Bringing stability to rupee key; bond yields to fall: Rajan

The Indian currency seems to be on firmer ground this week, but the currency still remains vulnerable despite the Reserve Bank of India’s (RBIs) second salvo. This peace has been bought at a huge price on the rates front.

Bonds have fallen by Rs 5-7 on the long end, the ten-year bond yield shot up to a high of 8.5 percent at one point and the AAA banks have had to borrow at 11-12 percent within a one-year period. And all this is happening at a time when growth is still sliding. The government's chief economic advisor Raghuram Rajan speaks on these issues. Below is the edited transcript of his interview with CNBC-TV18 Q: There is some temporary peace on the rupee, but what is the end game of the steps unleashed by the RBI? Is the government waiting for the rupee to go to 57? When do you think the steps can be rolled back? A: The key issue is not targeting a particular level for the rupee, it is bringing stability and creating some comfort. Neither the government nor the RBI is happy seeing the rupee continuously depreciate and remain volatile. The end game is more stability. Q: We are in an unstable global environment plus we are also in a structurally difficult domestic environment where imports are much higher than exports. So, can you buy stability on the rupee with these factors? A: Stability doesn’t mean we want to fix the rupee at some exchange rate; that is clearly not the intent. However, in a situation where there is a sense amongst the analysts that the rupee can go anywhere, that would hurt the economy as a whole. It is better in such a situation to bring some calm to the market, to bring some stability to expectations by saying that at such times we will come into the market, take the necessary policy measures to bring some stability to the rupee. Again, let me emphasise that this is not an attempt to say that the rupee will stay fixed at some number forever. That is not the intent at all. What we want to do is give investors some sense that they can be comfortable about the rupee not going into a freefall, and that there will be some push back if there is too much volatility. They should feel comfortable entering the equity or debt markets. There is absolutely no intent to kill growth. We hope that this way of stabilising the rupee is going to be substitutes for other more damaging ways of doing that like for example, a programme of interest rate hikes over time.

Q: Why should not the RBI or the government use the opportunity to actually kill some demand? After all the persistent increase of imports over exports to the extent of trade deficit which is 10 percent of GDP and CAD that is 5 percent of GDP indicates that there is an inherent demand that needs to be killed. Don’t you think that some of this should be used to reduce that demand? A: I don’t believe that our problem with the CAD is primarily one of excess demand. Some demand is at play but I don’t think it is excessive because consider a place where there has been a large burgeoning of the current account deficit – we can’t do much about the price of oil. Gold is something that has picked up in the last few years, but I don’t see gold as being an expression of excess demand. It is more an expression of the investment habits now finding their way into gold rather than into financial instruments. Similarly, when you look at the items that have propped up in recent years, iron ore exports have come down, scrap imports have gone up and coal imports have gone up. These aren’t necessarily an expression of excess demand – that is people buying a lot of consumer goods, this is more an expression of supply constraints in the economy. Q: How long will this decimation of debt paper going to persist? People are sitting on real losses and you are giving a timeline of stability on the rupee which is not a very clear indication when this game will end. How much time will you give it? A: You should see the measures trying to constrain liquidity for little while, push up the cost of speculating against the rupee which means pushing up interest rates at the short end. In that process, as you tighten liquidity some entities that are liquidity short have been selling bonds – longer term bonds and as a result bond yields have gone up, bond prices have fallen. This will largely be a phenomenon that is temporary. Money will start coming in as they see these attractive bond yields and overtime these yields will come down. So, even if the liquidity tightening measures are in place I don’t see that necessarily bond yields should stay as high as they have been. Even today we saw substantial reduction in bond yields. As the initial liquidity shock gets managed, I would see bond yields coming down. So, I don’t usually give investment advice but one should think about waiting out the period because as the yields come down some of those paper losses would go away. _PAGEBREAK_

Q: You said the intention was not to increase rates to kill demand or to kill import demand but don’t you think the developments on the external front or on the rupee have taken away the initiative to cut rates altogether? A: I don’t think so. The RBI enacted a bunch of extraordinary measures over the last two weeks. If they wished to they could have announced a rate hike over that period as well. So, the RBI is as concerned about growth as the rest of the economy. They have constrains on what they can do but in the longer run both the RBI and the finance ministry and the government more generally is intent on restoring us to a path of stronger growth. Stronger growth will solve many problems. Some of that strong growth relies on actions on the real side. You have seen entities like CCI being set-up for taking more decisions. Now they have a secretariat which allows them to accelerate that decision making. For example, on the coal allocation front, a couple of decisions are being taken to increase the pace of growth. We have seen action on FDI limits, so, when you couple that with the fact that the agricultural sector is going to do better this year on the back of good monsoon plus the fact that government spending has been strong over the last few weeks and going into the next few months. We see the potential for stronger growth over the next few quarters. It can all come together and I don’t necessarily believe that what we should expect is because of the decision that were taken is tightening of monetary policy. You can separate the two decisions on trying to stabilise the rupee and the path for monetary policy over time. In fact, the reason to do what has been done in this way is that this can be more limited than the change in monetary policy which is something that could be seen as a substantial and much more durable change. Q: Is there an idea to improve the flows meanwhile through some multi-lateral loan or an NRI bond or a sovereign bond? A: No. There are three parts to the plan. One is to get growth going again and a number of measures are taken to get growth going again. Q: Is that still medium-term that could take months? A: Yes. Second is to act directly on the CAD to limit some of our imports and to encourage exports and a number of actions are being taken on that front. That will also play out over time but the more immediate effects will be on things like gold, the steps that we have taken. Third is to enable stable financing of the CAD. All options are being studied and options will be rolled out over time. When you think about the financing of the CAD, one of the important factors is equity investors, equity FII investors to come into the market. There has been some claim that we are not bothered about. No, we want to give equity investors in India and outside a satisfactory experience. There is absolutely no intent. There is no intent to kill growth. There is absolutely no intent to favour one set of investors – for example bond investors at the expense of equity investors. We are trying to stabilise the currency in a way that does the minimal damage to growth. In fact, it can be seen as growth enhancing because once investors expect some greater stability in the currency there is more appetite to invest. It means that we don’t have as much of a problem in terms of the fiscal deficit. We don’t have as much as problems in terms of inflation and we don’t have as much of a problem with stretched corporates finding that their loans are now much more weighty because they are priced in foreign currency. Q: You spoke of all options. What is the hierarchy? Would Non-Resident Indian (NRI) bond be preferable to a sovereign bond? Would a multilateral loan be preferable to NRI bond? When you say all options, what do you have in mind and what is the hierarchy? A: When we look at options we are looking at options that give us additional money. Money does not come at the expense of money that is already in. It just changes form. Q: So you do not like NRI bonds? A: No, I didn’t say I do not like NRI bonds. I said we are looking at additionality. Also we are looking for something which is sustainable. You do not want to pay a huge amount for one form of financing because in the long run paying excess amounts for that form of financing is not going to be sustainable. We want stability. There is no point getting in a whole lot of money for a few months if it is going to leave after things change in the international environment. So these three, additionality, sustainability, stability are how we look at the different options. I am not going to open my game plan or our game plan to you by telling you what the hierarchy is, but you can guess by looking at these criteria how we evaluate the different options. Q: When you say that you do not want one form of incentives to cannibalise on money that is anyway coming and when you say you do not want to pay too much of interest for a small amount of money you seem to be suggesting that that is what the NRI bonds would do. They would cannibalise the flows coming into Non-Resident External Rupee Account (NRERA) or those kinds of accounts? A: No, I did not say that. You said that. We are examining all these options on these criteria and as and when we see the opportunity we will rollout some of these options. The idea is we want the CAD safely financed and we want to shrink the CAD. However, whatever remains we want to finance it safely rather than go for easy options. Q: There is a lot of trepidation in central banking circles about a sovereign bond. Formal central bankers whom we have interviewed on different occasions have openly said, Dr Jalan was there on the channel about 48 hours ago, expressing his utter fear of sovereign bond. Is that something that the government will contemplate when central bankers at least in India are not looking at it or looking at it with aversion? A: This is why we need to take careful decisions. We are talking to a wide variety of people, not just the bankers who come to us. However, trying to make sensible decision in an environment which is perhaps different from the one that prevailed 5 years ago or even 10 years ago. We need to make carefully considered decisions and again the emphasis is on safe, sustainable financing of the CAD. _PAGEBREAK_ Q: So are you saying the mood is changing on sovereign bond that is also an option? A: You are going to try every which way for me to commit to a particular form of financing. We are considering all of them. I have been talking to bankers. They pitched their ideas, different bankers pitched different ideas. All ideas are being considered. This is something that various wings of the government and also the RBI are all involved in discussing. It would be premature to rule out any option for financing. Q: None of you have spoken about multilateral agencies as a source of loans. In 1991 those were the guys we went to. Wouldn’t that be an option? A: Do you mean go to the International Monetary Fund (IMF) right now? Q: Yes, or any other multilateral agency. A: I can rule that out immediately. That is not an option on the table. Q: At the moment we have placed a lot of emphasis on monetary policy and rates market to deliver on the foreign exchange front. Fiscal consolidation has not been considerable. If you take 4.9 percent as last year's achievement, this year's 4.8 percent goal is not much. Do you think that more needs to be done over there and even that 4.8 percent would be in danger going by the rupee depreciation and higher crude prices? Are increases in diesel prices not keeping with either of them? A: Last year the Finance Minister when he first promised 5.3 percent there was immense scepticism in markets that he would achieve. What he did was achieve 4.9 percent through a considerable expenditure compression. So, to that extent I think you should give him the benefit of doubt when he says we will do 4.8 percent this year. As you have already said there are factors that make it harder to achieve 4.8 percent. However, certainly he has emphasized once again that he intends to achieve 4.8 percent. Given his performance last year I think that financial markets should respect the credibility he has earned. Q: How is that fiscal consolidation, it is actually ripping open the fiscal purse? A: The intent is to substitute one subsidy for another. So, we are reducing the diesel subsidy regularly and by the time the Food Security Bill is rolled out in full measure hopefully we will have eliminated substantial part of the fuel subsidy which is relatively poorly targeted. So, in that sense, to the extent that this fuel subsidy diminishes substantially overtime there would be room created for other kinds of expenditures. Of course overtime improving the targeting and reducing the leakages from the public distribution system would also help in reducing the size of the bill for the food security. Q: A lot of economists are veering around to a sub 5 percent growth for the current quarter, GDP for the full year a lot of people are now even beginning to question 5.5 percent, what is your number now? A: Number of economists are saying that some of our GDP goes unaccounted. So, Pronab Sen has written in one of his articles that he believes last year which came out the last estimate we have is 5 percent. He thinks it was actually 6.5 percent because of fair amount of activity. We catch up with that later on when the annual survey of industry and so on come. However, that said across the world we have seen some slowing into the first quarter of this year relative to what was expected before hand and certainly we have to acknowledge that. We are still hopeful that the stronger than expected monsoon as well as the substantial push out of government expenditures or rather bringing forward of government expenditures this year will help energise growth over the next few quarters. So, my hope is that growth picks up substantially from where it is now. However, I would agree with you, we haven’t come out with a fresh forecast of GDP numbers. However, I would agree with you that growth has been less than what we expected, at least the data that has come in has been a little worse than the expected at the beginning of the year. However, in terms of fresh numbers we have wait and see. My sense is, if you adjust for the growth that we don’t pick up, it would be a little towards the lower end of the range we suggested but how much I don’t know. Q: That simply puts a question mark on the tax revenue collection and therefore on the fiscal deficit? A: As I said that lower growth has a lot of implications for the economy. One of our primary objectives over the next few months has to be to get growth up because better growth will paper over many problems that we have. Q: The consumer price index (CPI) inflation number that we last got was also a very obscene, nearly close to 10 percent mark. Given that monetary policy looks helpless to help growth at least in 2013, you would agree? A: I don’t know but you can say that because a part of the CPI inflation is food inflation, to the extent that we have a stronger monsoon, greater agricultural production and pretty good rabi crop to the extent that all this comes into play it could moderate food prices. That could have a pretty strong effect on CPI inflation as we move into the later part of this year. So, I won't totally rule out the possibility that with a stable rupee and moderating inflation that the central bank finds some room to be more accommodative. Q: About 37 days from now the RBIs current incumbent will hang his boots, any guesses on who comes next? A: I have no idea.