Cut in SLR aimed at reducing financial repression: Gaurav Kapur, RBS

In a chat with ET Now, Gaurav Kapur, Senior Economist, RBS, shares his opinion on the RBI’s policy review. Excerpts:

Mythili Bhusnurmath: Rajan, at the press conference, spoke about the need for the government to give the RBI fiscal space, and the need to stick to the fiscal consolidation target. Does this mean that the RBI does have some doubts about the government's commitment? Do you think it is true that the RBI has reasons to believe that the government is lax on commitment and does not have the ability to deliver on the 4.1% fiscal deficit target?

Gaurav Kapur: At least on the policy front, the RBI does not seem to have said anything. But there are always chances of a slippage and that is something which remains to be seen.

4.1% is indeed a very challenging number and it is not only about the reduction in the fiscal deficit. From the RBI’s perspective, what matters is the quality of rationalisation or quality of fiscal consolidation. So, to the extent that the government continues on that path by keeping a lid on subsidies and taking other necessary measures like the long-pending ones in taxation, it would provide a more sustainable space for the monetary policy.

In my opinion, at the moment we are in an intermediate environment where the RBI is trying to implement a new monetary policy framework. Such efforts started with moving away from WPI to CPI. Also, it is implementing a framework where you are giving long-term inflation projections, hopefully with some specific inflation targeting framework in mind. This is something that has been suggested by the Urjit Patel committee.

At least the RBI has taken those guidelines into account. In fact, in the current statement, they have talked of the January 2016 inflation and risks to it. Mind you, they are not talking of 2015, but of 2016. It means the issues around the government’s finances and the challenges around meeting the fiscal deficit target — all these issues matter to the RBI and at this stage.

The RBI continues to reduce financial repression by cutting the SLR. At the moment the RBI is taking it as given. Even if the situation evolves at a later stage where fiscal slippages do occur and the government does not do anything structurally in a manner where the objective of fiscal consolidation is diluted, the RBI should be comfortable.

But at this stage, it is all a given. I do not see the RBI judging it either ways.

Mythili Bhusnurmath: The RBI is clearly concerned with the growth inflation trade-off. So, the governor says that growth is less and inflation is higher than what he would like in the best world scenario. On which of these two fronts — inflation and growth — do you think the RBI could relax its stance just a little bit? Are there reasons to hope that growth is picking up or inflation is in fact coming down? If the RBI were to shift its focus on growth or inflation, which of the two could the RBI afford to do?

Gaurav Kapur: I do not think RBI would want to shift the focus away from inflation anytime soon. It is quite clear from RBI’s actions. Even in the inflation targeting framework, the intent really is to support growth over the longer period in a sustainable manner.

To support growth, inflation needs to be curtailed. Considering the limited instruments the central bank has at any point in time, the main objective they can achieve is continue targeting inflation with, of course, some eye on growth. But it cannot lose focus on inflation.

On the growth side if the situation warrants action — suppose if poor monsoons do drag down growth, may be not in the first quarter but in Q2 or perhaps Q3 — then the RBI might ease the liquidity conditions a little bit. Because at this point in time they also seem fairly comfortable with the way the liquidity conditions are.

They also look comfortable with the fact that the overnight rates are moving between eight and nine on fairly small amount of transitional liquidity shortages in the banking system.

So I think they would perhaps allow some room to support growth without losing focus on inflation. Their primary focus will remain on inflation. The only way they can support growth is by gradually providing a little bit more liquidity through the repo window, and perhaps at some stage through the CRR. It would obviously mean a change in their stance. But this may not happen any time soon.

In my opinion, in the next couple of quarters we will continue to remain in this intermediate stage. There is another big unknown right now — when the Fed raises rates. The markets are beginning to bring those expectations forward. We all know what it can do, the kind of volatility it can create and the pressure it can bring to bear on currencies in emerging markets.

India is still significantly better than it was at the same time last year. We do still have a number of challenges, high inflation being one them. So, on RBI’s part, I do not think they can lose focus on inflation. But they might provide liquidity. The provision for liquidity just might be the way they would support. By way of this, they might provide limited support to growth from their side.