefit from subsidised LPG cylinders. But beyond a certain point you are reaching people who can well afford to pay for it. Whose pocket is that coming from? It is coming from the very pockets of the people who are getting subsidised.

Thapar: So just to underline when you go from 9-12 you are reaching people who can actually afford to pay who do not need subsidy and this therefore would be a misdirected subsidy.

A: You are going from 87 to 97 according the government's figures - 87 percent of the population, 97 percent of the population. If you are subsidising 97 percent of the population you are basically subsidising people who are paying for it themselves.

Thapar: I think the message from the governor is crystal clear. This would be a misdirected subsidy. On the other hand The Hindu on its front page on Monday claimed that finance minister Chidambaram will be able to reduce the fiscal deficit to 4.65 percent which is actually below his 4.8 percent target with a combination of very severe expenditure cuts, probably mimicking what he did last year alongside pushing to next year a far greater proportion of subsidies than he has done in previous year. To the extent he depends on the latter would he not in a sense be pulling the wool over people's eyes? He is just passing the buck to someone else.

A: My sense is there is a certain amount of carryover of this year's subsidies into next year's accounting which compensates what was carried over from the previous year.

Thapar: If he does more than the previous years …..

A: It depends on how much is done etc. Again let me emphasize that there is a fair amount of fiscal correction that is already embedded into the governments plan.

Thapar: There is something very interesting when you say I guess it depends on how much more than in previous years because what you are really saying in layman's language, "A little cheating is okay but if you are going to do it people will catch you out."

A: You said it.

Thapar: A few hours ago the American Federal Reserve has increased the quantity of tapering that it does by USD 10 billion. Does this have adverse implications for the Indian economy – that concern or perhaps even worry you?

A: When combined with the fragility of some other emerging markets like Turkey, there is a sense of risk off which pervades the financial markets and during that initial period they tend to be undiscriminating. Perhaps even emerging markets which are more liquid, which are doing better become the place where they sell because they want to get out of emerging markets. I can't sell in place A so I sell in place B which is more liquid.

So, we all get hit and we have been hit in the last few days by that. Do I worry that this continues beyond a certain point? I don’t think we are in the same circumstances that we were in July-August.

Thapar: Our situation is not as vulnerable or as fragile as it was in July-August that is the first point you are saying.

A: Primarily because of significant actions by the government and the RBI on bringing the current account deficit down.

Thapar: If he misses the fiscal deficit target which we are now accepting that he may do and if he misses it by a number that worries people rather than an amount that people are sanguine about - would that then with increased tapering create a problem?

A: First, I don’t expect him to miss the target. Second, people will look at the totality of the fiscal plan and not just this year but also going forward. So, to that extent a little bit this way that way will not be a huge problem provided there are credible plans over the medium term.

What people worry about is how much debt you are going to build up as a country. Our debt profile is actually quite reasonable.

Thapar: Future credible plans are only reassuring if you are actually meeting them in this year. If in the first year or the second year, you look as if you are failing no mater how credible the future looks people will say will the future also then be unmet or failed?

A: That is precisely why I said they will look at it in totality. If you are missing by a little bit but a lot of what you have done eased fiscal consolidation, you get credit. While if what you are doing is you are missing by a lot and whatever you have done is pushing stuff into the future then I think you get less credit.

_PAGEBREAK_Thapar: In a recent interview to Nikkei Asian Review you said India could grow at 10 percent for 20 years provided the right steps are taken. What are the right steps that need to be taken? We all want to grow at 10 percent for 20 years but what are the right steps?A: Infrastructure, human capital, business regulation, finance - four steps.Thapar:  Infrastructure has been acknowledged as a right step for a long time but no one seems to be doing very much about it?A: We have huge plans in place. Delhi-Mumbai industrial corridor, Eastern Freight corridor, Mumbai-Bangalore, these were words, these are now I believe – talking to people who are financing this being translated into action on the ground. Actual investment coming in.Thapar: At a fast enough pace to satisfy you?A: There is actually competition. Satisfy me? I want to see this progress. However I think we are starting, putting the plans on the ground.Thapar: Number two was human capital?A: There we are not doing as good a job as we could on quality of education. We have done reasonable job on quantity. We have got everybody atleast in the first few years into school. We have got to keep them there by improving the quality of education.Thapar: This is at best a medium-term. Probably in India a long-term target to achieve we don’t seem to do it quickly enough, do we?A: We can. If we take really a strong push here, we start testing more kids in school. That is one of the things that we have sort of thrown out of the window. We need to do that.Thapar: The telling thing was the stress you put on the word "can" – we can, as if chances are we probably won't?A: I don’t think we should be so pessimistic.Thapar: Number three was finance.A: Number three was business regulation. Business regulation we have got to make it much simpler. We have got to make it much simpler for the entrepreneur to start up. Yes, we need to protect the environment, we need to protect the rights of under privileged to their land etc, but we can speed up the process by which we respect those rights, by which we respect the environment.Thapar: Does business regulation also include making labour laws easier for people?A: I think that is a win-win situation there that we have a vast amount of labour, which is unprotected. At the same time as we have these labour laws, which make it very hard for us to give them more protection.Thapar: So, you are saying change the labour laws and make them more flexible?A: We can make them more flexible even while giving more protection to the vast number of contractual labour.Thapar: Do you think politicians are in a mood to listen to this advice, to make labour laws more flexible? And having listened to it to think they are going to be capable of acting because it requires deft action?            A: I think it requires political will and then communication because I really do think there is win-win for all sides here but it requires a leader to see that and then to start talking about it. Labour thus far has been taboo in some sense. We need people to start talking about it because ultimately the jobs for that demographic dividend that we hope to reap, we won't get those jobs until we make these big changes in business regulations.Thapar: You are putting a lot of faith in politicians when you say we need a leader to recognise that and then to act on it. So, far when it comes to making labour laws more flexible it is a taboo subject, which leaders shy away from. You are hoping the opposite will happen?A: Absolutely.Thapar: Fourth finance.A: Finance is actually the easiest in my view of the four. We need to have a more competitive, inclusive, deeper financial system.Thapar: This is where you as a governor can play a major role?A: Absolutely.Thapar: What are your plans there? You have two or three top plans?A: Banking system - we are going to make more competitive, we are going to bring in a whole new set of structures. We ofcourse have to have these new banks that we are going to licence. So, that’s one. Monetary policy we are going to talk about a little bit. We are going to create a framework which is clear, which is on par with the rest of world. We need to be much more clear about it. Financial inclusion – we need to improve financial inclusion. Reach everybody and reach them not just for credit but payments. Let them have a safe account that they can use.Thapar: How much time do you give yourself before you deliver on number because that is entirely in your purview as governor?A: I have a three year mandate that is my contract. Thapar: It will be done before the three years are over?A: We will push as hard as we can to do what we can over the next three years.Thapar: I want to remind you of one thing you wrote in one of your articles not so long ago. You said what should central banks do when politicians seem incapable of acting? What is your answer as a central banker in today's context?A: What I said in that article is they shouldn’t try and compensate for the politicians because that could create tremendous problems for the system down the line which is what many countries are doing, keeping interest rates really low because they don’t see political action. That is also building up vulnerabilities one of which we are experiencing because we have seen a lot of easy money come into the emerging markets now leaving.However, I think in India we can contribute to the growth agenda as a central bank because there is so much development to be done. One of the things we are focusing on over the next few months is can we push the development agenda from our side because much of it does not require legislative action.Thapar: Once again this is a central focus for Raghuram Rajan as governor?A: Absolutely.Thapar: All the polls suggest that at the national elections just three months down the road we are going to see a BJP led government with Narendra Modi as Prime Minister. How do you as governor of the RBI view the prospect of working with Narendra Modi?A: Whatever government comes into power the central bank and I would be very happy to work with that government. Whatever government comes in, there is a very clear agenda that is necessary for us going forward which is bring back growth.Thapar: Let me ask you a simple key question. You were appointed by Dr Manmohan Singh and the Congress administration would you feel a moral need to offer your resignation to a new government. So, that if they want they can have a new man as the governor or you think that would be politicising the office for you to even think of it?A: I haven’t thought about what I would do. I don’t have an easy answer to the question. I think this office, as this office of any technical administrator is something that goes on when there is a change in government.Thapar: It is above party politics?A: As far as I understand, which is why I have no comment on the next government. Whatever government comes in the RBI and I will work with it.