‘Brexit can be quite damaging if it happens’

The Reserve Bank of India will do whatever it takes to moderate market volatility in case Brexit (the term used to signify a potential exit of Britain from the European Union for which the country is holding a referendum on June 23) happens, said Governor Raghuram Rajan. Delivering the Foundation Day lecture at the Tata Institute of Fundamental Research in Mumbai on Monday, Rajan answered audience queries with adroitness coupled with adequate doses of humour. Excerpts:

How are we preparing for Brexit? What do you expect to happen?

I think Brexit can be quite damaging if it happens. Of course, we have already factored in some probability of it happening in the markets. If it doesn’t, we may see a market rebound.

If UK exits, that will create some market volatility. UK may suffer a significant fall in growth as its central bank has been saying.

The other issues are the consequences for the European Union — whether the peripheral countries then decide to stay in the Euro area or leave — which will also create more turmoil.

Some have even gone to the extent of arguing that the decision the British take may be an advance call on what happens in the US elections. The US elections are also fraught with potential risks from Brexit.

We are preparing for it. We are monitoring the market, we have good policy, we have long-term liabilities but plenty of reserves. We will do what it takes to moderate market volatility.

Do you think the age of endless growth and optimism in India will go down as is happening to Japan, Europe and China?

We are at a significantly lower level than all these economies in terms of per capita GDP. There is a lot more room for us to grow by just building infrastructure (roads, ports). It is unduly pessimistic to think that our growth will slow suddenly. There is a lot of scope for increasing domestic demand.

Therefore, let us first get macroeconomic stability and then build domestic demand based on this macroeconomic stability.

If you don’t, then you grow based on indebtedness and high inflation and that comes back to hit you and then you slow down. We are in the process of getting that macroeconomic stability.

Risk premia for SMEs tend to be so high that banks have stopped lending to this segment. How will your asset quality review affect SME lending?

I think it is a real problem .The slowdown happened way before the asset quality review started. It is a source of worry that the access to credit has slowed down from an erstwhile reliable source, the public sector bank. That is what has made the need to clean up those balance sheets so that they have the capacity to re-enter those areas (small and medium enterprises and industry).

In the meantime, however, there are other institutions that are emerging to lend to these kind of enterprises. Small finance banks have the mandate to lend to SMEs.

There has been growth in SME lending which suggests that banks are willing to lend, the problems you are talking about have emerged in the last couple of years because of the need to clean up PSU banks.

As the clean-up gets over, the public sector banks will back to lending to SME clients whose businesses they know and understand rather than go after businesses that they don’t understand.

When you don’t get any credit, the price is infinity, what you would like is credit at a reasonable price.

For SMEs, access to credit is important. And if you mandate that the price has to be low you may ensure that nobody wants to lend.

That requires some work, and more confident the lenders feel of getting the money back the cheaper they are willing to lend at. We have new institutions such as the trade receivables exchange where SMEs can sell their receivables.

Are you in favour of strong currency as it would ensure that savings do not go into real assets such as gold?

I haven’t really understood gold buying behaviour so far. People are buying gold irrespective of the price.

Our real effective exchange rate (REER) has been relatively flat over the last 15-20 years. In order to keep our exchange rate from depreciating steadily or abruptly we have to bring our inflation differential to about 2 per cent above the rest of the world.

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