Interest rates not holding India back; markets not ready for more liquidity: Raghuram Rajan

In an interview with ET Now's Mythili Bhusnurmath, RBI Governor Raghuram Rajan talks about the latest RBI policy statement. Excerpts:

Mythili Bhusnurmath: Your take on yesterday's policy?

Raghuram Rajan: I think we have to be specific on the specifics. Broadly, we sent the message on where we were on the monetary policy path. Everybody understood what we were saying. I think that was pretty clear. I do not think that was a missed opportunity.

On other issues, it really depends on what people think the liquidity problem is. There seems to be a sense that rates are going up and so it must be liquidity issues. People think that somehow the RBI has to fix that.

We have continuously stated what our liquidity position is. Of course we have made a lot of changes in the liquidity framework. We still continue to review it. In fact, I have called in market participants to understand what it is that they are so worried about on liquidity. There seems to be a sense that something more needs to be done.

When there is the need for infusing long-term liquidity, we use the appropriate instruments which include open market operations. When there is a need for short-term liquidity — which happens, for example, when government balances build up — we resort to short-term instruments.

Mythili Bhusnurmath: RBI has been infusing liquidity into the system every day throughout December and January. So, it's clearly a systemic shortage rather than a short-term one?

Raghuram Rajan: It sometimes depends on the actions of certain players in the system. Now obviously, when there is a build-up of balances, we try and offset that.
Whenever there is a sense that there are permanent liquidity needs, we act accordingly.

Mythili Bhusnurmath: But two months — isn't that too long a period to justify that kind of a reaction?

Raghuram Rajan: Yesterday the government announced a buyback of Rs 20,000 crore. We knew that was going to happen. That was part of liquidity easing, because a buyback means money is flowing into the system on a permanent basis.

Mythili Bhusnurmath: Markets worry that the RBI, in its role as the inflation watchdog, tends to keep liquidity tighter than warranted only to err of the safe side. What do you have to say to that?

Raghuram Rajan: We have no intention of keeping liquidity tighter. In fact, we have supplied through various instruments whatever the market is looking for. But our longer-term instruments are not fully subscribed to yet, even though they are available.

Mythili Bhusnurmath: So it is a function of rates, of yields — is that what you are saying?

Raghuram Rajan: Absolutely. But again, there is a price for liquidity. If the market does not want to be willing to pay that price, things will be as they are.

But I want to emphasise again that we do not really want to keep it short. That is not our current intent.

Mythili Bhusnurmath: You are through with 15 of your possible 18 policy statements. In hindsight, had you thought transmission would be so slow? More importantly, was the RBI behind the curve in cutting rates like earlier it was in raising rates?

Raghuram Rajan: I do not think interest rates are what hold back the economy today.

Mythili Bhusnurmath: But about 4-5 months earlier when the sentiment was upbeat, could it not have provided that extra kick?

Raghuram Rajan: I do not know. We could always debate it for a long time.

Remember, there was a time when people said I was nuts to even think of bringing inflation down below 6%. They said I was subjecting the economy to severe stress. But all that is in the background now.

Some said oil prices benefited us a lot. Remember, the government has kept back 75% of the oil price bonanza through higher taxes. That means it is not oil prices. Yes, commodities have helped and government's food management has helped too. But you should be gracious enough to give some credit where credit is due.

Inflation has come down largely according to the path that the RBI set out. The point here is that when you are fighting in a system which has got used to double-digit rates of inflation. In India, people still have really high expectations. Of course, expectations are high globally, but it is more so in India's case.

Mythili Bhusnurmath: To whom is the biggest credit due — commodity fall, government's food management and fiscal responsibility, or monetary policy?

Raghuram Rajan: We can debate on that too. But what is more important lies in borrowing. A lot of people focus on borrowings — whether by firms or by individuals.

Firms now seem to be very reluctant to take on credit. Banks have not therefore felt the need to pass through rate cuts to them. But savings also needed a big change. Remember, our household savings had fallen considerably, and even now they are not at a point where we are comfortable.

Mythili Bhusnurmath: But now they are getting close to 3% real. So, maybe there is a case for giving them a little less — 1-1.5 was what I think you aimed at?

Raghuram Rajan: Let us see where the 3% real comes from. Last month, inflation was 5.5%. The policy rate was 6.75%, which makes it 1.25%. Add another 0.25% for the one-year treasury bill; that makes it 1.5%. That is where we are. So these notions of 3-4%...

Mythili Bhusnurmath: Between the bank deposit rate...

Raghuram Rajan: Even bank deposit rates, if you are talking about long-term deposits to get into the 8% and so on, even then it is 2.5% at best. But what is important is that for the first time depositors are getting real rates.

That actually requires a lesson in what real rates mean. A lot of depositors are complaining about the fall in nominal interest rates they get. They say they cannot make ends meet. Well, you are better off than in the past because your principal is not eroding now.

Mythili Bhusnurmath: Coming to NPAs, doesn't a line need to be drawn while going after defaulters? Isn't some kind of a balance needed? While punishing the promoters, don't we need to ensure that the asset is not ruined? After all, the asset was created with public money and economic recovery is part of the answer, isn't it? Do we cut the nose to spite the face?

Raghuram Rajan: No RBI policy says we are targeting promoters. We respect the private sector and regard the risk they have taken. There are many promoters who despite their best efforts are in trouble — due to bad luck, government policy, bad project structure. We should never reduce risk-taking; we should in fact celebrate the successful risk-takers.

Every time we have talked about NPAs, it has been always about setting the projects back on track. Now there are two paths. One is to not take any action — or to extend and pretend. If a project is not doing well, it needs action on the part of the banks.

Sometimes they will need to write down the debt because it's too high; the promoter has no incentive under the current structure; sometimes tariff authorities have to take steps to increase the tariffs for the project. In essence, a whole lot of people have to come together.

What actually happens in the extend and pretend phase is nobody pays any attention. The debt grows, cost of overruns become tremendous but nothing is ever done to restart the project. It eventually gets bad for for the economy.

But the banks do not want to push even at that point, because it requires recognising that it is actually an NPA. They take the hit, and then simply say: what can we do under existing structure?

What we are trying to do is move from this extend and pretend phase to recognising, putting in whatever resources are needed and moving forward. For the banks this requires adequate capital. The government has said repeatedly that there will be adequate capital which will allow them to absorb the hits.

But those hits — may be in some cases, and not across the board — may be necessary.

Yes, economic growth can set it right. As they say, rising tide lifts all ships. The problem is that we've waited 5-6 years for growth. Remember, all the forbearance started in 2008. We thought it apt to postpone it because the crisis was bad. It was a small problem then. It would have meant just small hits on bank balance sheets.

Since then, the problem has grown. More assets have become stressed. Now the question we have to ask ourselves is, do we hope and pray? We have had two bad monsoons; the world economy is in a bad situation. A number of stressed Indian sectors are also globally stressed. How long do you think it will take for steel to come back? Are we going to hope and pray that our economy does so well that eventually steel prices go high up?

Things like that take time. So the point is, do you extend and pretend while waiting for such things to happen? Or do you take actual action? And that action is precisely meant to put stressed projects back on track. It is not to penalise promoters; that is never a priority.

Yes, eventually promoters who have behaved badly in terms of whisking away assets, over-invoicing or holding the banks up will have to figure out the way forward for themselves. The system will deal with them. But that is not the objective of this exercise.

The objective of this exercise is to put stressed assets back on track. When I talk about promoters being behaving badly, I am talking only about a minority of them. But at the same time, I am also talking about a culture where it is a presumption that the banks are there to take the hit.

What is worse, bad promoters pocket all the benefit while banks go down under. This is not in the interest of the tax payers of this country. That is not in the interest of the larger public. More importantly, it is not in the interest of the promoters themselves.

The promoters must not allow a few bad apples to increase the cost of capital for all. Remember, when you talk about interest rates, the bulk of interest rates is not the repo rate, but it is what gets added on. It is the 13%-14% that they are paying a risk premium because of bad behaviour.

Mythili Bhusnurmath: Is our legal system so weak that PSBs can't take action against defaulters? Also, you've asked banks for aggressive pre-emptive provisioning. At a time when the need is for a longer rope, why ask for more provisioning?

Raghuram Rajan: Again what is important is capital — that they should have enough capital to take the losses. But if you look forward, putting the project back on track is going to give them the cash. Today the project is not paying; it is sitting there; the road needs to be built nobody is getting the permissions.

That road, once built, will make the 90% of the capital investments — which has already gone in — actually start producing. So, these kinds of actions need concerted efforts on all sides.

We loook to give banks the incentive to say, okay, we have the capital backing us now; we can take action on this and move it forward. Maybe this promoter can work out; maybe we need to get somebody else in; may be the state authorities will cooperate once they understand.

Mythili Bhusnurmath: And the legal system?

Raghuram Rajan: Legal system is a different issue. A lot of this has been done in the shadow of the legal system.

Now, if we had a strong bankruptcy code, we could do a lot of out-of-court negotiation, knowing full well that there is a backup in case things did not work out. This is how lot of other countries work.

Mythili Bhusnurmath: But in India, if you go to court, you get stuck interminably?

Raghuram Rajan: Exactly. Our Draconian laws are our real problem. that we have Draconian laws. But the courts interpret those laws as allowing them to intervene even though some of the laws say the courts cannot intervene.

The point is that if a promoter wants to hold up things, he can hold them up for a long time. Which is why we have created instruments like the SDR. These are attempts to get around this problem.

Now the point is, we have to use them well. We are currently monitoring the process to make sure they are used well. You typically do an SDR when you do not have confidence in the promoters. You do it when you do not want to let the promoter stay in control, or you want to have at least some control over the promoter. We need to make sure that that happens.

Mythili Bhusnurmath: When it comes to revealing the names of defaulting promoters, is there not a case for greater transparency on RBI's part?

Raghuram Rajan: Let me tell you, we did not give out names precisely because of previous court rulings. Those rulings protect defaulters; they say we cannot publish their names.

Mythili Bhusnurmath: The Supreme Court ruling?

Raghuram Rajan: No, some previous rulings by courts. Our point is, we were looking for legal certainty. We have no problem revealing the names of defaulters if the legal system allows us.

Mythili Bhusnurmath: Sure, but there is a Supreme Court in the country?

Raghuram Rajan: Absolutely. So, now that there is a ruling we have no problem doing it.

Mythili Bhusnurmath: Will you be coming out with these names, because I understand the Reserve Bank is thinking of filing a petition before a larger bench?

Raghuram Rajan: Look, there are different issues involved. People conflate these issues. That can be to the detriment of the larger good.

There is an accusation that we are hiding defaulters or protecting them. We have absolutely no interest in doing that. We only want that the privacy of genuine defaulters — those who defaulted because of situations and not wilfulness — is protected. Otherwise, it will kill risk-taking in India.

We have no problem with revealing names of wilful ones. But there were previous rulings and some uncertainty about the rights of those people. Remember, the Supreme Court has been very strong on privacy rights also. So, there was clarity needed. Now that the Supreme Court has come out with a certain view...

Mythili Bhusnurmath: You will be making those names public?

Raghuram Rajan: To the extent there is a public case, we will not stand in the way of those issues. There is a different issue about the inspection reports of banks. A lot of inspection reports are shared with us because we are the regulator.

Those reports can cause a certain amount of anxiety in the public. Putting those numbers or data out in an indiscriminate manner may cause panic in the system in certain cases. I am not saying in all cases, but I can visualise circumstances.

Mythili Bhusnurmath: I am talking not of individual accounts, but the NPA system as a whole.

Raghuram Rajan: We make those things clear on a regular basis. You have to keep in mind that projections always have assumptions. You have to be very careful that people understand what those assumptions are.

For example, your assumption was growth when you started this interview. You said growth would make for a tremendous reduction in NPAs. But does it make sense to say what percent of growth will cause what percent of reductions?

You have to map things out. We have mapped it out.