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‘Monetary policy needs a single harmonious index’

— Photo: PTI

Y.V Reddy… ‘Priorities will change when financial markets return to normalcy.’

A day after the annual monetary policy was announced, Reserve Bank of India Governor Y.V. Reddy spoke to The Hindu in Mumbai, on the hierarchy of policy objectives, measuring inflation, messages from the turmoil in the global financial markets…. Excerpts:

Yes. There is a hierarchy of objectives valid in the current context. The emphasis has shifted recently towards maintenance of price stability because inflation pressures were more than anticipated. In the long run these objectives converge, but in the short run there is a trade-off. If we do not have price stability or financial stability, there will not be a conducive climate for growth. Prioritisation of objectives is based on the current context and is essentially done for the short term.

In the U.S., the Federal Reserve is convinced that inflation is a problem. However, the conditions of the financial markets there warrant a sharp reduction in interest rates and pumping in liquidity.

Of course, [the] priorities will change when [the] financial markets return to normalcy.

A mandate had been given to the National Statistical Commission for updating the inflation indices. Now there is a permanent statistical commission entrusted with the task of updating the weights and making them [the indices] more representative.

The other task is harmonising the index. This is what the RBI has been seeking. Monetary policy needs a single harmonious index which all over the world is based on consumer prices. The WPI [Wholesale Price Index] we have is really a producer price index .We may have different indices but headline inflation [in other countries] is always tracked by the consumer price index.

It is also important that the indices are made available without a lag.

The existing regulatory framework in the U.S. is complex. More important is to realise that our existing legal framework facilitates universal banking. Banks are permitted to do both retail banking and investment banking. But the extent of investment banking most banks do might be limited because of obligations imposed by SLR [statutory liquidity ratio], CRR [cash reserve ratio] and priority sector advances. But banks in India are heavily oriented towards retail banking. That might be because of the state of economic development and financial sector reform. But one big issue we are trying to address in our monetary policy is capital adequacy. When capital is economised the risks in investment banking becomes greater.

That is why there is a realisation that banks as they exist in India are more oriented towards retail banking.

I articulated in a speech in Paris recently that in every country people would like to transact business and keep their savings in a very safe place. Traditionally that place has been a bank. It is for public policy to provide for such institutions.

By allowing banks to do non-retail business, we are exposing them to risks and not catering to the reasonable expectations of the common man.

I entirely agree with you because traditionally a bank is associated with trust. By a licence they are permitted to be highly leveraged and allowed to take non-collateralised deposits. In a way a licence confers a fiduciary responsibility to some extent. Therefore to the extent in their dealings they are not willing to maintain the trust, the banking system is itself undermining the trust.

Increasingly the world over, banks have become transactions oriented rather than trust based. It is not a good thing and in a philosophical sense we have to restore the integrity of the banking system, the trust of the customers .We should not economise on the capital.

The current account deficit is currently in the region of 1.5 per cent [of the GDP]. I would say that a figure up to 3 per cent would be comfortable in the current situation. That is a judgment. We have also articulated this in the policy that even if there are FII outflows, we can manage the current account deficit with other flows — external commercial borrowings which we are trying to restrict, some FDI and NRI deposits.

Second, even if sentiment changes we have the weapons to handle them. If there is volatility on account of FII outflows we have reserves, more than $300 billion.

We also have ample resources to take care of domestic liquidity too through MSS and CRR. I do not see any stress in dealing with capital outflows. It is a management issue and we have to be constantly on the alert. External sector policy should be prepared to take care of volatility in both directions.

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