Liquidity checks will help banks mobilise deposits

Written by Shobhana Subramanian | Shobhana Subramanian | Updated: Jul 29 2010, 07:35am hrs
A day after the Reserve Bank of India raised key policy rates, deputy governor Subir Gokarn said he expected inflation to moderate to 6% by March next year as policy actions helped cool demand pressures. Gokarn told Shobhana Subramanian he also expects banks to up deposit rates to be able to garner money. Excerpts:

Are you confident inflation will come off to 6%

There is an upside risk to the 6%, but to our mind, its a baseline scenario taking into account that food prices and commodity prices will moderate and our policy action will cool demand side pressures. So, we see all of these converging to 6% by March. I dont think anyones really disputing the turnaround in inflation; the disagreement appears to be on whether it will be 6% or 7%. Monetary actions take effect after a lag and we expect the action we have taken during the first six months to have an impact on demand over the next six months and that will be the third contributory factor to the inflation number.

Do you mean we will see GDP growth at 8.5% with an easing of demand side pressures

Yes, the 8.5% growth emerges after taking into consideration whatever constraints will be imposed on growth by higher rates or lower liquidity. The 8.5% and the 6% forecasts are consistent. That is possible because were expecting a fairly significant recovery in agriculture on the back of a zero growth last year.

The interest rate corridor has been narrowed but is this good enough to reduce volatility

Until now, the reverse repo was the operating rate and it didnt matter. Whatever the corridor was, the repo was not in play. Now, it is of concern to us whether the corridor is of the right width. So, weve begun the process of narrowing without any definitive answers. We will study thisis it a constant width or a variable width and what do we need to do to implement it effectively.

Growth in deposits is slower than the growth in credit

Yes, there are concerns on this disparity and our assessment is that this is a transitory phase. Until June, there was excess liquidity. Because of this, banks had no incentive to mobilise more deposits because they had enough of a cushion. Also, there have been withdrawals of bulk deposits by PSUs, but that process is coming to an end and a combination of liquidity constraints and accelerating credit growth will give banks an incentive to mobilise deposits.

One reason for the lower deposits has been inflation

Clearly. Inflationary expectations are one part of this and if these start to moderate, the currency in hand issue should get sorted out. Once again, this should be seen as a transitory phase and not as a permanent shift. Secondly, as banks feel the need to mobilise deposits, they will have to compete with small savings. They have a choice either to raise rates or to constrain credit growth. Today, there is no excess liquidity and we will now be working in an environment where liquidity is more controlled.

At this point, which way do you see capital flows moving

The risks run both ways, the baseline we think is going to be an adequate cushion in terms of the current account deficit as well as our requirement for balance sheet. Right now, the risks are balanced; we dont really have a very clear view. Weve got to keep in mind that weve got used to having a very comfortable cushion on balance of payments and must be watchful.

Does RBI want to attract foreign money in debt market

Weve had our hierarchy of preferences with a strong preference for direct investment. Moving to the portfolio realm, we had a preference for equity flows because the risk is borne by the investor. And debt, therefore, has been at the bottom of the heap. There are merits to debt, especially to fund infrastructure, but whether the trade off is worth it given where we are now, needs to be studied.

What is the RBIs view on where the rupee is headed

The wider the gap between capital inflows and the current account deficit, the greater the pressure to appreciate. But since weve basically said we are somewhere in the middle of this, its difficult to discern a very strong tendency either way on the currency. The deficit is relatively large and will probably persist in absolute levels although as a percentage of GDP it may go down. On capital flows, the outlook was extremely optimistic early in the year, had moderated significantly since then. We still dont see a problem but we may run into a bit of a coverage issue, thats one tail risk.