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'Zero policy rate is not an option in India'

April 22, 2009 09:07 IST
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Reserve Bank of India Governor Duvurri Subbarao describes his first seven months on the job as challenging, partly due to the uncertain global economic environment and also because he has had to adjust to living in the financial capital, Mumbai.

It hasn't stopped him from reworking the monetary policy statement. Apart from the changes in presentation, the annual statement and the three reviews are likely to be rechristened. Subbarao spoke to Sidhartha on his plans and assessment of the economy. Excerpts:

You have talked about lower growth during the current financial year but are we seeing signs of bottoming out?

People frequently ask me is if the worst is behind us and the economic cycle has turned. One lesson of this crisis is not to forecast all that. We will know we have turned around after we turn around.

However, there are some signals, like the purchasing managers' index of ABN Amro Bank that has improved, though still less than 50 (the neutral level). The industrial production numbers are negative but there are some positive indicators like capital goods or FMCG. People have talked about certain sectors like commercial vehicles, two-wheelers, cement and steel that are faring better. These are signs, but I would not be calling them definitive.

In your previous two policy statements, you had kept rate changes away from the review. This time, you cut the repo and reverse repo rates, while saying there was further room for rate reduction by banks. What is the rationale?

Even within the policy rate adjustment by RBI, there was room for reduction in rates. The question before us was, should we reduce policy rates further and, if so, should we do it at this point of time or defer? There were arguments for and against. We thought the balance of advantage was in doing this as part of the policy, in that we still want to signal a very definitive indication for lower interest rates. And, we have to take into account the headroom available for further adjustments.

How much room would you have on reverse repo, since you are already down to 3.25 per cent?

I would not like to speculate on how much we will have or how much room we can reduce it to. I do want to say that to compare the reverse repo rate in India to the policy rate in the US or the bank rate in England is erroneous. We cannot go down to zero. That's not an option. However, depending on the situation, we will calibrate. It's neither possible nor advisable for me to put a number to it.

There is status quo on the policy on foreign banks, citing the global uncertainty. But given that RBI vets all stake acquisition proposal for banks and has licensing powers, is it not time to open up more to foreign banks?

In terms of entry, you know the policy now and that's the policy we will operate. Any relaxation will come only after a review is undertaken. On branch expansion, we have gone beyond our WTO obligation. This morning, we liberalised off-site ATMs. Within our overall policy, we would like to see that foreign banks have a competitive business to take on and they serve a positive purpose in India. I am unable to put a timeframe (on a review and opening up).

NBFCs still have problems accessing capital. So, was that the reason for deferring the higher capital adequacy requirement? Also, in light of the observations of the committee on financial sector assessment, what is the long-term roadmap for them?

NBFCs serve a valuable purpose. One of the drivers of growth in India over the last four years, and one of the less recognised aspects, has been the increase in quantum and quality of financial intermediation. By that, I mean not just the banking sector but also the NBFC and micro-finance sector. The entire financial structure has contributed to India's growth. We talk about consumption and investment, but if you go behind that, it's because of the more efficient and more extensive financial intermediation.

We have deferred the deadline for increases in the capital adequacy level of NBFCs, keeping in view the current situation and the difficulties in raising capital. The world is talking about counter-cyclical policy and this you must see as a counter-cyclical policy. Beyond this, how NBFCs reshape themselves in order to be more relevant economic agents is for them to do, but RBI will do whatever is necessary. There are NBFCs specialising in certain niches, there are NBFCs of varying sizes, they are a very heterogeneous set, so it is difficult to say this is what we will do.

You have talked about a review of the benchmark prime lending rate mechanism. What is the ideal system, since in other countries, too, banks lend below the prime rate?

A laissez faire situation would be that banks determine the rates of interest and respond to signals from the economy. However, in a developing country like ours, where the rural and the agriculture sectors need to served, we have to have mandates, with which we have to live for some more time. But having allowed certain sectors privileged status, there is always a tendency to expand it. If everything is a priority, then nothing is a priority. So, identify very few priority segments and mandate a lending rate for them and leave all the others free to serve the economy better.

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