Aggression not on rate cuts, but on transmission: Raghuram Rajan

The Reserve Bank of India has cut the policy lending rate by 25 bps and rolled out a raft of measures to ease liquidity.

In an interview to Bloomberg TV India, RBI Governor Raghuram Rajan says the central bank has used up whatever room it had with the 25 bps repo rate cut and has not held back anything.

The changes in liquidity measures, which were part of the continuous monetary reforms, will help lower lending rates going forward. Citing historical instances, he said it would have been a “mistake” to do a big rate cut, as the RBI is not sure whether aggressive cuts really work if banks don’t cut lending rates. He ruled out the notion that the RBI has been conservative, and said the policy aggression was not on rate cuts but on rate transmission by banks.

This has been a decisive shift on the liquidity front, reversing the norm for almost five to six years. Can we expect more rate cuts in the current year?

You should see this as a continuous path of reform, where we move from what was a monetary policy system having certain peculiarities relevant to the Indian situation, to something of a monetary policy framework that is more tuned to the open economy. Of course, our blue print has been the Urjit Patel Committee report.

But this is just an extension of that process. To some extent, the shift in philosophy is significant, but it is part of the continuous process. The Urjit Patel Committee report suggested that we move away from facilities to lend to market-based auctions.

We have been doing that steadily – overnight repo auctions, overnight reverse repo auction, and term repo auctions. What that does is it allows us to set the rate in the market closer to the policy rate.

Could it be inflationary because you will see more money coming into the market? Some people are calling it a sort of quantitative easing…

It’s interesting, but the answer is no. We are replacing one form of liquidity with another. We are providing more durable liquidity. That means it is less temporary in nature.

And that also means no more money creation. QE is about creating excess reserves and forcing it on banks. We are not creating excess reserves but are accommodating demand for reserves.

While balance sheets continue to be impaired, what do you hope to achieve from the broad fundamental macroeconomic point of view?

The single biggest change that has happened is the move towards the marginal cost pricing (marginal cost of fund based lending rate or MCLR). That will, to some extent, put pressure on banks as the marginal costs falls to pass it through to the lending ways.

Even before the policy rate cut, the median marginal costs have come down by 25 bps; overall tenors and overnight rates have come down by 50 bps. As banks will revise the MCLR every month, you will see this rate cut feed in going forward.

Do you think all the conditions have been met on transmission front?

Everything is moving in the right direction. More transmission will take place. Transmission also takes place as a result of competition between banks, and between banks and money markets. There is fair amount of liquidity in the money markets with the start of new fiscal year. My sense is that rates will drop.

We have already seen overnight rates and commercial paper rates fall on Tuesday. Some people asked me if I worry about market reactions. Markets were reacting to global as well as local factors. I don’t worry too much. The broader point is to get the economy going over the next few quarters.

Has that optimal monetary stimulus setting been achieved because some move has been made in the small savings rates as well?

We still have one of the highest inflation rates. There are countries which are in deflation and that’s reflected in our WPI. But CPI is still 5.0-5.5 and there are other elements that are stubborn.

To the extent that our inflation goes closer to the world inflation rate, room will obviously build up for more policy rate cuts. It depends on a variety of circumstances, including the fact that the capacity constraints that is important in our economy is not manufacturing capacity constraint but in services, as well as food. My hope is as the lower inflationary expectations build in, some of those price increases will abate.

In this particular policy, economists were placing a 20-30 per cent probability of 50 bps rate cut. Did you opt to wait for the monsoon data instead?

We have always used whatever room we have had. We are not holding back rate cuts for any reason. We do what we can because we are aware that the economy is still somewhat below capacity. People may call it conservative. But I would say given our past history and given the fact that we are building credibility and given the fact that we have delivered so far, it would be a mistake to throw it all away on a wild aggressive move. Two, I am not sure the aggressive moves pay off if there is no transmission.

In Tuesday’s policy, you should see the aggression on the transmission that we are trying to make the transmission happen. So don’t call us conservative. The moves were pretty bold given the past framework. We do not think there are big risks in the move. The industry and markets will over time see the larger effects of this.

You did not get to meet bankers on Tuesday. Have you heard from them in terms of transmission?

My sense is banks will say they will transmit as things happen. All the conditions are in place – both on fiscal and monetary side – and there is no further impediments and we should see things happening.

Can I disagree to say bank balance sheets are the biggest impediments?

There is no impediment that monetary policy and liquidity management can do something about.

Risk aversion and capabilities are things we do not have much control over, because we regulate but don’t own banks. If you look at credit growth, one of our worries was that public sector banks were falling behind credit growth. I don’t think it is bad if banks are repairing their balance sheets. It is not about liquidity or monetary policy and need not hamper the transmission.

The fear psychosis is that it is easy to get a loan for a fridge or washing machine but when it comes to industry, things are not moving. Is it correct?

I don’t think fully. So far, investment demand from the private sector has not picked up strongly. When it does, we will be able to test your proposition whether credit growth is being hampered because people are not willing to lend.

Hopefully, some of the slack in the public sector is being picked up by the private sector. There have been loans that have been made without appropriate diligence, where you can question the circumstances in which they were made.

What an appropriate view will be is to put yourself in the shoes of the bankers at that time and ask if under those circumstances this was a reasonable loan to give — did you take additional precautions, did you do appropriate due diligence, did you take the collateral and did you take proper care of public money? In some cases the answer will be yes and in some cases it will be no.

Always, when industry is going through a bad time, there are a whole lot of suggestions that it is a temporary downturn, and it is a matter of time before it strengthens, and also that there are so many jobs at stake.

The same thing has happened in the past, and it is unfair to apply a 20-20 hindsight to that.

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