Inflation is a disease which the country needs to get rid of in order to achieve sustainable growth, said Reserve Bank of India Governor Raghuram Rajan.

In an interaction with the media a day after announcing the third bi-monthly monetary policy, the Governor hoped that with the new government in place there will be more action on the supply side. Once this happens, the kind of action the RBI has to take on the demand side will be more benign.

Rajan also flagged the importance of ensuring that non-cooperative defaulters do not hold up collections by banks.

Excerpts from the interaction:

Why did the RBI hold the rates?

Inflation is a disease which we have to get rid of if we want sustainable growth. Moderate inflation is fine.

The high inflation we have had, close to 10 per cent and sometimes above, is detrimental in many ways. With high rates of inflation, you need high rates of interest to keep people saving in fixed income.

Now, the real interest rate may not be very high (because it is nominal interest rate minus inflation), but from the perspective of the business house which is investing, it has to invest at those high nominal interest rates and the possibility inflation may come down creates a lot of fear about locking into long-term rates at that level.

So, it has a dampening effect on investment.

Inflation also has an effect on the external account. If inflation is high, there is a natural tendency for the currency to depreciate relative to the rest of the world.

And these depreciations are rarely balanced and tempered, they come in bouts, they can be very sharp and they create their own inflationary pressures.

Also, it puts off foreign investors. They don’t want to invest in a country in which these inflation differentials are high. And, of course, inflation hurts the common man tremendously as he doesn’t have access to an inflation-protected wage unlike many of us in the public sector.

So, I think, for all these reasons if we want sustainable growth, we have to bring down inflation.

Now, the problem in the last few fights against inflation has been that every time we looked like we are succeeding, the clamour arises: “Oh, we have had high interest rates, inflation is coming down, why don’t you cut interest rates?”

It is true that we don’t want higher rates for longer than we need to have, but we don’t want to keep fighting every two years, which is what we have been doing over the last five to six years.

So, our point is, let us try and reliably bring down inflation. And we completely agree that it is not only a demand side sort of defence, it has to be supply-side also. But in the absence of supply-side interventions or in situations where the the interventions are limited, demand compression has to take more of the brunt of fighting inflation.

Our hope is with the new government we will get more action on the supply side and, therefore, the kind of actions we have to take on the demand side will be more benign.

We have had only two months of the new government and there are lots of important, sensible policy statements that have been made. But implementation is only beginning. And so we have to see it roll out.

That is why we have said that based on current trajectory, we feel comfortable with our (inflation) projections over the near term.

In the longer term, there is more uncertainty because the target is also down from 8 per cent (by January 2015) to 6 per cent (by January 2016). We have come down from 11 per cent in November to 7.3 per cent now. It will go up a little bit towards the end of the year because of the base effect. But we have to do something similar over the same period next year.

These (inflation projections for January 2015 and January 2016) are not two separate goals. It is part of a continuous process.

And, of course, central banks cannot be schizophrenic or volatile in their interest rate movements that as and when the interest rate cycle turns, better that it turns decisively in one direction rather than keep moving up and down on a monthly basis.

We think we are currently set for appropriate disinflation but we will have to adjust appropriately when the time comes.

Are we being too tight relative to the growth situation? I don’t think so.

In fact, my sense is, you see industrial growth numbers starting to pick up. I would very much doubt that it is the cost of capital that is the primary factor keeping back investments today. Of course, lower cost of capital would help. But as I have said repeatedly, if we cut the policy rate, it is not clear banks will follow suit cutting the deposit rates until inflation comes down.

So, to continuously say that policy rate is the problem, I think, is missing the overall picture of the other constraints on investments.

What is the RBI doing to help banks deal with wilful and non-cooperative defaulters?

With SEBI, we are trying to ensure that wilful defaulters are prevented from accessing all kinds of funds and not just banking funds.

If somebody has damaged the system by deliberately making away with funds or diverting funds, the fear should be that they are cut off from accessing new funds from the public, whether it be through the markets or through the banks. So, there is some discussion on how we can do that.

We are looking at some legislative changes on the powers of creditors in recovery. For example, what more names should be notified under Sarfaesi.

Similarly, we are looking to see if asset reconstruction companies can get stronger powers to intervene earlier, similar to banks.

We are looking at our own definition of non-co-operative defaulters and trying to see how we can make it operational. We have this genre of promoters who hold up collection at every court using every instrument that they can even when it is clear that the laws suggest that they should pay. Our legal system affords various ways of hold-up. Now that is completely legal. But from the perspective of the financial system it is a problem because it can take years to collect when this thing happens.

So, we are saying that you (non-cooperative defaulter) are a financial risk. You are not a criminal in any way. You are not violating the laws. In fact, you are using the laws very much to your advantage. But you are a financial risk because you are not paying when the bank has got judgment against you.

So, from that perspective can we increase the costs, not so much from the legal perspective but from a financial stability perspective. Therefore, if new loans are made to you, the provisioning requirements for banks will be higher and that increases the cost of making loans to that person and hopefully makes them to think twice about holding up the system.

So, I think, there is a perfectly fine financial stability angle there. To name the borrowers non-cooperative, we have to work out the process by which this can happen.

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