Beyond the numbers, growth is still fragile

Written by Sitanshu Swain | Hemang Palan | Updated: Oct 28 2009, 06:33am hrs
Treading the fine line between inflation and growth, RBI governor D Subbarao explained the need to start exiting from liquidity support in an interview with FEs Sitanshu Swain and Hemang Palan. Excerpts:

How acute is RBIs current dilemma over growth vs inflation

Our inflation pressures are more acute than those of other countries. At the same time, we recognise that supply-side pressures, especially food prices, have driven inflationary pressures. We evaluated to what extent monetary policy will rein in inflation or anchor inflationary expectations. And the cost on the other side will be that growth impulses might be hurt. Thats the policy dilemma.

With such a sharp focus on inflation, will you be able to push growth

We have to weigh the costs and benefits of supporting growth without comprising on price stability. I cannot define a solution any more than that. Yes, there have been indicators of growth like the IIP numbers, infrastructure numbers and slowing rate of export decline. But we have to go beyond the numbers and see what the actual situation is. So, the growth is still fragile.

Much of the growth we saw in Q4 of last year and Q1 of this year has been because of fiscal stimulus and monetary easing. That impact is waning. So, we tried our best to balance these concerns. At this time, the judgement is to initiate exit, but stick to some non-conventional measures. Down the line, well have a more conventional reversal.

You reduced growth targets for credit off-take and deposits, whereas H2 was expected to see expansions that indicated higher growth

We are all calculating and responding on a dynamic basis in a highly uncertain situation because our own macroeconomic situation is also determined by global sentiment. We raised the indicated projection for non-food bank credit to 20%. Now, we have scaled it back to 18%. I have been speaking to banks every month, if not more often. Back in August, many said that 20% is attainable. In September, they were more circumspect. Today, they say 20% is not possible.

What I gathered from banks is that more people are coming to discuss projects. Project and financial closures are taking place. People are raising other sources of money like NBFCs and external sources and will come to banks for credit certainly down the line, perhaps in Q4, but certainly early next fiscal.

Do you think credit off-take was hit because rates didnt fall as expected

Credit demand is a function of the lending rate. To the extent that the lending rate has been above their accepted rate, corporates are not demanding credit. Its a question of supply and demand.

Do you think an asset bubble is taking place

I do not think there is any concern about an asset price bubble building up. However, there were concerns about stress in the commercial real estate sector. Two considerations: first, the pace of expansion in credit to the commercial real estate sector has been among the fastest. Secondly, we looked at the restructuring by banks and the proportion of restructuring to the total assets within that segment. We found that restructuring in the commercial real estate sector is higher than the aggregate level of restructuring. So there is stress building in the system. Banks have told us that while there has been a price correction in the housing sector, a similar one is yet to take place in commercial real estate, as the full capacity built up is not being utilised. Taking all this into account, we have raised the provisioning requirement for commercial real estate loans. We want the commercial real estate capacity built to be utilised.

What is your take on capital flows

Capital flows are manageable. I think they are just about comparable to our level to finance the current account deficit. We are nowhere close to 2007-08 levels, where capital flows were far in excess of the current account deficit. If and when capital flows exceed that, we will have to take a view on how to manage it.

How do you see the Res movement

We do not have an exchange rate target or a pre-announced exchange rate. We intervene in the foreign exchange market mainly to control excess volatility. However, capital inflows far in excess of the current account deficit will certainly put upward pressure on the rupee. We will have to weigh the costs and benefits of an appreciating rupee against stabilisation, intervention in the forex market, and the liquidity and inflationary pressures.

What are the next phases in your exit strategy What will be its impact on rates

Its not as if we have written a book on an exit strategy and its implementation. Uncertainty in the current global and domestic situation does not give us scope to write a book like that. I have no view on interest rates. You will have to wait for the markets to determine interest rates.

But what I do want to say is that monetary transmission has worked to some extent in the money market. It did not work in the credit market. Even in the credit market, it is inaccurate to say that it has not worked at all. Banks have reduced BPLR, banks have reduced their effective lending rates, and the interest cost to corporates has come down. Thus, there has been some transmission, but not as effective as expected.