Expect marginal reduction in inflation in 2-3 mnths: Reddy

Reserve Bank of India Governor YV Reddy said GDP growth cannot be below 8%. "Investment demand is strong, while consumer demand is marginally less. I would be surprised if growth falls well below 8%. If growth slips then it will be possible to jumpstart the economy. However, the major shock for growth could be fuel."

The RBI Governor said there is an overhang of liquidity in the system.

He expects a marginal reduction in inflation in the next 2-3 months. "Using the rupee to control inflation is a good intellectual proposition. However, there is no change in RBI's exchange rate policy. The exchange rate is market determined and hence is not an instrument. 5.5% inflation seen only by March 2009."

According to Reddy, the Statutory Liquidity Ratio, or SLR, has to come down in the medium-term. "As government borrowing and fiscal deficit comes down, so should SLR."
The RBI Governor said that January-February IIP, Index of Industrial Production, numbers may have been understated and could be revised higher. "Fiscal policy could put pressure on Monetary Policy. However, IIP should pick up. The current situation is very different from the slowdown of 90s."

Excerpts from CNBC-TV18’s exclusive interview with Dr YV Reddy:

Q: Is this your last annual or April policy?
A: Yes.

Q: Going by the logic of the situation, the political authorities definitely want someone who will keep inflation at bay. I don’t think they will get a better inflation warrior. Haven’t they sounded you out?

A: You are introducing uncertainty into a settled contract. If I have to use financial sector language, you are introducing excessive speculation in the whole matter.

Q: It is also a very gracious thing to allow the next government to have a chance of thinking about its governor and also the exigencies of the situation, as these are unusual times? It is not unnatural for a government to believe that the ship should not change its captain at this juncture?

A: If I were really a successful inflation warrior, it wouldn’t be where it is now.

Q: It is an image, but the reality is always different. It could have been worse if there were someone else. One never knows. After this policy, people are a little hesitant to use that term. There is a belief that in this policy you have been partial to growth. Is it because you are worried about growth? Have you been soft?

A: I will bring your attention to one particular word that I have used in the document in regards to the various considerations. I used the word exaggerated bearishness. On January 29, when we were discussing, everybody said inflation is low and we can afford to reduce the interest rates. That is called exaggerated bullishness.

So, you have to look at the context and not at the impression. I feel quite certainly that there is an element of exaggerated bearishness about the type of problems that we face. Similarly with regard to the growth, if you take my record in terms of growth that we assumed at the beginning of every year from 2003-04 and the actual outcome, I have been more conservative. The fact is that the Minister clearly wants to say that I am very conservative. So, I don’t think the basic characteristics have changed.

Q: But unusual situations require unusual responses also from central bank governors. One is wondering if you are playing cheerleader because look at the IIP figures, at 5.3%, and the capital goods numbers, which were double digits and have dropped to single digit and at one-month even alarmingly single digit. So, that could create a worry? A lot of economists are projecting 7-7.5% would be basing their forecasts on these kinds of data?

A: There are two-three levels at which one has to analyze. One has to analyze in terms of aggregate savings and investment, and productivity at one level. At one level, given our track record and given the savings, investment, and productivity, it now can be more or less settled that GDP growth rate has to be above 8%. If you agree on that proposition, then the question is whether we are on the downside.

Last year, we felt that there are some elements of overheating and have been trying to moderate it. We have succeeded in moderation. Unless the case is that in trying to attempt moderation, we have overshot and have come far below. So, that is an unlikely situation, for the simple reason that you look at the demand side. Once you agree that basically it is a domestic demand driven economy. In domestic demand, you have the issue of investment demand and consumer demand.

Investment demand is strong while consumer demand is marginally less. Therefore, if at all any moderation has to happen, such moderation will come due to global factors, even if there is a slowdown in global factors. So, it is very difficult to imagine that it will go below 8%.
As long as you accept that services would be about 10%, which is more than 50%, then 3% for agriculture, and then derive what should be the manufacturing industry growth to arrive at 8%.

Q: You don’t think 8% is ambitious?

A: My range is 8-8.5%. What I am arguing is that it cannot be below 8%. So, between 8% and 8.5% is where it will settle. That is a matter of judgment. In my view, manufacturing industry’s data that has come so far is perhaps in some ways another estimate. It should pick-up either actively or perhaps there would be a revised estimate.

Q: Statistical correction will come?

A: Possibly, that is our internal assessment.

Q: If you are that confident on growth, then why not raise the reverse repo rate? If you don’t give a reverse repo hike, when the inflation is at 7.4%, are confident of growth?

A: Reverse repo or repo?
Q: Not repo, but reverse repo, unless you do another CRR?

A: But what's the whole idea?
Q: You don’t want to push up rates when you look at inflation at 7.4%?

A: Once we accept there is significant uncertainty in the financial market, it is the time that you reduce the carter? This is not the time to reduce the carter.

Q: But you also had the option to increase both repo and reverse repo rates?

A: Yes, there were two-ways. Either increase the repo or reverse repo rate. But then you have to have a range of instruments. Since you have a range of instruments, there are two-three considerations about the type of instruments that you pickup. After analyzing, you pickup an instrument for which there is maximum flexibility. There is maximum flexibility for CRR and there is certainty of considerable overhang of liquidity. So, there is certainty of a problem and flexibility of an instrument, which is mostly related to identifiable problem. With regard to repo rate, it is a policy rate and in some senses it is reflective of fundamental view.
Domestically there are underlying demand pressures but there is also been a supply shock in the last one-quarter. Globally, what will happen after 4-5 months is that people are uncertain about the type of impact on the economy. So, when there are too many uncertainties, you don’t get locked in an instrument. But it doesn’t mean that it should not be used. Something has not been used today, or anything that is used on a particular day depends on the concentration, uncertainties, the instruments, and appropriate flexibilities. So it is a choice made currently to use this instrument pending consideration of all other instrument, which will be based on the incoming information.

Q: Your feel that inflation may moderate into 2-3 months. What do mean by moderation? Is 5.5% your ultimate goal, is that your meaning of moderation?
A: The policy endeavor is to reach 5.5% by the end of the year. That is practical. It would depend on 3-4 factors. One, the supply side measures that have been taken by the government will start impacting. The monsoon conditions also should have a favourable impact. The global conditions with regard to some of the agricultural commodities are not likely to deteriorate further.
Some of the monetary measures that we have taken, if they have necessary impact, it should moderate but at the same time we have to recognise the statistical base. So, given all that, there may be only marginal or slight moderation in the next 2-3 months. But what we are hoping is that it will not go up but it will go down somewhat slowly. But after two-three months, and that is the time when many of these things will kick-in, we expect some supply elasticity to kick-in. We should be able to move towards 5.5%.

Q: There are many economists, who have calculated extrapolating on incoming supplies and money supply and the rate action that it could remain up to 7% up until October. Would that be extremely disconcerting?

A: We have to watch what is the underlying. More than a week-to-week number, there are a number of factors which one has to watch them very carefully. Given the global inflationary pressures, and the type of supply bottleneck let us divide them into three parts sectorally -- food, fuel and metals. As far as food is concerned, two or three commodities may be comfortable. With regard to others, there is a marginal shortfall and that will be influenced with international factors. So, primary articles may be slightly elevated but it may not be to the extent of 7%, it may be less than that and it will again depend on the monsoons.
On fuel, it is very difficult to say. But it is safe to assume that like many other countries also it to pass through, we may keep it in abeyance rather than allow it to pass through. Which again means there will be moderation on account of fuel. Much depends on the way metals will move. How will global economies behave if the anticipated slowdown occurs? If China succeed in slowing down, it could be moderated. It is possible to say that instead of 2-3 months, which will be only July-August, it could be delayed by three-months which is quite possible, but there are too many uncertainties. One thing is common for both global and domestic consideration, the pressure will continue.

Q: Considering that we are in a very adverse and unusual situation with respect to inflation, considering the trajectory over the past five years, why are you fighting shy of using the rupee as a weapon to fight inflation?

A: We should be very clear as far as our exchange rate policy is concerned. Essentially, it is based on demand and supply. It looks at only overall volatility. We don’t have a target, and range.

Q: Why are you not using it proactively?

A: The question of using an exchange rate for fighting inflation will be an interesting intellectual proposition. If you say that the exchange rate should essentially be determined by the market forces, where is the question of using an exchange rate?
Secondly, you have to have some policy on exchange rate, that has to be consistent with macroeconomic balance. You cannot keep changing the exchange rate at will because it is not like an interest rate that you can change. But exchange rate is determined as much by what others do and what you do. So, therefore the degrees of freedom that you have to handle as an instrument are to be considered.
Thirdly, if you just take empirical evidence and take ECB for instance, it is appreciating like never before, but has the highest inflation for decades. So, that type of correlation is misleading. So, the whole concept that exchange rate can be used as an instrument to fight inflation on a one-to-one basis is a proposition to which I won’t agree to.

Q: There may not be a one-to-one, but it is some kind of a weapon. Maybe you will have to move 10 units of exchange rate for perhaps two units of gains on inflation. But it will still perhaps make a difference at a time when inflation is backbreaking?

A: RBI has always held on that exchange rate has not been used as an instrument for this and that. And that position continues.

Q: Actually you had said that the degree of freedom one has is limited because there are other actors and it will depend on inflows. But actually the degree of freedom that the RBI has is immense. When you have USD 313 billion, the degree of freedom is immense. Actually, if you look at the numbers from January 1-March 31, the reserves have gone up by USD 35 billion. Even assuming that one-half or 45% of it is revaluation, it is still USD 20 billion. Even if you don’t use rupee appreciation, it still means RBI has put in Rs 80,000 crore by way of rupees into the system. Could that have been perhaps tackled differently?

A: It will be really interesting to look at the numbers of February and March. Why don’t you simply exclude January?

Q: Even February is not less?
A: February-April would be quite interesting, especially March and April. If you just look at the FII inflows from February-April, you can see the intervention data.

Q: As of January 1, it was USD 275 billion and February 1, it was USD 292 billion. So, that was over USD 15 billion. February 1-March 1, it was USD 301 billion. Another USD 9 billion bought, assuming it is revaluation it is still USD 5 billion.

A: There is another thing that you seem to forget. We get income on reserves, which is added to the reserves. So, you have to add income to the reserves and have to add the revaluation and then you have to compute.

Q: But those were months when there were portfolio outflows. So, there were pockets, which were using that infamous interest rate differential to make money.

A: If that is true then there should have been an acceleration in the last three months compared to the three months before. But that has not happened. When the interest rate differential has increased in the last quarter compared to the previous quarter, the actual inflow in the last quarter was less than the quarter before. So, therefore there are different sets of data.

Q: You also will have to deduct the portfolio outflows and then perhaps it is not a very big difference?
A: You get the net position.

Q: Would there be an RBI internal study whether the interest rate differential is being used in a camouflaged manner that probably it is coming in as trade flows, probably because of transfer pricing you underpriced exports and take an ECB but don’t reveal it as an ECB?

A: In the ultimate analysis, the net position should be shown in the reserves.

Q: And that has been burgeoning.

A: That’s why if you compare the different quarters, the net position in the last quarter, the increase is less than the quarter before. So, in whatever way it comes, it has to be accounted for.

Q: You still believe that absorbing money and releasing rupee reserves has not been very expensive for the economy?

A: We have to consider the whole issue in the totality of the package. In the package, if you have to manage liquidity, you have to manage liquidity and this is not something which India alone is doing, quite a few countries are in the process of doing it including the other fastest growing economy, namely China.
So, if the two fastest growing economies, who are supposed to be propelling the growth of the global economy, are adopting a particular practice obviously there must be something to be steady in favour of that practice.

Q: RBI releases a lot external data in terms of BOP the various categories in which flows come in but they come with a lag. Now, I am not able to make any foolproof case or even as an academic compare the performance of the economy or flows before a rate differential because the data for January-February-March will be released on June 30. In an occasion when we have to play on currency futures and genuinely hedge, with such a lag in data, it is extremely difficult to take a punt or view even for a normal importer or exporter?

A: The lag that we have on data on trade as well as data on the balance of payments is the standard world practice.

Q: What is the status on SLR? Do you see any changes in the SLR percentage in FY09 itself?

A: There is a lot of dynamics that is happening. As Deputy Governor I was one of those who wanted the SLR to be down. We got it down to statutory minimum. We wanted SLR to be down. If you are talking of say one-year, I wanted to bring down CRR as an objective but contextually. If it had to be taken up, it had to be taken up. Similar is the situation with regard to SLR. But if you ask me about the medium-term, SLR has to come down.

SLR has to come down for at least 2-3 reasons. One in terms of banks own management and second is there is an inherent contradiction. There is a conflict of interest. Government, which is the owner of the 70% of the banking system, is using the bank itself to fund itself through regulatory prescription. That is something which is not consistent with the fundamentals of reform.

Second, as we go along, the government is bringing down the fiscal deficit. The government is bringing down the borrowing problem therefore there is no need for that type of SLR. Third, non-banks participants that are coming in like insurance, pension funds etc. The medium-term inherent logic is bringing it down. Now, how to do it with disruption to the whole system and that is the issue.

Q: But in FY09 itself you are not expecting an opportunity?

A: It depends on evolving circumstances. If we think it is necessary, it should be considered, there is no question about. There is no ideological preference retaining it to 25% and fortunately we have necessary legal enabling provisions.

Q: Even in your remotest analysis of the economy, is there no nightmarish fears that the economy will slip off the growth track because several market participants sometimes see this prolonged high inflation, high interest rate scenario as ending in a syndrome where like in the late 90s there could be a half finished steel plant, job cuts ‑- in your idea that doesn’t exist at all -- we need not fear it at all?

A: In my mid-90s situation is very different from today's situation. First, in mid-90s much of the investments occurred in anticipation of demand. Today, investments are occurring because there is pressure demand. So that’s a qualitative difference. Second, at that point of time it was beginning of the productivity and efficiency era. But today we are talking of a situation where we are globally competitive. So, that is the second difference. Third, you just see the level of investments and savings. The savings and investments have grown by somewhere from the 20s to now at more than 30s. So how can we compare these situations? Therefore, the situation where we accustomed to 3-4% growth and 8-9% inflationary is reverse now. 8-9% growth and 4% inflation and we should be around that.

Q: D you fear that the manner in which inflation has suddenly burst up and looks like a prolonged recession or stagflation in the US, given these, if these factors are prolonged, is that anywhere in your worldview that the growth could slip seriously off-track?
A: I would be surprised if the growth falls too much below 8%. As I have said, my estimate is 8-8.5% but the lower band cannot be very much below that.

Q: I am speaking beyond FY09?
A: Even beyond FY09 for the simple reason that the macro conditions are very favourable and we are in that range of potential output. If it is likely to fall then it should be possible to jump start the economy. On the inflation side, the measure issue is going to be the uncertainties and the pressures that will come through food and fuel. On food some good news is that the policy has been initiated last year by the government, so there should be some possible scope for comfort. So, the major source of shock may still be fuel.

Source : News Bulletins/CNBC-TV18