Participants from RBI:

Dr. Raghuram G. Rajan – Governor
Shri H.R.Khan - Deputy Governor
Dr. Urjit R. Patel – Deputy Governor
Shri R. Gandhi – Deputy Governor
Shri S.S. Mundra – Deputy Governor
Dr. Michael D. Patra –Executive Director
Moderator: Ms. Alpana Killawala – Principal Chief General Manager

Ladies and Gentlemen, good day and welcome to the Reserve Bank of India Conference Call on First Bi-monthly Monetary Policy, 2015-16. As a reminder, all participant lines will be in the listen-only mode, and there will be an opportunity for you to ask questions after the presentation concludes. Should you need assistance during the conference call, please signal an operator by pressing ‘*’ then ‘0’ on your touch tone phone. Please note that this conference is being recorded.

I now hand the conference over to Ms. Alpana Killawala. Thank you and over to you Ma’am.

We have provided the whole path of inflation during the year in the policy document and in the Monetary Policy Review we have given you a path of inflation for 2 years ending in 2016-17. So we take the whole path of inflation into consideration. And as we mentioned, there are frictional factors and transient factors like base effects and seasonal effects that will characterize this path going forward. So it is not that we are targeting only 5.8%, we are targeting the whole evolution of inflation over 2 years.

I have two questions: The first question is what is the potential growth rate that RBI is considering in its model to decide on future monetary policy action? And the second is regarding transmission. What we saw in the last easing cycle is that in 2012-13 we had a 125 basis points repo rate cut, significant cut in CRR as well from 6% to 4%, and all we got was a 50 basis points cut in bank lending rate. So this time around the bank lending rate cuts will happen probably but by a very small amount. So even if we achieve a 50 basis points cut in lending rate through the course of the monetary policy cycle this time around, do you think that is enough to kind of support economic recovery more from the investment side rather than the consumption side?

You may be looking at approvals, you may be looking at only one side because what we really need for the stock is the net change and that is just 4.6 billion from April-January for 2014-15, which is relatively small numbers. I for one am not aware of a substantial explosion in ECBs and I do not think any of my colleagues are and I do not think the numbers bear that out. The thrust of your question was “Are we going to think of some draconian measures?” The answer is ‘no’ because what we would like to do is incentivize corporations to do more of it and perhaps find better ways for banks to monitor it and we will examine our regulations on that basis, but at this point I do not think there is a clear measure that is being contemplated in any way.

Obviously, the bank would be incurring because again the bank has to keep an extra capital credit is required by the bank also, so even that would not incentivized for the corporates also to get into long-term hedging in?

As far as the real interest rate goes, thus far we have been talking about the risk-free real interest rate in the Indian context which typically would mean a look forward CPI, something like the repo rate minus the look forward CPI. So that would be a good definition or working definition for you of what we think is the real interest rate. As far as the WPI goes, clearly, it is an issue that it is a number that we look at to inform ourselves of what is going on, both from international forces which have an effect on the WPI as well as corporate pressures because often this is a number which indicates to some extent corporate pricing power and corporate input cost. So it gives us a sense of what corporate see inflation as different from say the citizen. So it is an element in our thinking, but our target, if you will, is the CPI, not the WPI.

I have two questions: One is that on the fiscal consolidation path, we are saying that government is on a deleveraging path because it is going on a fiscal consolidation path, on the private sector we see mid-privates they are also on a deleveraging path, banks are not able to lend big ticket size because they are capital constrained. I am talking about the PSU banks which constitute 70% of the total book, FII limits are not being opened up and whatever corporate bond FII limits is there, precisely the money is going to PFCs. So one question which I have if at all when the economy picks up who is going to fund this growth?

Sir one more question was there that on the WPI and CPI as you have answered, now there is a stark difference between the fuel inflation in the WPI it is a (-14%) and CPI it is (+4%) The core reason which used to be close to be 0.98, now that is no more there from the last three or four readings. So how is RBI looking at it because I think it is very difficult to get this composition of CPI right and the way the data is collected, obviously, the series is not that old, but is RBI looking at that also or it is just that headline number and the core number which we are going by?

The petroleum that we import is reflected in WPI, but what is reflected in CPI is the fuel that households consume, and in the fuel category you will find that its really firewood and electricity prices which are determining the evolution of the fuel category. Most of the motor fuels that households use are in the transport and communication in the CPI. So that is the difference between the WPI and the CPI and we watch both very closely.

What you basically I think hinting at is what is our measure of potential growth? Because that is the plug figure which is going to tell you whether it is consistent with our stance or not, right. I think this is what Michael talked about earlier. Of course, we have to admit that we are still trying to understand the new CSO numbers and we are somewhat constrained to project growth based on the new numbers which we do not understand as well as we thought we understood the old numbers. So that is why it may seem that, as Michael said, determining potential growth is not that easy with such a short series of data and that creates a little bit of noise. But we feel fairly comfortable with our stance given, I think some of us have old growth numbers in mind, others have new growth numbers in mind, but we feel that to some extent we are still slightly below potential.

Currently, the investment cycle is not really picking up because the system, that is the banks and borrowers, are undergoing a time correction, and by a time correction I really mean that banks are faced with stressed assets and they need to maintain capital and borrowers need to de-lever. So given this backdrop, would it have made sense to cut the CRR, I am giving a number say about 100 basis points, which would have actually helped transmission, not from a liquidity perspective, but really from a cost of funds perspective for banks. It could have actually compressed this time correction, in some ways this will actually be tantamount to a backdoor recapitalization of the banking system and could have complemented the Rs.7,000 crore that was budgeted and could have actually helped transmission. So is that line of enquiry correct, what are your thoughts?

I think that you are comparing apples and bananas. The issue of the CRR as we discussed in the morning, of 50 basis points reduction in the CRR if you have a 10% would have resulted in a 2 to 5 basis points reduction in the lending rate. I think the issue of banks not having enough projects coming to them and corporates being leveraged, in some ways that issue is being tackled through the government’s increase in investment that was announced in the budget. So, that is where the investment gap in some ways is being filled up or the cycle is being kick started with respect to roads, railways and the power sector.

I just wanted to ask, you have been reducing fixed rate overnight liquidity injection earlier. Does it also mean we will be reducing the overnight LAF and if so what will allow us to do that?

I do not think any reduction in the overnight LAF is currently contemplated. It will stay at 0.25% of NDTL and we want to keep a readily accessible window at a fixed rate. Everything else has been moved to the market rate and that was the intention. With us now providing additional liquidity as need be to ensure that the rate is close to the policy rate- the market rate is close to the policy rate.

My question is regarding the reverse repo. Since like 2008-09 we are not operating on a reverse repo rate and we understand that the WPI was around 10%. When we are looking at CPI and we are comfortably sitting where CPI may come down going forward. Are we looking to operate at a reverse repo going forward at any given point of time?

I hope you do not mind in saying this, but this is the second issue that I found a little puzzling this time around, first was the CRR, why people got sort of gung-ho about it, and the second is this movement to reverse repo. If I were to move to reverse repo today, that means the operational rate in the market would move down to 6.5%. You are talking about 100 basis points cut in the policy rate. Smell the coffee guys! We are not going to cut interest rate by 100 basis points overnight. So, the policy rate is today at the repo rate of 7.5%. If I want to bring that rate down, I will cut the policy rate. And I have given you the conditions under which we will cut the policy rate. But this whole suggestion of moving to the reverse repo and moving to liquidity surplus is, pardon the expression, just nuts!

Two questions, related: One is on the Monetary Policy Report, the projection of CPI inflation for August 2015 is somewhat higher, the midpoint is around 5% but the policy statement said that it is closer to 4%. I am just wondering whether there is a subjective element that you have induced on the model to talk about the 4% target for August. Second is that if you have built in a forecast for about 4% CPI by August, will the number above that surprise you and affect your monetary policy decision?

The 4% projection for August really comes out of what we already know. What we know today is that there will be base effects right up to August which will allow CPI inflation to ease down to 4%. That is what our projections show. I wonder if you have separate projection show that it will come 5%, but most market participants seem to suggest that these favourable base effects will take it down to 4-4.5% and then it will rise again.

I am just looking at the projection of CPI inflation in the Monetary Policy Report. The midpoint does not show 4% for August 2015.

You may well be right that there is a disconnect in perception, so let me say what I think RBI’s perception of comfortable liquidity is. We have done away with the windows where you could borrow any amount of liquidity at a fixed price. And as a result, certain market players who used to finance themselves through our windows are finding it harder, because now they have to go and raise the money in the markets. We have tried to keep the market rate at close to the policy rate by injecting sufficient amounts of liquidity. Occasionally, there are spikes, for example, on March 31st. But if you look at the volatility around the policy rate it has been substantially lower. Of course, it would be zero; if I give you an unlimited ability to borrow at the policy rate, because then you would just go to the window and borrow as much as you wanted. But given that we want to stop that and move towards market borrowing by the players, I think we have achieved a fair amount of consolidation or narrowness in the movement of market rates, they now tend to hug the policy rate. So, we would say there is a plenty of liquidity in the market, at least short-term liquidity when we hug the policy rate. There is also the aspect of long-term liquidity which is by how much do we increase the size of our balance sheet to accommodate credit growth. And there we make an estimate of what the nominal growth of the economy is, how that translates into an expansion in the size of our balance sheet and over the year we try and maintain that size of growth of the balance sheet. In some years, that is determined primarily by our purchase of government bonds, in some years that is determined primarily by our purchase of foreign exchange. And if we do purchase substantial amounts of foreign exchange over and beyond what we want to grow the balance sheet at, we have to sort of adjust the size of the balance sheet by selling government bonds, in other words, sterilization. That is basically what we do. I think we have been successful at both aspects but clearly, people you talk to may think differently.

Ultimately, banks have to take a call. This is not their primary source of borrowing and cannot be their primary source of borrowing. Our windows cannot be the primary source by which the financial system finances itself. Now, there have been some murmurs from the banks that somebody puts in money at 5 o’clock at night and they cannot immediately turn around and deposit at an adequate rate there. That is a question of management; we have extended our windows for banks to be able to redeploy that money quite a bit. We have accommodated some of these requests, but ultimately the Central bank cannot be the way banks manage their liquidity, they have to find other ways including sometimes not taking their clients’ money or giving them an appropriate interest rate if it comes at 7 o’clock at night. So, the short-term liquidity management sometimes is a source of friction, but banks have to figure out what is an appropriate amount of liquidity they are going to offer their clients and there is always an amount of liquidity at which they can perfectly well manage their balance sheets today. I do not think that we are going to persuade them to reduce lending rates by offering liquidity in the amounts that we possibly can. I mean, we are not going to be able to offer more than 1% of NDTL under any circumstance through windows. That was what we were doing in the past and we brought them down. So to see that as the reason they are not reducing lending rates, seems to be beside the point, it is not the real reason.