Inflation is elevated relative to where we want it to be: RBI

RBI Governor Urjit Patel along with deputy governors Viral Acharya, SS Mundra, BP Kanungo, N S Vishwanathan and Executive Director Michael Patra (2nd left) poses for a photo during a press conference after monetary policy review meeting in Mumbai (Photo: Kamlesh Pednekar)
After the Reserve Bank of India (RBI)'s first bimonthly monetary policy review for financial year 2017-18, Governor Urjit Patel and top central bank officials spoke to the media on its decision to hold the repo rate, the liquidity situation, stressed loans in the banking sector and other issues. Edited excerpts:

On holding interest rates

Urjit Patel: The Monetary Policy Committee (MPC) made a detailed assessment of macroeconomic and financial conditions, both domestically and globally. On the basis of its judgement and the evolving outlook, the MPC decided unanimously to keep the policy rate unchanged. The MPC also decided to preserve the neutral stance of monetary policy. It noted inflation is set to undershoot the target of five% for the fourth quarter of 2016-17. For 2017-18, inflation is projected to average 4.5% for the first half and five% in the second half, with risks balanced around the inflation trajectory. The committee took note of the reduction in bank lending rates but saw further scope for more complete transmission, including for small savings and administered rates.

On liquidity

Patel: After demonetisation, there was a surge in liquidity in the system which RBI had to absorb to preserve financial stability and ensure unclogged channels of monetary transmission. At its peak, liquidity absorption was close to Rs 8 lakh crore. RBI employed a mix of conventional and unconventional instruments. From the second half of February, the situation was under control, greatly facilitated by the wartime pace of remonetisation. By the end of March, liquidity absorption was down to Rs 3.1 lakh crore, all of which was held in reverse repos.

Looking ahead, our endeavour would be to drain out the remaining liquidity overhang, manage the new drivers of liquidity in 2017-18 and ensure that the normal requirements of liquidity consistent with a growing economy are met. The learning experience through the demonetisation period and the constraints circumscribing instruments, such as the market stabilisation scheme (MSS), underscore the priority warranted for strengthening the instrument toolkit of RBI. It is in this context that RBI has proposed the institution of Standing Deposit Facility, drawing upon international best practices and recommendation of the expert committee.

Deputy Governor Viral Acharya: With rapid remonetisation and increase in currency in circulation being seen, we do expect the quantum of durable surplus liquidity to come down over the next few quarters. However, over the next three-four quarters, we do need to manage the quantum of liquidity that remains. And, we will employ the whole toolkit that we have at our disposal such as the MSS, longer tenure variable rate, reverse repos and open market operations, if necessary, in a well- telegraphed and nimble manner so as not to have a large price impact on government securities. We will keep dealing with short-term liquidity concerns with overnight and short-tenure repo and reverse repo operations.

Challenges to inflation

Patel: The MPC saw the path of inflation in 2017-18 as challenged by upside risks and unfavourable base effect towards the second half of the year. Accordingly, inflation developments have to be closely and continuously monitored and food price pressures kept in check so that inflation expectations can be re-anchored. The future course of the MPC will largely depend on incoming data.

Acharya: While there is surplus liquidity in the system, it is getting drained out through large quantity of variable rate repos that we are doing. As of now, we don’t have a reason to believe that there is leakage happening through that into inflation numbers.

Executive Director Michael Patra: The move to inflation below four% is challenging. There are no lucky disinflationary forces on the horizon that were there in the past. Therefore, in this context that we moved the stance from accommodative to natural. The evolving outlook will decide how the RBI will move. But it is cautioning you that inflation is elevated relative to where we want it to be.

On stressed assets with banks

Patel: Having completed the asset quality review of the banks and with several other critical ingredients in place, such as the insolvency and bankruptcy code and the oversight committee, the RBI has been preparing actively for next steps for orderly resolution of banks’ stressed assets. This will be undertaken concomitantly with resolution of the weakest bank balance sheets under the aegis of a revised Prompt Corrective Action framework (PCA) and our new enforcement department that has started its work this week.

We reiterate that further creeping forbearance in the treatment of bank losses is untenable and costly for the rest of the economy. The measures that will be announced soon to deal with banks’ stressed assets and weak balance sheets, along with the institutional strengthening that we just alluded to, should help enhance confidence in our banking system, restore corporate demand and put us on the virtuous path of healthy bank credit and industrial growth.

Deputy Governor S S Mundra: The overall capital adequacy ratio in Q3 of public sector banks was meeting regulatory requirement. But clearly there would be more demand on banks’ capital as we have completed Q4 and going forward. A number of instruments have already been introduced. If there is a need, there could be a relook even at existing instruments. The message we are trying to give is that all instruments are meant for resolution in a serious sense and not for postponement of a problem. That would be the basic focus going forward.

There is clear acknowledgement that there is no one-size-fits-all solution in the asset quality situation we are in. There would be case specific instruments that would be required to be deployed and number of them would be introduced. We expect to have the revised PCA framework by mid-April and then it will become operative.

On RBI’s preparedness with the US Fed’s decision to unwind its balance sheet

Acharya: Unlike in 2013 when it was a sudden move, this time around they have been telling us for some time. We are gradually prepared for it. Also, emerging markets are in a much better shape overall and, on many dimensions, we are macroeconomically very stable. It is something that the government has taken action towards. It is something that the RBI has taken a lot of steps forward for. The US Federal Reserve is a very large balance sheet and it does create significant capital movements in the global economy. But we are vigilant and we are prepared to deal with them.

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