• JULY 12, 2004

"Our economy is operating more efficiently than the Chinese economy."

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 Indian economy

EQTM: Do the long-term objectives laid out in this year's budget signal the change in India's growth potential?

Dr. Mohan: I think what this budget is signaling is its emphasis on the one hand on agriculture and second on social welfare to a certain extent. What I think is, one way of understanding the budget is that in achieving the objective of achieving 7%-8% plus growth in the medium term, we need to understand that it is very difficult to do it if the medium term potential growth rate of the agriculture sector remains at 2.5%-3%. So, if you are ready to achieve 7%-8% growth in the medium and long-term then we need to understand that agricultural growth needs to be higher than what it has been for decades, which is 2.5%-3% average growth.

So I think that in the medium and long-term sense, what the budget speech is signaling is this attention towards raising agricultural growth and that would have to include measures and strategies for diversification of agriculture. Obviously the budget speech itself doesn't go in to that kind of detail, but I think its acts as a very important signal that is coming out, which is signaling understanding and appreciation that if you are indeed to go 7%-8% higher rate of growth, then we have to accelerate growth in agriculture as well and particularly through diversification.

EQTM: There is a perceptible change in the government's stance towards the agriculture sector. As a result there has been a lot of criticism that the government is too focused on rural areas. What is your view on this?

Dr. Mohan: As I was just explaining that to achieve 7%-8% plus long-term economic growth, you can't get it unless there is 8% plus growth in other sectors, because even if we raise agricultural growth, say, in the medium to long-term to above 3%, 4% or 4.5%, to achieve average growth of 8%, very clearly other sectors have to grow higher than 8%. And, therefore I don't see any contradiction. In fact, for the other sectors to grow at higher rates, the vast buying power with 60% of people engaged in agriculture (needs to be harvested) so that the other sectors could grow faster if the agriculture sector grows faster. So, I don't see any contradiction here.

EQTM: Inflation (WPI) has breached the 6% level. How do you see inflation going forward from here and how do you see this impacting the debt markets going forward?

Dr. Mohan: Well, I think that we have dealt with this at some detail in the annual policy statement on May 18th, where we had analysed the situation quiet exhaustively and also an accompanying paper on the macro developments etc. As was mentioned there that we have been looking at the inflation situation in detail both domestically and internationally and with opening of trade, the international inflation also gets transmitted domestically. But as we had said that time that one is observing certain inflationary pressures internationally, particularly to do with commodities. And what has happened in the past year or so is that the prices of commodities like steel have risen considerably, certain extent in textiles and of course the petroleum price increases. And if you then look at domestic price increases, you find that a large proportion of the domestic price increases, in the last couple of months, has indeed been because of these kinds of products. I don't have the exact numbers but my recollection is that 70%-80% of the headline inflation that is growth in pricing inflation as base index is explained by internationally transmitted pricing pressures.

In fact if you also observe that the consumer price index has not really grown very much and inflation remains at 3%-3.2% and thereabouts. And the reason for that is that the consumer price index obviously does not directly include commodities because people don't eat commodities like steel and iron. Of course they come in indirectly through their impact on consumer prices. So, the weight in the consumer price index of food products is much higher and corresponds to much lower in the wholesale price index and because of the good monsoons last year and the expectations of a good monsoon this year, food prices have remained quiet benign. So one is not seeing domestic, either supply induced or demand induced price pressures. So I think that the current expectation that we have given in the annual policy statement is that we are observing international pressure through the international price trends, we are analyzing domestic price trends and our observation was that on balance we felt that the domestic factors are more important than the international factors and that view continues.

EQTM: There are some talks about the monsoons being delayed and some amount of uncertainty on that front. We also have falling food grain stocks, probably due to the various schemes that are implemented, probably out of choice? Could you share with us some broad numbers on how much India produces and how much we consume and what is the level of buffer we need to have incase we need to have one?

Dr. Mohan: I don't have the numbers offhand in my head but my recollection is that the buffer stock is now around 25 m tones or thereabouts whereas the level of need that has been used in the last couple of years is around 15 m tones. So we are much above the minimum buffer stocks. So one does not see any kind of difficulty as far as that is concerned and the current expectations are still that we will have a normal monsoon.

EQTM: The return offered by the Government Saving Schemes has been kept unchanged. Is this likely to act as a deterrent to the natural course of movement of interest rates?

Dr. Mohan: What has been done really is certain rationalisation of the savings instruments so that the senior citizens have been given an additional instrument. But one commonly used instrument, the 6.5% tax-free bond, has been discontinued and also the retired government employees' savings deposit schemes. So there has been a rationalisation. There is still an improvement, the number of schemes that are subject to administered interest has clearly been reduced so I think there has been some rationalisation so the situation is certainly better than before.

EQTM: Interest rates in the US are on the rise. There is fear that the rate of increase in rates could be more than expected. In your view what will be the impact on foreign monies that is invested in Indian stock and debt markets? Have the forex reserves peaked already?

Dr. Mohan: I think if we look at our experience, there has clearly been a case that forex flows would reflect the interest rates prevailing in the sending economies and the interest rates prevailing here. I think we need to keep two to three things in mind, one that the forex flows which we have been getting in the last many years, and we have been publishing in the last many quarters the sources of accretion to forex reserves, that a large proportion of accretion to forex reserves is really non-debt creating flows, that is on the current account side, large remittances which were around US$ 20 bn last year, which are not debt flows but plain remittances to relatives and families in India. And I think that if look at the pattern in the last many years we don't see it responding to anything really and it seems relatively pure transfers for maintenance of families. So that is one source that is in the current account side and these large remittances is another reason why we have a current account surplus in the last three years. So that continues.

Second is foreign direct investment and foreign portfolio investment. Because we have these limits on investments in debt securities that have only been increased now by the finance minister, marginally. It was US$ 1 bn now it is US$ 1.5 bn or US$ 1.75 bn. So you know it's a small increase. Most of those flows are basically into equity markets and therefore those flows are much more dependent on the performance of the economy and therefore the performance of the equity market, performance of company profitability, etc. So most of the flows that we are getting are really not that sensitive to foreign interest rates, but at the margin of course there will be an effect. As again stated in the annual policy statement, we are quiet prepared for whatever flows that may or may not happen.

EQTM: Where do you see India today in terms of economic strength or weakness and where do you see it going forward?

Dr. Mohan: Well I think that we need to look at two or three things here. One that we have had sustained growth of around of 5.8%-6% for not 5 years, not 10 years but actually almost 25 years and it think that this is something we need to understand more and more. This is not something that has happened in one year, but has basically been consistent with certain ups and downs but with that kind of an average basically since 1979-80, and I think this is one of the turning point. So given that over this period, there has been widespread economic reform in all areas of the economy, presumably the economy is getting more efficient. In fact if you look at our investment rate and our growth rate, then actually I can conclude that our economy is operating more efficiently than the Chinese economy. The Chinese economy may be growing faster, but we are getting around 6% average growth at around 24% investment growth. They are getting 8%-9% average with 40% plus investment rates.

So in some sense one would have to conclude that the current level of economic reforms that have been going on for twenty years have been pushing the economy to a more efficient growth path and to the extent that the process is continuing, one would assume that we will continue to go forward in a similar fashion. The issue really at this time is whether after three decades of 3%-3.5% growth in the 50s, 60s and the 70s, from 3.5% we went up to 5.5%-6% over the last 20-25 years. The question really is now whether we can now shift up to 7.5%-8% growth for the next 15-20 years. A growth rate of 6%-6.5% is not much of an issue given the momentum in the economy, the question is whether we can ratchet up to 7.5%-8% like we did 25 years ago.

Even with the highest levels of efficiency you can't really get an 8% growth with much less than 30%-32% investment rate. And therefore, for that to happen, there really has to be balanced investments in infrastructure, industry, agriculture and also this could be aided by fiscal discipline. I think one of the key messages of the current budget is really the emphasis on fiscal consolidation and the very transparent commitment to follow the Fiscal Responsibility and Budget Management (FRBM) Act, which decrees that the revenue deficit should come down to nil in five years and fiscal deficit to 3%. At present, just under 10% of GDP is borrowed by the center and states combined so a very large proportion of financial resources are going to government and particularly for financing revenue deficit, both of the central government and the states. However, one of the encouraging things is the transparent commitment given by the finance minister of notifying the FRBM Act. The Act, as you would know, was passed by the parliament last year but was not yet notified and the finance minister notified it just three days before the budget. This was a very very significant act. So with this kind of commitment that has been given loud and clear, as the government draft on financial resources is done, more financial resources will be available to the private sector for investment. That ought to give us higher growth in overall investment, but the public investment would also have to go up correspondingly for infrastructure. So that's really the issue, how successfully we can do that.

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