RBI governor on how to boost growth

RBI Governor D Subbarao said it was important to calibrate the exit from expansionary monetary policy. This is to ensure that growth, which has been driven by some of the interest rate-sensitive sectors, is not affected. In a post-policy interview with Sidhartha, he said RBI does not like to take mid-policy action. Excerpts:

Is managing the economy and the monetary policy getting tougher by the day?

No, it's not getting tougher. But, the margin for error as we get out of the expansionary phase is lower. So, it is more important to calibrate the exit.

You have said that inflation is the main worry. So, why increase policy rates and the cash reserve ratio (CRR) by only 25 basis points each? What was the logic?

The logic was that we must align our policy instruments to the evolving macro-economic situation. We have said, and everyone else has said, that we must get back to our normal stance in tune with the economic situation. It could be argued that we should take a fewer number of larger steps than a large number of baby steps.

In doing this, we were mindful of the growth and inflation dynamics. Growth is coming from sectors which are interest rate-sensitive.

Even as we need to raise our policy rates to normal levels, we must be mindful of managing the recovery as well. We also have to take into account the liquidity situation and ensure that there is sufficient liquidity for the private sector and the government. So, taking into account all these considerations, we thought calibration in smaller steps is better.

Given that the government's borrowing programme is front-loaded, was the smaller hike in rates influenced by the fact that you need to maintain sufficient liquidity and also keep costs low at least in the first half?

I don't think you can draw one to one correspondence between calibration of monetary policy and the government borrowing calendar. Of course, in determining the borrowing calendar, in consultation with the government, the evolution of the monetary aggregates and the revival of credit demand have been taken into account.

But, it is not as if we had front-loaded the government borrowing programme and have back-loaded our normalisation process in order to manage a lower yield for the government. Both are decided on larger considerations.

By increasing the rates and the CRR by a smaller magnitude, you seem to be keeping your options open on a mid-policy action. Does that bring in an element of uncertainty in the market?

Your inference that I am setting myself up for a mid-cycle correction is not correct. It is not as if we programme mid-policy correction. A mid-policy action is not something we will like to do. It is done after considerable thought. We want to schedule our policy action at the scheduled policy time.

How much of a worry is emanating from capital flows in terms of putting in place some controls or checks on sources such as external commercial borrowings?

As part of monetary and financial sector management we keep a watch on capital flows. At the moment we have balance of payment numbers only for the first three quarters of the last financial year. The numbers for the last quarter are not available to the Reserve Bank also. However, we have some rough numbers and they show that capital flows in 2009-10 were modestly in excess of the current account deficit and there might be a modest net accretion to reserves.

This year, there are various estimates of capital flows. We are watching this carefully and it is not clear whether they will be far in excess of current account deficit, it is not clear whether we will intervene in the market and it is not clear whether we will sterilise all that. Action will be calibrated in accordance with the evolving situation.

In case of foreign banks, where a review was due last year, you had deferred it in view of the financial crisis. Has the situation changed sufficiently to warrant a review?

This review is not a full-fledged review that was programmed in the 2005 policy. There was a sense that in April 2009, we will revisit this policy. But in April 2009 we had said that we are deferring this until there is stability in the financial markets and there is a shared understanding on the regulatory and supervisory issues. I believe we have not reached that point yet. So, a full-fledged review of foreign banks is still due.

However, there is an urgent issue that has come up, which cannot wait until a full-fledged review. It is on whether we should mandate all foreign banks to come in a subsidiary mode only. Under the 2005 policy, banks can come either as a branch or as a subsidiary. Banks have chosen to come to India as branches.

There are concerns that pending resolution of all the issues thrown up by the crisis, there is a need for resolution of the mode of presence of foreign banks for the purpose of standardising it, for the purpose of supervision. However, we thought it is good to consult all thestakeholders and so ordered this review.

Will the proposed paper also deal with the issue of voting rights and the tax structure for branches and subsidiaries?

No.

What prompted a review of the holding company structure?

Internationally, I am told that the standard model is to have a financial holding company of which the bank is one of the subsidiaries. In India, there are willy-nilly bank holding companies but there is no standard model of what a bank holding or a financial holding company. This has implications for the development of the financial sector and this has implications for the stability of our banking system.

After the policy review in October you had said that you did not plan to issue fresh bank licences and in February the government announced that you are planning to issue new licences. So, what changed in a period of four-five months?

In October, our public position was that we were not considering it. But internally, we were discussing it and talking about whether for the purpose of fostering competition and for financial inclusion, we must issue such licences. The Finance Minister announced in the budget that RBI is considering this. So, there is no conflict between what I said in October and what's happening now.

How long will it take for you to issue licences and how many new licences are you comfortable with?

It is inappropriate for me to speculate. I do not have an experience so I am not in a position to provide a timeframe. The discussion paper is scheduled to come out by end of July and once it comes out we will have some idea. I do not want to venture any suggestion on the number.

Is RBI comfortable with issuing licences to business houses if they come forward with a proposal to set up a bank?

It is a big issue in the licencing regime that we will evolve. Again, it will not be appropriate for me to talk about it because I want the discussion paper to be open-minded. I don't want anyone to believe that I as the Governor or RBI have a pre-determined view on it.

Asset-liability mismatch is a concern that you have talked about and you have taken some steps to partly address that. How much of a concern given the maturity profile of the liability and the tenure of loans being extended? Was there some discussion around it today?

Part of the risk management of banks is the ability to manage mismatches. Part of the responsibility of the regulator is to see that banks do not go overboard. There is of course additional pressure in the current situation because of the pressure to finance infrastructure. We all know that the requirement is $1 trillion (Rs 45 lakh crore) and infrastructure financing requires large investments of long gestation.

Banks can help in that effort but it will be unfair to expect banks to take the entire burden. We, from RBI, have relaxed exposure norms for the infrastructure sector and it is not prudent to relax the norms any further. Asset-liability mismatch management is the task of the banks and the regulator and is not a matter of concern.

You have mentioned about real estate prices in Mumbai going beyond the pre-crisis levels. Given this background how much of a concern is it for banks on the asset price side?

We looked at this and raised the provisioning norms. That pre-emptive measure had an impact on restraining the flow of bank credit to the real estate sector. We are watching the situation.

There has been this debate on the Financial Stability Development Council (FSDC) being some sort of a super-regulator. The Financial Stability Report had also talked about providing clarity on the link between FSDC and the high-level coordination committee on financial markets. Do you in RBI share this concern of the new entity being a super-regulator?

No, I don't have those concerns. The Finance Minister has very clearly laid out the proposed mandate of this body, which is macro-prudential supervision of the financial system and of conglomerates besides financial sector development, financial inclusion and financial literacy. He very correctly added the caveat that it will not compromise of the independence of the regulators. There is no clarity on the relationship with HLCC at the moment but the government will soon put out a discussion paper on it.