It is important to keep an eye on demand-side pressures: D Subbarao

The Reserve Bank of India in its July policy review adopted a more hawkish tone. However, with a fairly good monsoon this year, the central bank sees food prices softening. It has also raised its growth forecast to 8.5% with an upward bias. Excerpts from governor D Subbarao’s interaction with the media:

You have revised the inflation projection to 6% by March. Is there an upward bias to that number? How worried are you with demand pressures?
No, we do not want to give that number an upward bias. It is our best judgement for inflation. I do realise that the prime minister has indicated inflation to be at 6% by December in his speech, but he gets inputs from a number of other sources but on the upside of inflation there are three factors.

The first one is the southwest monsoon for the remaining two months—rainfall has been fairly distributed across the country and we can expect some softening of food prices. Second, the deregulation of petroleum prices—if more petroleum products are deregulated and the sooner that happens, it will have an impact on inflation. Thirdly, about demand side factors — capacity sluggishness is not at its cyclical peak but very close to that. It is important to keep an eye on demand-side pressures.

On the downside if global growth is subdued, as is the current indication, there will be a downward pressure on commodity prices. Also, I have been told that if there is spare capacity around the world and because India is growing faster, our requirements are higher, there could be some softening in import prices. I hope that monetary policy actions taken since January will start having an impact.

If you are sanguine about the targets you have set out for growth and inflation, have policy rates normalised now?
Those are not targets, they are projections and we are sanguine about them. In the April policy, we talked about whether we had reached neutral rates. Firstly, we have not reached neutral rates and how fast and through what steps we will reach there are questions that will be determined by the macro-economic situation.

Current policy rates are not consistent with the macro-economic situation. It is difficult to say that this is the neutral rate, because the way economists define a neutral rate is rates that are consistent with growth rates and low and stable inflation. In an economy that is growing very fast, there is no stable neutral rate, it is a dynamic concept. But if we take the movement of rates from the highest point before the crisis, ie a 9% repo rate and the lowest point of 4.75%, the neutral rate is somewhere between them.

Has the growth projection for deposits been retained to what was stated in April?
I think that the 18% growth projected in the April policy should be achievable, although I know that the numbers for now are lower. We spoke to the banks about this. Deposits have declined because of public-sector enterprises, particularly oil companies, and mutual funds withdrawing deposits. We expect this trend to reverse.

Do you want to ensure that the repo rate remains the operative rate?
We expect this one-time liquidity shortage to ease substantially by month-end. However, the absorption mode that we have seen in the past years, when we kept abundant liquidity, the situation changed from a uni-directional mode to a bi-directional mode. For now, the repo rate will be the operative rate and the system will remain in the injection mode because monetary transmission works better that way.

Is there a possibility of informal modes of finance entering the real estate sector and thereby leading to inflationary spiral?
We have taken rising real estate prices into account. Information that we have says that in cities like Mumbai and Delhi, prices have reached or overshot pre-crisis levels and in other cities they are inching up. Asset prices have always been a part of inflation calculation for us unlike other central banks.

You have said in the report that some sectors are facing capacity constraints. Which are these sectors and could this trigger a capex cycle?
Subir Gokarn: There is not a very firm picture. We have anecdotes from industry representatives, but clearly the auto sector and some engineering industries will see a capex cycle. Whether this is beginning of a new capex cycle, we will have to look at it from two perspectives. One of the strongest drivers of IIP has been capital goods. A lot of capex programmes that were in the pipeline before the slowdown, seem to be back, which I think is good news from the inflation management perspective.

What is the RBI’s position on raising FII limits in corporate bonds and gilts?
There is still some cap left there. Raising limits is not on the immediate policy agenda.