Governor, Reserve Bank of India
What type of major challenges is the Indian Economy facing today?
I think you could put them under 4 headings. One, growth. India has slowed down considerably from the 9% plus it had achieved even post-financial crisis. Today we're at about 4-and-half, 5 percent, and growth needs to be brought up. Second, we have a large fiscal deficit. It's come down substantially over the last couple of years, but it needs to be brought down even more. So that's challenge number 2. Challenge number 3, which we seem to have faced reasonably well so far, is we have a large current account deficit. We were borrowing from the rest of the world. At one point it was 6 and a half percent. I have great pride in reporting that in the last quarter, it came down to point 2 percent. So we've brought that down considerably. It may go back up a little bit, but I think hopefully we have stabilized on the external front.The last issue is inflation. We have high rates of inflation. We need to bring that inflation down again. We've had a little bit of success in the last few months, but we need to do more. I think if we do all four, we will have brought macro-stabilization back to the country and we should see more growth, more sustained growth I should say.
But it's very difficult to do all four, all at the same time.
Well, yes and no. I think they are interrelated, so if you pick a few, things fall into place. Take growth. A lot of large projects have stalled for a variety of reasons. If you can remove the impediments and they get back on track, not only do you get more investment, but you get more production because those projects start producing. As you produce you also get less inflation because the supply is coming in. So a number of things could be solved at the same time if we can solve these kinds of issues.
And, after the election, we have a new government. What are your expectations and hopes for the new government?
First I think we should recognize that before the election, there was some worry that the mandate would be fractured; that we would get an unstable government. I think the resounding message from the election is, India today has a stable government which is going to last for the full 5-year term, it has a leader with a mandate, and therefore, it is very positive news relative to the anticipation before the election, and that's reflected in the stock market, in the currency, and so on.The second positive, I think, immediate positive, that I would take away is, as I said, one of the big issues is getting projects implemented, finished, on track, getting legislation which is pending finished.You don't need whole new thinking for that. You need implementation. And I think the strong government with Mr. Modi at its head has again and again said that is priority number one. So we should expect some of those things to be taken on a revolutionary footing.
You came in as the governor of the RBI, at a time when the country is facing an economic slowdown. So what will be the role of the RBI to spur growth?
We also came in at a time of double-digit inflation. And to my mind, inflation is one of the big pediments standing in the way of growth. With these high and fluctuating levels of inflation, not only do you not get enough financial savings-people are investing in real assets because they're not putting their money into deposits and so on-but also, it creates uncertainty for industry. You know, what will inflation be down the line, what will my cost of capital be, and so on. So, we need to bring down inflation to create sustainable growth. So our sort of point again and again has been that we will bring down inflation, we will bring it down in a way that is not wholly disruptive of growth. We understand that there is a need for short-term growth. But for long-term growth, we cannot do it without lower rates of inflation.So we are very much focused on bringing down the rates of inflation. And I think that's also important to convince foreign investors that their money is relatively safe in India, that you won't have continuous currency depreciation. We are intent on preserving the domestic value of the currency by bringing down inflation. If you look at longer term inflationary expectations amongst professional forecasters in India, there's been a substantial change from expecting high levels of inflation. They are coming down to what we are saying, what we are focusing on.
But lowering inflation can't be achieved only by monetary policy. You need government action. What kind of action do you need?
Absolutely. And the government, Mr. Modi, when he was a Chief Minister, prepared a report on what needs to be done on the food side. A big side of inflation is food inflation. And clearly we need more, a better supply side in food. We need less waste, for example, of certain kinds of food. We need quicker movement of food to where there are shortages. We need the possibility, occasionally, of imports, when certain domestic production is under stress. So a number of things need to be done on the food side. And that will help reduce food inflation. But of course other interventions to increase production-the large projects, for example-will also help reduce some of the supply constraints on the economy, other supply constraints.So, this is really a joint effort on the part of the bank as well as on the part of the government. Our attempt should be to make sure that we don't stand in the way of credit flows to investment. We would like to encourage longer-term investment to create what is necessary for the supply side. But of course, in the short run, to prevent runaway inflation, some demand compression, especially on the consumption side, has taken place. And you know, that is, when the supply side is not responding enough, obviously, to prevent inflation some demand compression is needed. But my hope is as the supply side starts coming back and especially as food supply starts evening out, we will have a much more reasonable environment in which to encourage growth.
You said, in the long term, inflation and growth go hand in hand, but still, some experts are speculating that the RBI's high interest policy would conflict with Prime Minister Modi's growth strategy. How do you react to this?
I don't think that conflict is as obvious as the commentators suggest. I think the government, again and again, has emphasized its desire to fight inflation. And I think the finance minister recently made the same comment. And obviously, you don't fight inflation by killing growth today, completely. There is, I mean you can fight inflation that way but that would imply a tremendous amount of harm to the economy. So you fight inflation by laying out a path over which you will bring down inflation. And that's the way you accommodate the need for growth also. That's precisely what we've done. We've said we will bring down inflation to 8 at the end of the year, 6 at the end of next year. There is a path we're drawing. We're not saying we're going to do it today with a huge increase in interest rates. But we're going to do it with moderate interest rates, so that the economy doesn't get killed in the process, but at the same time we are doing what we need to do. I think both sides will cooperate, and it will be a joint effort in bringing down inflation. It's not just monetary policy that will do it.
And with the high interest rates, many companies in India are still borrowing money from the bank. And those high interest rates are discouraging company officials from reinvesting or investing in a new stage. How would you support these companies?
First, I don't think for many companies the primary factor is the safe level of interest rates or the sort of positive rate we suggest. Some of them are working with high spreads, but that's because they are very risky. So they have to bring down the risks in order to get access to financing. A number of companies that have a lot of debt are dealing with that. Before this election, they were dealing with it by selling assets, and that's raising liquidity. Post-election, some of them are seeing the stock market boom and they are raising money through the stock market to deal with the high levels. Both actions are very welcome, because that suggests you have recognized that part of your problem is not interest rates, but leverage. Those are two different things. If you have high leverage you need to bring that down because you have over-leveraged relative to the state of the economy. Companies are realizing that that's a good thing. I don't think... I mean, clearly, interest rates do matter for investment, but I think the bigger impediments to investment are now on the governance side, which the government is going to sort of focus on, rather than on the financing side.
In previous interviews and speeches, you mentioned the inclusion of company people across the country. What do you mean by this? Is this related to the development role of the central bank?
It is related to the development side of our role. And it's one of the ways we promote growth, by bringing more people into the formal system. Too many people in India don't have access to a savings account, so they bury their money in the ground and the next time there is a flood they are destroyed, their life savings are destroyed. We need to give them a safe savings account that we can access. Too many people don't have an easy way to make payments. We need to give them that ability. People can't send money from Bangalore. They need to send money to a remote area in India and they can't send that money because of a substantial loss from the fees that they pay. We need to change that. So bringing more (money) can enhance growth, but can also enhance wellbeing. Similarly, giving access to finance to small and medium companies, another sort of focus area for Mr. Modi, would be a very good thing, would bring more companies into the system and give them easier access to finance. For that we have to work on the financial infrastructure.You know, how we sort of register collateral. Sounds like boring stuff. But if you have good title to land, if you have well-registered collateral, it makes it easier for small and medium sized companies to get access to finance. Those are the things we are trying to work on to make sure that growth reaches everyone, but growth is higher as a result.
Foreign direct investment is a necessity for India's growth. From the RBI side, what kind of measures are you thinking about to attract foreign companies, including Japanese firms?
First I think the primary importance of foreign direct investment is, in my view, the knowledge, the ideas, the organization skills, etc., that they bring. We obviously have in India a variety of existing capabilities. But getting new infusion from outside is always a good thing. And I think that would be very useful. Second, I think that as far as FDI in India goes, you see that people who have stayed in India for some time are making money. Unlike in some other countries, in India, if you are willing to stay the course, understand how things work, you can make a lot of money. Third, I think India, like any emerging market, there are a variety of players, a variety of participants. So when you go in you have to do your homework. You have to understand who you align with, what not to align with, what makes sense. So a little bit of homework there would be a good thing to make the experience better as you go.
The US Federal Reserve is planning to end quantitative easing by the end of the year and is considering a raise in interest rates after that. What do you think is the risk of this causing further turmoil in emerging markets, including India?
Well first I think India has come a long way since May of 2013 when the first announcement of tapering came out. That time we were running a large current account deficit, and it caught us partly, I would say, by surprise...the fact that we were running a large current account emerged over a few months. And that, combined with the extent of volatility in the financial markets, was a moment of surprise. I think the Indian Government as well as the central bank took a number of actions soon after. And I'm glad to report their positive effect. Of course we've benefitted like other emerging markets from the cooling down of concern since then. But I'm hopeful, in the same way that we were relatively unaffected by the volatility in January this year, while other emerging markets experienced some turbulence. With our stronger government and the risk perceptions having changed in the eyes of investors vis-a-vis India, we will not be as subject to volatility.Of course you can never say never. We are preparing for any possible volatility, but I would hope that it would be much more diminished relative to the past. That said, I do continue to express worries about the broader sort of structure of monetary policy in the world. We are an integrated world, but unfortunately monetary policy is very much domestic focused. And so, as a result, we have significant spillovers across the world transmitted by global capital. And these have consequences. And these are consequences that are not easily offset by just allowing exchange rates to appreciate or depreciate as the case may be. And emerging markets also have greater difficulty in allowing exchange rates to move in the same way as industrial countries can. So, I've been arguing that there's a need to think about this. I've used the word coordination, but I don't mean I think that India sits together with Federal Reserve bank people to determine US interest rates, no way. What I'm saying is we need to understand these spillovers better and to take them into account a little more. Because they are moving us to a different place from even what the originators of the policy might want.To my mind, this is something that we central bankers have to talk about in the years to come to develop a better system. I think the International Monetary Fund is also spending some time thinking about what its role should be. And I'm glad that some of my initial sort of comments as well as the comments of other emerging markets have sort of, in a sense, caught hold in the public debate, and we're all debating what a better approach might be.
Could you explain in more detail the measures, the concrete systems safeguard for preventing the spillover effect?
Well, one is first avoiding creating substantial spillover effect in the first place. And to that I think the idea that perhaps we should examine unconventional policies and ask, is this really needed in the state in which the economy is, does it have positive effects for the economy, and so those positive effects for the economy and for the globe outweigh the negative effects it has on other countries? That's the kind of debate we should have first. Second, I think there are some policies we have to live with because they have positive effects. Then we should try to diminish the negative effects of the spillovers. And those negative spillover effects can come from rapid movements of capital into countries and then out of countries. So to avoid the consequences of that, we have to think of a better kind of safety net in the world whereby countries, when they experience a lot of capital inflow, don't have to resort to substantial reserve accumulation to avoid the potential negative consequences when that capital goes out.So think of stronger safety nets around the world such as better IMF lines of credit, more tolerable ones.
But what is the risk of competition among the major central banks to keep these unconventional accommodative policies?
So the question is, what is the cost of the unconventional policy. What we're seeing in a number of countries is that one of the costs of unconventional policies is that financial risks rise as you keep the unconventional policies. They even rise domestically. For example, Governor Stein, at the Federal Reserve board, has talked about financial risks rising in the United States, like government loans coming back, and so on. Others have pointed to risks rising in the UK. So across the world, as we are making policies very very accommodative, financial risks tend to rise. And if my policy has to be accommodative because your policy has to be accommodative, the collective rise in financial risk can be significantly more. It's not just domestically that it's rising, it's also rising across borders. As the capital flows across borders, the risks rise elsewhere also. So even though inflation may be low, and in fact, may be close to deflation, it may be that we are all better off with less accommodative policy because of the consequences in terms of finance. That's the discussion we need to have.
I want to ask you what aspects of Abenomics are you paying attention to?
Well, again, to be careful not to comment on the polices of Japan... I mean, clearly there has been a revival in growth expectations about Japan from outside Japan. Clearly, in Japan you can see evidence of rising inflationary expectations, which is quite important to deal with the problem of consistent deflationary expectations over time. And I think that there is a lot of hope that the three arrows of Abenomics together will put Japan back as an enormous player in the world. To some extent, I think I can be candid in saying Japan has been missed for the last decade or so. And it would be so, so important for the world for Japan to come back in..., I mean, nobody expects Japan to do the 8% growth that it was doing before, because it's now a developed country. But to rise back to its potential, and to expand that potential, I think everybody is eager outside for that. So we're very much hopeful that all three arrows come together to work to push Japan to a higher growth, sustainable growth.
Many are waiting for the structural reforms, the third arrow of Abenomics, but India is also facing the challenge of structural reforms. How urgent is that?
I think across the world we all have to change because of the changed nature of the world economy. The old pattern of growth is no longer working. Different people have different views on what that old pattern of growth was. Some people believe that it was industrial-country demand, emerging markets supplying that demand, which is what was happening the last few years. Of course, if the industrial countries slow down, especially the large, consuming countries, we have to find other sources of demand. Domestic demand is going to be much more important in emerging markets. But it also means that everyone has to refit themselves into this new pattern. So one is that big phenomenon. The other big phenomenon which you clearly are experiencing in Japan is population aging. Demographics is kicking in in a number of countries. As you know, China is also getting older, but a number of countries are also.... How does, how do we play into those new demographics?The third big phenomenon is technology. We are seeing certain kinds of jobs being displaced by technology. You've seen that in Japan for quite some time, and were seeing that slowly happening even in the emerging markets. So, we need to deal with all this by changing the way we do things. That typically implies structural reforms. So everybody has a job to do and undoubtedly everybody realizes, including those who have been preaching structural reforms for others, that when it comes to doing structural reforms for yourself, it becomes very difficult. Because you're hitting against the status quo, you're hitting against the vested interest, you're hitting against politically powerful interests. So, it's not easy, but it is necessary.
The last question...I want to ask your opinion about what kind of economic landscape you see for India in the coming decades?
Well a decade is a long time. But I am hopeful that over the next few years, we will consolidate. You know, you can think of the last few years as a period when we've been trying to strengthen our institutions, strengthen environmental laws, strengthen acquisition laws so that there is cohesiveness in the population, the degree of conflict is reduced. We also have local government expanding in India. This process is, think of it as if we are a European Union plus. I mean, we have more people than the entire European union many times over. I shouldn't say many times over, I should say at least significantly more than the entire European Union. And our states, each one of our states, is a huge country in its own right. And we are trying to develop a structure that both adapts to the modern economy, but adapts to modernization amongst the people. So the hope over the next few years is that we not only achieve this process of institutional consolidation, but we do it with stronger growth. And we show the world that democracy is not a tax, it is actually a premium on democrative processes of growth because it creates a more sustainable growth path in the longer run. Let's see. I mean, we need to do a lot of work in India, our work is definitely cut out, but I'm hopeful that at the end of it there will be a story to talk about.