Stressing that “big bang unthinking reforms” will only lead to problems later on, the Reserve Bank of India (RBI) Governor Raghuram Rajan said the central bank is instead keen on implementing “steady regular reforms at a measured pace”, including ensuring over time a fully convertible rupee and thereby a completely open capital account.
In Washington DC to attend the Spring Meetings of the International Monetary Fund (IMF) and the World Bank Group, Rajan — a former chief economist at the IMF celebrated for predicting the 2008 financial crisis and a former chief economic adviser to the Indian finance ministry — spoke to Arun S on a wide range of issues including the need for India to first build a strong capacity to set a global agenda so that it can be carried out once Indians get to occupy leadership positions at the IMF. (Edited excerpts)
Q: The IMF has forecast India’s growth at 7.5% in both 2015 and 2016, while the World Bank is projecting 7.5% and 7.9% in these two years. In the RBI’s projection, what level of oil prices have you factored in and what impact will a change in this level have on the country’s growth?
A: There seems to be a general consensus that oil prices should stay in the $55-65 (per barrel) region for this year. The RBI’s growth projection of 7.8% in 2015-16 is consistent with that. Anything can happen and this consensus can be wrong. (India being a net oil importer) lower oil prices will contribute to the country’s growth and higher oil prices will subtract from it.
Q: The quantitative easing by central banks such as the Bank of Japan and the European Central Bank has made the rupee stronger against the yen and the euro respectively and is hurting India’s exports. How do you assess this situation?
A: The quantitative easing by a number of advanced countries has led to a relative appreciation of the dollar. We have kept pace more or less with the dollar and so we have appreciated against a number of currencies. When you look at the effect of the appreciation, you need to think about what is the true inflation that makes sense from the perspective of our exporters and the firms that compete with imports. You also need to think about the productivity growth. You can offset a real appreciation of the rupee by being more productive, by cleaning up your inefficiencies. So we have to look at both these factors.
Some would argue that for a company that is buying in a whole lot of commodities, CPI (retail) inflation is not the appropriate inflation, but WPI (wholesale) inflation is. If you look at WPI inflation, then our exchange rate is not as overvalued as compared to looking only at CPI inflation. So it depends on which industry you are in and which the appropriate inflation rate is.
The second factor is, has that industry experienced productivity gains in India relative to the rest of the world? If it has, it could still be very competitive. Software industry is an example where they are competitive despite wage increases and strong rupee because they are improving productivity. So you have to take all these factors into account.
As of now, the decline in our export growth is not hugely different from what other Asian economies are experiencing. Some of them (currencies) have depreciated more than what we have. So without further study we can’t attribute the decline in export growth to just a stronger rupee. There are variety of other reasons, including the slower growth in some of our key export destinations. If this kind of pace of appreciation persists for a long time, then there is certainly a chance that it could become overvalued.
Q: So then will it merit an RBI intervention?
A: I won’t comment on our intervention, but it is one of the things that we do keep an eye on. When we talk about exchange rates, we are looking at volatility, which is how fast are they moving and what is the reason behind it.
Q: The World Bank has said though capital flows into India has gone up from 1.9% to 3.4% of GDP, volatile portfolio investments form a larger share of the total. Are you concerned?
A: We would be particularly concerned if it was short-term portfolio debt or short-term bank debt. More of it is debt, but there are limits on corporate and government debt. Government debt (limit) has been reached some time back. Also we have prevented portfolio investors from reinvesting in short term debt. What ever they have to invest in today should be at least three years in maturity. That has given some maturity structure to the debt that we are getting. It is not all sitting at one-day or 30-day paper, but in longer term paper. These measures will help.
But remember we are a current account deficit (CAD) country. So you have to finance your CAD some way. Though CAD has shrunk, you either finance it through foreign direct investment which is probably the safest mode. But at some level you take other forms of financing also. You have to make sure that you don’t take too much of anything and certainly taking too much of short term debt will lead to worries.
Q: Has India taken up the issue of the delay in IMF governance reforms?
A: India has expressed its concerns regarding the delay in governance reforms and has urged the IMF to find a way to move faster. Having a multilateral institution with strong legitimacy is in India’s interests. We are a country that depends on open global economic order. We don’t belong to any power blocs. So for us it is extremely important that the multilateral system work. It is important for us that multilateral institutions have legitimacy, which is why we are very firm in pushing for the needed governance reforms.
Q: Is India pushing for a major role in the IMF’s leadership, including, possibly, for an Indian to head the IMF in the near future?
A: IMF leadership is not something which is open right now. We have a good managing director (Christine Lagarde) in place. But it is important to think what we want to do once we have leadership positions. Overtime leadership positions will open up in these institutions to people from India in the same way as they opened up for people from China. They key is what are we trying to achieve (after getting leadership positions). I would say as much as focus on governance and management, is having a focus on agenda. We have to be clear about what agenda we want to set for the world, and for that we ourselves have to do some preparation. We need to build stronger capacity to think about these issues and not just be reactive.
Q: You recently said rupee might become fully convertible in a few years, something that has now been echoed by the government. What reforms are being planned as part of internationalisation of the rupee?
A: The process of internationalisation of the rupee has been a steady one which the RBI has followed overtime. It is a measured pace of internationalisation, which is we take one step at a time, see how it works and take another step. For example, a few months ago, we allowed international institutions to borrow using rupee bonds. We saw how that went, understood a little more of what was going on and now we have opened up rupee borrowing to Indian corporations (raising money through rupee bonds overseas). There is a steady process. I don’t think anybody today advocates big bang unthinking reforms along the lines that more is better and let us do everything in one go. Those tend to create problems down the line. Steady, regular reforms is what we are engaged in. Over a period of time we will find that we have done everything necessary to have a fully convertible rupee, an open capital account etc, that is where we will get to. Let us see how long we will take.
Q: Banks seem to be at odds with the RBI regarding the base rate formula. What is your solution to ensure monetary transmission in a transparent and effective manner?
A: We don’t have a problem with banks on base rate. We allowed them the option of choosing average rates or marginal rates. But overtime we are more convinced that we need to look at this base rate setting process, may be nudge more towards marginal calculations as they set rates.
We would like to hear their concerns in cutting the rates and see if we can address them. Eventually, we will have some kind of a market benchmark to which they tie their deposits to and their loans to and if there is any mismatch, they can hedge it through interest rate derivatives. That would bring them on par with global best practice. It is something that we need to explore more. But right now, what we are saying is perhaps moving a little more towards marginal pricing as some banks do already in India, would be perhaps more appropriate.
Q: The IMF had recently raised concerns regarding the deteriorating corporate financial position and worsening bank asset quality in India. What is the progress on the efforts to curb bad loans?
A: The non performing assets have been growing. I am hopeful that we are near the peak or that we have even passed the peak, but we won’t know until it is well and truly clear with the passage of time. We are trying to do everything we can to help the banks clear it up as well as giving them the incentives to do it. We have made a number of regulatory changes that give them more flexibility. The banks are also working very hard to clean things up. We have had to change the entire mindset in this setting. It takes time. But I am hopeful that we have done a fair amount to put it back on track.