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"The monetary policy stance has served its purpose of maintaining stability and showing the beginnings of a recovery." - Views on News from Equitymaster
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  • Apr 29, 2002

    "The monetary policy stance has served its purpose of maintaining stability and showing the beginnings of a recovery."

    Dr Yaga Venugopal Reddy will succeed Dr Bimal Jalan as RBI's 21st Governor. He has earlier served as Deputy Governor at the Reserve Bank of India from 1996 to 2002. Currently, he is serving as India's executive director at the IMF.

    We bring to you an interview dated April 29, 2002 with Dr Reddy, where he spoke about the outlook for the economy and highlighted some of the thinking behind the monetary policy for fiscal 2003.

    EQTM: Considering the signs of economic revival, what is the general outlook for the economy?

    Dr. Reddy: As you would have noticed, we have indicated a possible GDP growth in the range of 6%-6.5% for FY03, which would be more than last year's growth and much higher than the year before last. This clearly indicates our optimism, as far as output growth is concerned. The reasoning for the same is; we saw a pick up in credit in the last quarter of the previous financial year. Secondly, we see that non-oil import is exhibiting signs of higher growth. Plus, there are signs that the world economy seems to be finding its way out of the woods. Therefore, there is every reason to believe that output growth is likely to be in the range of 6%-6.5%. Also, contributing to higher growth could be another good agriculture year.

    EQTM: Could you highlight some of the salient features of the recent monetary policy?

    Dr. Reddy: Basically, if you see the monetary policy stance -- as far as liquidity and interest rates -- it is a virtual reiteration of what we said the last time. Plus, we have spoken about the interest rate flexibility that is desired. By and large, the monetary policy stance has served its purpose of maintaining stability and showing the beginnings of a recovery, which was the objective and seem to have been achieved. Therefore, we should pursue in the same path.

    But while doing so, the monetary policy took into account, what maybe called the very current realities of the liquidity and the interest rate regime. Therefore, what it tried to say is that there is a scope for injecting some liquidity but it cannot be today, by virtue of the current liquidity, and so it indicated June. At the same time it has said that it can happen before. So, the direction has been given, the magnitude has been given but the timing has been kept open. Similarly, for interest rates, the direction has been given - softening, the magnitude has been given but the timing has been kept open. This is a nuance to see what is the extent of the pick up and how it will jive with three factors; namely the flow into the capital account leading to creation of money, demand for money -- private credit, which is expected to grow plus the Government borrowing requirement. That is how we are trying to maintain a balance while moving ahead on reforms.

    EQTM: As mentioned before, more important than agriculture growth is agriculture-led demand, which did not come through in FY02. What is the expectation for FY03?

    Dr. Reddy: Basically, if one looks at the credit pick up in the last few months from the information available, whatever pick up we see is not so much on the industry side but more on the infrastructure side and there is a beginning of a pick up in agriculture demand also. But we still do not have a firm view on agriculture demand. But the improvement on the manufacturing side maybe significantly linked to export growth.

    EQTM: The forex reserves are steadily increasing. FII investments have slowed down and FDI has not shown a sharp spurt. What is supporting this rise? Does it portend a definitive move towards capital account convertibility?

    Dr. Reddy: First, as far as the move towards capital account convertibility (CAC) is concerned, the CAC conditions are several and foreign exchange reserve is only one of the items. So, I think you should recognise that we believe in gradual movement towards CAC. And we have to look at the health of the financial sector. We have to look at the fiscal situation. And then only can we take a view. Having said that, with a step-by-step assessment we are making gradual progress. So forex is only one component and not the most important component either.

    But what is adding to the reserves is difficult to pinpoint. But if we compare the last quarter of last year with the corresponding period of the year before, then we see that the invisible inflows is fairly high. Also, external commercial borrowings would have added to the reserves. So, I would say that it should be partly borrowings and significantly the invisibles. These are the two major areas, which seem to explain the pick up in reserves.

    EQTM: India's saving rate has declined over the past few years to 20% while China has a savings rate of 40%. Could this be affecting the investment rate in the country and subsequently growth?

    Dr. Reddy: As has been articulated by the Reserve Bank in its reports, the major issue with regard to savings is with respect to public sector savings, which are negative. Therefore, if you look at household savings, the numbers are not any reason to get alarmed and continue to be healthy. So, at some point, you should find these savings rising if the Government savings improve. Yes, the contractual savings -- long-term savings -- in India is a little less than China. Naturally, when total investment is dependent on domestic savings for large economies, low savings will have an adverse impact on growth. But higher productivity could make good some of the disadvantage of inadequate savings. So there may not be a one-to-one relationship between savings and growth. But definitely, lower savings is not conducive to growth. It is ideal to have high savings and high productivity.

    EQTM: The lower interest rates have increased money supply in the banking system, which seem to be finding their way into G-Secs and calls. What measures are being taken to channelise the funds to industry?

    Dr. Reddy: The enabling conditions for adequate supply at a reasonable price is what RBI has done. RBI has been in a position to ensure reasonable supply of funds at a reasonable rate without disturbing the market conditions. At the same time maintaining low inflation rate. Therefore, enabling conditions have been created. Now, the demand pick up will depend on a number of factors. As I mentioned earlier, there is some evidence of demand pick up in non-food credit in the last quarter. So hopefully, there has been, what one may call, the lagged effect of the monetary easing that has taken place over the past year. Perhaps, one can say, there is a lagged effect but we have to wait and watch.

    EQTM: The RBI has stipulated that banks disclose spreads. What is the reasoning behind this move?

    Dr. Reddy: Basically, what happens, especially in a slowdown, is that banks sometimes add a risk premium. Therefore, inspite of the lower interest rate regime, banks are charging higher interest rates. As a result, the spread in some banks could be unreasonably high. The monetary policy clearly talks of only 'some banks'. If those banks find their spreads are unreasonably high, then they should reduce it. So, the move is not an assessment of the totality of the banking system. But some banks appear to be having larger spreads and it is not good having such large spreads, as high interest rates are undesirable. One should not be doing such type of risky lending. We want to deregulate interest rates but want to sensitivise banks to the undesirability of having unreasonably high spreads.



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