Dr. Rakesh Mohan is the Deputy Governor of the Reserve Bank of India. Before his current stint with the RBI, Dr. Mohan had been working with various government research agencies and is also an author of a number of books on the Indian economy. He was also a Member of the Economic Advisory Council to the Prime Minister and Telecom Regulatory Authority of India.
In an interview with Equitymaster and Personalfn, Dr. Rakesh Mohan, Deputy Governor, RBI shared his views on the domestic and global economy.
EQTM: What is your view on the economy considering that the monsoons have been normal and the Indian industry is showing strong signs of resilience? How do you see the scenario panning out in the next two quarters?
Dr. Mohan: Let's take the current outlook regarding the economy with reference to the April 2003 policy statement. At that time we were coming out of one of the worst droughts the country had faced in the last 15 years. However, at the same time the industrial growth had picked up in the second half. We also saw predictions of a normal monsoon in the country for 2003-04 at about 96%. What has happened since then is that Iraq war has ended, the world economic outlook has improved, especially the US and to a certain extent Germany and Japan too are showing signs of growth picking up.
Also, during the April economic policy statement the inflation had inched up to over 6%. We had studied at that time how international prices will determine domestic prices and had estimated that the inflation in the country is likely to go down in the second quarter of 2003-04. In fact the trajectory of inflation has been pretty much consistent with what we had projected. Now taking in to account the good monsoon estimates and with the good expected crop output figures we have further reduced our inflation estimates. This in itself is significant change from the earlier policy.
Also the investment climate has improved especially with the stock markets behaving the way they have in the recent past. Considering the April policy this is a significant change in dimensions. Again the view is that with both the interest rates being low and the stock markets having gone up, one would expect investment demand to start picking up. We can see some sign of that in rise in capital goods production as well as imports. These are some precursors to the expectation that investment demand may be picking up in the next few quarters. Thus considering all these factors we have raised the growth forecasts from 6% to 6.5%-7.0%, with an upward bias.
EQTM: The Indian Rupee has appreciated dramatically vis-a-vis the US$? How do you see that playing in to numbers going forward?
Dr. Mohan: Well we have to take it in the right context. Remember that the Euro has moved from being around 1.16 Euros to the US$ to 0.8 Euros to the US$. In that context, the appreciation of the Indian Rupee is almost nothing. We need to put this question in the context of currency changes happening in the world. While the Indian Rupee has appreciated against the US$, it has indeed depreciated by 2.5% against the Euro, a little more against the Yen and around 2.5% against the Sterling. What this shows really is that our exchange rate policy which has stated as not having any fixed target, or any target for that matter, as a policy designed to contain volatility while being market determined, has really been working very well.
EQTM: Coming to the topic of fiscal deficit, the structural deficits do not seem to be going away. Do you see that sooner or later they will pose a hindrance to the soft interest rate scenario, considering that the Indian industry may start demanding more credit going forward?
Dr. Mohan: The monetary policy stance has been to ensure adequate liquidity in the system. So we will go along as the situation warrants. While we agree that fiscal deficit is definitely a cause of concern as far as the economy is concerned, the liquidity in the system is high enough.
EQTM: There have been a lot of expectations of a cut in bank rate. With no rate cut there has been a disappointment. Investments in instruments nowadays are triggered by expectations of a rate cut, for example, in income funds. From that perspective what is your message to the retail investors with regards to the interest rate scenario going forward?
Dr. Mohan: As the monetary policy statement has indicated, in times of a boom, when the markets are going up, there is often a tendency of overshooting. People have to be conscious of this and watch movements carefully and not go blindly into investing. If for example, we take the case of the Euro-US$ exchange rate itself, that it was going in one direction earlier and then within two years the Euro shot back to 1.16 to the US$. People need to understand that things can change quite fast in the monetary markets and they need to carefully watch the same.
EQTM: With regards to the debt-restructuring program that the centre has initiated for the states, what are the benefits for the state as well as the centre of the program?
Dr. Mohan: What the centre has decided to do is to restructure state liabilities to the central government. The central government will restructure the loans by substituting loans of say 14% or 13% or 12% in that order, allowing the states to prepay. Meanwhile the states now have in their books equivalent amount of market borrowings with lower interest rates. So the states have actually benefited to the extent of close to 6%-7%, differential in interest rates. For the centre this program has reduced the flow in interest receipts from the state governments by exactly that amount.
EQTM: With regards to the retail-lending segment, are we looking at a sustained growth in the same or is it more of hype?
Dr. Mohan: We need to look more broadly at this issue. In fact we need to look both back as well as forward. Ten years ago retail borrowing was not known. We had to save up to buy a car or a fridge. There was no question of getting a car loan from a bank. What has happened in the last ten years that the demographics have changed. With that there are many more people with incomes that are in a position to buy all kinds of consumer goods. The security of income streams has become higher so that lending institutions lend more. Even if we assume economic growth in the region of 6.0%-6.5%, not 8% in ten to twenty years, we have a huge number of people coming in to the consuming classes, so that demand may increase indefinitely. However as the volumes increase, the lending agencies have to implement better appraisal, information and record systems so that they have a better capacity to assess the capacity of the borrower. Here, I would like to use the term 'conducive credit culture' that actually holds a lot of meaning in this context.
EQTM: How do you see NRI money playing a role in the India's development scenario going forward?
Dr. Mohan: I think if we look at the flows more in terms of remittances, they have been quiet large in the last five years. Thus the NRI deposits have been distinct from the remittances. And for investments, the flows from NRIs in different forms have been quite important. Also I think that during times of some difficulty, like the floating of the RIB at the time of the bomb and the floating of the IMD during the South East Asian crisis, these acted as safety valves for India. So I don't think we can underestimate the contribution that NRIs have made in different ways. Yearly NRI inflows in the form of remittances have been to the tune of US$ 15 bn. This is more than the total software exports of the country. Imagine families across the country getting these remittances.
EQTM: With the NRE rates being cut what are the intentions of the central bank?
Dr. Mohan: What you don't want to do is give NRIs returns that are much higher than market returns. What we have done here is bring the returns in line with the market returns. NRI deposits are bank deposits that are almost risk free in nature and you can't give risk free returns that are not in line with market returns.