The Reserve Bank of India Tuesday held rates, crushing market and India Inc's hope of a rate cut. In an exclusive conversation with CNBC-TV18's Latha Venkatesh, RBI Governor Raghuram Rajan said the central bank needs little more comfort on inflation before cutting rates.



The governor added that significant rate cut depends on the deflationary process. He is not uncomfortable with undershooting 6 percent inflation target and is not aiming for a 4 percent consumer price inflation by January 2016.



Below is verbatim transcript of his interview:

Q: I hope we will continue to get this chance to interview you as Governor of Reserve Bank. I hope you are not going away to the BRICS Bank?

A: No

Q: There were reports saying that your name was mentioned?

A: I have not heard anything about it.

Q: You have not been told, not asked?

A: This is a job that I am doing the only job I care about and I am happy here.

Q: You are happy here but it is quite possible that you may be requested to take on?

A: That is hypothetical question.

Q: No I am not indulging in hypothesis.

A: No, I have not been asked about it and I am very happy here.

Q: What is the sense you are getting about this 6 percent in March 2015 and the 6 percent in January 2016? Do you think you will achieve it more easily? Can you give say a chance of more downside surprise?

A: Every reading we have had on inflation since November of last year has been good and so that is suggesting that something is happening in this economy which is changing the environment. Now after five years of very high inflation we should not be faltered for trying to make sure that this is the real thing because we have had false alarms before.

In every additional inflation reading we seem to confirm the trend. Our policy was saying that we need a little more comfort but we want to do this in such a way that barring exceptional eventualities that we can’t foresee, when we change we change in a direction that is easy to anticipate and you would anticipate that further moves would be in the same direction.

Q: Do you suspect that given that you have got downside surprises, very pleasant ones over the last 12 months to the inflation reading, is there a decent chance that it will continue?

A: I am hopeful and what we want to do is see if that actually happens. However, all the macro economic surprises India has had over the last year, somebody is watching out for us, have been positive. So, let us hope the trend continues.

If you were mean reverting you would say we have had so many positive surprises now we should start seeing some negative surprises.

Q: What according to you should be the positive real rate of return because at 6 percent it is 2 percentage points, the positive real rate? Is that not enough for you if you see so much clarity up until next year? Do you want to remain at 2 percent or would you be comfortable with 1 percent?

A: The real rate that should prevail in economy depends on so many things including what is your comfort level with rate of growth, the kind of investment cycle that you are seeing. So, when the economy is weaker, the real rate that you would expect would be lower and as it strengthens you would want a higher real rate to prevail.

If you look at the world, what real rate is prevailing in other economies, it is in the 1.5-2 range for developed countries and for emerging markets a little higher. So, we don’t have a specific precise number in mind but the range would be somewhere between 1.5 and 2.5; that would be a perfectly acceptable real rate.



Q: If that is the acceptable real rate and your forecast is that inflation is going to be in and around 6 percent through calendar 2015 there isn’t so much scope for rates to fall at all?

A: You are making that judgment I am not going to verify or deny that judgment.

Q: The trend you spotted was yours?

A: Obviously, the scope for further rate cuts, of significant rate cuts depends on the pace of disinflationary process. Six is not a magic number that we hope to stick to. Overtime it has to go below six if the government formally approves the target of four plus minus two then we would be nudging closer to the four overtime number.



Now that timeframe over which we reach the four has still to be determined and so on. However, that would give you more room at that point to cut more. You are absolutely right there if there is a certain real rate that we need for savers in this economy that means a certain amount of room and that to get more room inflation has to fall further.

Q: In that case is it possible or is it very much in your thinking that this 6 percent 2016 target is a very transient target, you will find yourself bringing it down in the months to come?

A: It is important that when you set something you stick to it.

Q: Do you see it coming is what I mean.

A: We may undershoot the target and if we undershoot the target we are not going to feel uncomfortable about undershooting. If we expect to overshoot the target we will try and bring it in within the target but the time over which it is going to reach closer to the central point of the band is something that will have to be determined as we formalise.

So, what is the period over which we are going to look at meeting the inflation objective? It doesn’t mean that we have to be at 4 percent on January 2016. As I said in the policy announcement that if we get to 6 percent we are at the extremes of the target and if we do better that is fine but at this point we want to get to 6 percent.



Q: Why have you maintained it at six because a lot of your base assumptions were USD 100 for crude and the rupee at 60, global growth of a certain order some of them at least have changed? Haven’t you changed any of your assumptions you haven’t inputted them?

A: We have input them and remember it was the model was saying seven percent in our last policy meeting. Now the model is saying 6.2 but in the previous policy meeting we said our subjective assessment over and above the model is that probably we are over estimating the inflation and development since then have correspondent to our intuition that the model itself has come towards where we thought it would be. It is now closer to our comfort range in terms of where we think it will be.



Q: Are you getting a sense that these factors be it rural wages or government management of stocks or for that matter global commodity prices, global corn, wheat food prices will sustain through next year? Do any of these looks secular to you?

A: I don’t think global prices are going to take off that rapidly unless there is concerted failure of the climate issues across the world as I think was the case in 2007 and 2008.

However, apart from that world food price provides that ceiling beyond which domestic food prices can not move much. So, that is going to be one good thing.

Food management hopefully is a secular positive that we improve it as time goes on and as a result we move food to where the prices are high.

Farmers make proper choices between what to produce so as to bring down prices in longer run. So, these are steady trends and hopefully, we will not be the only large country in the world experiencing double digit inflation. Right now we look like we have escaped that well and truly.

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Q: I am just checking somewhere if in your study of these trends is there expectation that we may undershoot next year as well on inflation?

A: We may, let us see how the numbers look.



Q: Are you that confident of rural wages because they have been coming down for a sustainably long period that the government has obliged on food stock management?

A: When you see a trend over a substantial amount of time you believe there is some underlying economic force pushing that. What was pushing up rural wages was a combination of things higher agricultural prices but also a substantial increase in construction this that etc.

Now because construction has been moderate and you have seen some fall in rural wage growth, it is still growing but not as fast as, partly may be the participation rate women leaving the labour force to study maybe that has also plateaued.

When some many things are going on it is hard to put your finger on one thing and say this is what it is. However, the fact that there is a trend gives you some hope that it will continue.

Q: When you said that the government is in sync or is agreeable to your medium-term inflation target of 4 percent.

A: Let me change the sequence. The government sets the inflation targets we meet it, right. So, the government is comfortable with proposing an inflation target with of four plus minus two. There have been a lot of studies that have gone into this right from, I think Narasimham proposed 4 percent so, 4 percent is a magic number in the Indian economists.

However, there is a logic behind it, think about 2 percent is what inflation targets in the world is and say our productivity differential is two percent.

If we want rupee to be relatively stable, the nominal value of the rupee relative to major currencies then a four percent inflation would keep us relatively stable assuming others are at their inflation target.

So, that is one rationale for the four and the plus minus two is because we are at the early stages of trying to maintain inflation within a band and some leeway there has to be for the additional noise and the fact that expectations aren’t as anchored.

Q: Have you actively discussed a target from the government, was this 4 percent discussed with the Prime Minister or the Finance Minister or the finance ministry?

A: The discussions are on with the finance ministry, that is why I said partly because you would want to know what is going to be there post January 2016 the finance ministry indicated its comfort with this number.

Now the details have to be fleshed out. I just wanted to give you a number beyond January 2016 that this is probably what we are going towards and the details of when, how, etc will have to be figured out.

Q: In that case were you not pressured into cutting rates or you don’t expect further pressure because this is the government’s given target?

A: The word pressure is sometimes bandied around in the press. We have a very healthy dialogue between the government and the RBI and the government says here are the things we are seeing, here are our concerns, here are our hopes and we describe to them what we are seeing and what our concerned are etc.

There is a sensible discussion of the economic environment and the need for policy and if you go by what the Finance Minister has said in public repeatedly that is what he says in private.

Q: He said repeatedly that I hope he cuts rates?

A: No, what he has added there is that ultimately it is the Reserve Bank’s decision and that is how you expect the dialogues to go on that here are my views, here is what I think but it is your decision and we and the government have a healthy dialogue. They understand our concerns and we understand their concerns and there is a meeting of the minds. So, that is how these policies essentially are discussed.

Q: What is your sense of this commodity super cycle? It seems to be at its ebb or lowest ebb at this point in time. Since you have read the global economy for so long in various previous avatars, what is your sense of the commodity cycle in 2015? Will it be benign to us?

A: All indications are benign and primarily from a slowdown in China which is creating the impetus. In the oil producing countries the fact that they have had number of years of fairly strong oil prices has elevated their budgetary requirements. They have essentially started spending more and therefore, a number of countries need fairly high oil prices to meet their budgets.

Therefore, with oil prices going down the only way they have of meeting that is to produce more and that is why there is a reluctance to cut.

There is a sense from some of the big oil producers I have been cutting all of the time, why should I cut once more and a point that Dr. Urjit Patel mentioned perhaps also a belief that these periods of fairly low oil prices if sustained for a little while can also be good for the oil producers in shutting out further projections. This is the predatory pricing idea.

But all said and done at least for the near future I am not sure what the exact oil price will be but it seems to me that it is going to be relatively benign given that strong demand seems unlikely to emerge for the foreseeable future.

Q: If that is the global cycle and in India itself you are seeing inflation slightly benign do you think now the threat from a Fed tapering is not very serious at least by the time it hits us ten others would have fallen?

A: I have said that if you wanted to discriminate between emerging markets, we have the label emerging markets so we could get hit if there is a general emerging market concern. But typically, after sometime discrimination starts and once people start discriminating there are number of positives about India that they would tick off including a stable and strong government, indicators moving in the right direction and our immense potential for growth. So, put all those together I doubt we will be first on the list to be hit.

Q: Relatively is that a risk that you don’t have to worry about?

A: You never say I am not going to worry about anything. They are always things that we have to pay attention too but we are well prepared. We are certainly much better prepared than we were in May 2013. I would say after the first flush of investor sort of concern we will see some discrimination.

Q: Is one of your ways of preparing to ensure that the rupee doesn’t get overvalued vis-à-vis the rear?

A: No, our attempt is, I mean I have said it many times to ensure there isn’t excess volatility in the rupee and that means not just current but also prospective. So, when we see a whole lot of money coming in and we are not sure of the durability of that money we try and pick up some of that money so that it doesn’t overly influence exchange rates both on the way up and on the way out.

But apart from that we understand fully the limitations of trying to maintain a particular value for the rupee. You need a much more restricted financial market than we have to believe that you can do it over the medium-term.

Q: The way you have been as a governor in terms of foreign exchange intervention is quite a distance from what you had written in the financial sector report that you wrote in 2008. So, what has constituted this change; a realisation that too much overvaluation is what causes disruption?

A: I said exactly the same thing or we said exactly the same thing that if you remember I don’t write the report myself, there are a bunch of people together but we said that intervening to prevent excess volatility were words in that report also.

We are doing precisely that. We also said we have to caution against trying to maintain a value over the medium term and against what seems like the forces of the market.

Q: Are you saying you have not moved at all from your position in that report? I mean you certainly have escaped phrases like this but reality after the global financial crisis has moved your position?

A: No, so we saw some of the global financial crisis while writing that report it was September 2008 when it came out. However, what my formal view is probably contained in paper that we, Barry Eichengreen and I and Eswar Prasad produced as a part of a committee and our view is that central banks should worry primarily about inflation but monetary and financial stability in also something that they should be concerned about.

Sometimes large changes in asset prices, whether it is exchange rates or credit and equity inflation is something we need to be worried about. So, yes you need to take some actions there but be realistic about how much you can do.





Q: According to you what has allowed this undershoot of inflation, what are the trends, is it like fall in rural wages or is it the government managing the food sales from the FCI well, what were the signals according to you if you have to dissect this positive inflation surprise, what would you attribute it to?

A: There is a whole bunch of factors, including luck. So luck is a stuff we can’t explain so that has also helped. But food management by the government has been important; the fact that minimum support prices (MSP) hasn’t moved up through two governments now at a substantial pace. Now that is not just driven by whim and fancy, it is driven by cost structure which hasn’t gone up.

Part of the reason also has to be that we are closer to international food prices than we were when this whole process of increasing MSPs took place and so, there is not that much more room to do it before you hit against the fact that imports are cheaper and therefore, they could come flooding in if you start moving domestic prices much more strongly.

So food has been a big factor. We still have work to do which is the seasonality in vegetable inflation, can we bring it down, can we ensure that there is storage movement, less wastage and the government is undertaking actions on that front.

The other aspect is once there was a sense that inflation was coming down it assumes a life of its own because we are worried about second round effects, the effects feeding into services. Services too have started coming down. Housing, you can see some impact. It used to be 10 percent every year, now it is slowly starting to come down and it is in the high 8s, early 9s. So, across the board we are having some impact and let us see.





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Q: You said that you are going to make it easier for banks or more flexible for banks to handle bad loans or potential sticky assets. The 5:25 rule will be applicable to existing assets as well. Is this not restructuring in disguise? That is what you were trying to end but you are starting it again.

A: Let us be careful about what I am trying to end. What I want to end is forbearance, which is called a non-performing loan performing. That is different from what we need to do, which is assets, which are stuck because there is too little equity coming in because the payment schedule is too high and they cannot make payments. Those assets could well become functional if the financial structure was altered.

I want assets to be functional to produce the stuff that they are supposed to produce whether it is electricity or coal or steel but we have to put assets back on track. The faster we do it, the better.

There is a bargaining process there. There are losses to be taken because the asset is producing less than what was anticipated at the time the investment was made. That loss has to be fairly divided and I want to emphasise fairly between the promoter, the banks and sometimes even the government.

However, if we can divide that, put that asset back on track, the economy is better off. I want to distinguish that from what in Europe sometimes called extend and pretend.

It is non-performing, it is not going to perform and you pretend that it is functional and you lend it the money to pay you back so that it is on your books but nothing is happening. Nobody is getting more loans to finish the project, it is stuck. I want to stop that and say move from this bucket to that bucket where you may have a different capital structure but you are producing now.

Q: What will the provisioning norms be for that? Will it be same as a standard asset?

A: I think that we have to go towards provisioning norms which recognise the size of the losses. So when I say, move, I also mean that we have to move to recognise the losses.

Let me be very clear here, there are two things that we control, which is when you declare an asset in NPA and how much you provision for it. The first part of it regardless of whether we say it is an NPA or not, the analyst community already has decided.

You call it a restructured asset, they call it an NPA. So they are not making a distinction and in fact as a bank it maybe worse off because some assets, which are genuinely just restructured, which have the same value shouldn’t be called an NPA, are being called NPA by the community.

For them it is better that those that are genuinely NPA or called NPA, don’t pretend that it is not an NPA. It is an NPA. It is not going to produce value for the next three-four years, let us call it an NPA.

The second aspect is about provisioning. Provisioning is prudential. What that means is if I don’t provision today and that asset turns worse, tomorrow I may have to provision double the amount or write-off double the amount, it comes as a surprise.

So many of these banks are public sector banks, the government today maybe setting aside only some money for recapitalisation knowing that things aren’t so bad but if things are really worse and they haven’t provisioned for it, two years down the line, the bill that will come will be substantially higher.

It is in the interest of everyone to recognise the losses as they come to set aside money for that so that you don’t have a surprise and at the point where you have to make big investments, the bank cannot do it because it doesn’t have enough capital. Let us recognise the true state of the banks and move on.

So when I say no forbearance, I mean let us recognise the true state. What that means is nothing on the real side, I am not standing in the way of you doing anything in terms of restructuring but recognise this as a non-performing loan and that you have to make the appropriate adjustments and give the bill to whoever has to pay the bill. Let us do that, let us move forward.



Q: When the current loans are recast in the 5:25 mould, an element of larger provisioning will be there?

A: If it is a standard asset today the norms for recast loans for standard restructured assets will apply. However, we are not going to add to that right now.

Q: We always had three buckets, we had standard assets, we had the NPL which is like the 15 percent then 25 percent second year and 40 percent the last year and there was the restructured. Does that continue?

A: That will apply till such time that it was suppose to apply.

Q: But what about the 5:25 projects?

A: To the extent that it is standard and all you are doing is maintaining the NPV and changing the term of the loan then in that case, we have to work this out, we can be a little more flexible on the provisioning. However, we have to work it out.

Q: Are you satisfied of the way the Joint Lenders’ forums are working? For the reporters from the outside it is actually the CDR mechanism becoming more opaque?

A: Joint Lenders’ forum should not be seen as separate from the CDR. It is a stage before the CDR mechanism. It is saying what do I do with the assets; do I restructure them, do I liquidate, do I get new management.

There is a decision before that and then it goes into the CDR process or it goes somewhere else. So, in that sense I don’t see why it should be more opaque than the CDR process itself.

Q: We used to get numbers of CDR cases, now in the pre case not much is known. So, are you satisfied?

A: We are monitoring it. It started in April of this year so it is a little early to get strong numbers. They had 120 days to do what they needed to do, so it is a little early. We will see what is going on.

The bank does seem to be quite happy with the fact that this has coordinated them a little more effectively and coordinated them early on because of the SMA-2 classifications being prompt.





Q: In the last downturn, 1995 to 2003 or 1999 to 2003, it ended with three big steel companies getting recast by the entire banking system, Jindal , Ispat and Essar had to be done, do you think something like that will have to be worked out for the gas based power projects?

A: Gas is probably one of the most problematic areas. The key there is - we have to recognise that the supply of gas, which was relied upon is no longer there. So this is one of those situations where there has to be a loss sharing agreement because the losses definitely are there. Let us see what government plans.

Q: Anything in the works? You are asking the banks to work with the government?

A: No, you don’t need to ask them to work with the government. They are working with the government.

Q: Get the government to work in some kind of a package or is it to be written off, will they go the Enron way?

A: No, they will have to figure out how they do it. I think these assets are salvageable at a particular price for gas and maybe the particular demand that they service, peaking demand maybe different from ordinary demand, those discussions are going on amongst people who have a much better sense of what needs to be done. Let us see what happens.

Q: Let me come to the new bank licenses and the guidelines that you have put out for small banks and payment banks. Will the old ‘fit and proper’ rules apply to these applicants, a lot in the previous round of universal bank licenses were rejected because of ‘fit and proper’, one regulator or the other objecting or saying that there is a move against that company, will that continue to hold or is it different because the stakes are small?

A: In this country a bank license is a license to print money. So you have to be a little careful about that. I think that we will have to follow reasonable ‘fit and proper’ rules, I don’t think that we would want to allow for weaker ‘fit and proper’. But I think there would be plenty of applicants who will meet reasonable ‘fit and proper’ criteria so let us see - I don’t think the rules were that strict last time either.

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Q: But we were told a lot of people didn’t get the license because of one ‘fit and proper’ miss or the other.

A: If you are being investigated by the CBI for something or the other, it is very hard for me to say that we don’t worry about that and not something ordinary but some serious allegations.

Until you are clear of that it is very hard to say we are giving you a free pass. However, I would say that my sense is that there will be enough people who would pass any reasonable ‘fit and proper’ criteria. I don’t think that is going to be the constraint.

Q: Financial Sector Legislative Reforms Commission (FSLRC) - how much are you with the government or is the government with you and is the area of disagreement only the appellate authority and the fact that RBI’s decisions maybe appealed against is that one of the two areas of disagreement?

A: I don’t think the government has made up its mind on every last detail of FSLRC.

Q: On this?

A: There is a group looking at the Appellate Tribunal for what is important and I have said this repeatedly, we don’t have a problem if penalties we levy are appealed whether to a tribunal or a court, that is fine.

The question is are you going to put policy decisions if I say equity is going to be 15 percent, it is based on the judgement as to what is the appropriate level of equity ownership in these kind of things. There is a whole range of things we look at.

Q: Only policy would be an objection? There have been times when the RBI has superseded bank boards or put its members in banks.

A: Penalties and size of penalties are one issue and that is fine but if you are talking about those kind of judgemental decisions where in the interest of the stability of the system, we say that maybe the bank has to be superseded or this and that.

Now you have to be little careful about putting too much second-guessing and third-guessing into those kind of things.

If we don’t follow due process there is already an appellate process through the courts so our decisions can be appealed in the courts and routinely our decisions to cancel the registration are appealed in the courts but the point however is that if every last thing - we just did away with this 80:20 rule, if that was stuck up in the courts for a few months, just think of the kind of arbitrage that would go on in gold purchases.

Q: I am with you even when you pull up a bank and put your representatives there. I am not questioning your argument that there shouldn’t be an appellate authority but the government seems to be, they want an appellate authority, you called it schizophrenic in that speech.

A: No, so the word schizophrenic was used with respect to something else which was that - one concern is the scope of any appellate authority. I don’t think we have any evidence that it has worked wonderfully well in other circumstances.

So be careful - yes rule of law is important but are your regulators in particular cases already constrained sufficiently by rule of law or do you want to put fresh levels of oversight and appeal. Be careful because it doesn’t necessarily improve the quality of decision making and can make it worse.

I am not saying never, I am saying especially when the economy is growing and a whole lot of new things have to happen, if you put oversight on oversight then you are likely to get paralysis and not much movement.

Q: You have very fine legal mind as the Finance Minister. You have been able to convince him?

A: We haven’t had a discussion about these issues.

Second important thing to keep in mind is the organisations they are talking about. There is one lesson you take away from the crisis, it is that different kinds of organisations worked and the same kind of organisations failed in other circumstances. So there is no ideal organisational structure.

However, the FSLRC recommends a certain restructuring of the regulators without a huge amount of evidence or analysis into why what it proposes is the appropriate structure.

Now, I think there are lot of good things in the FSLRC report including for example the call for a financial resolution authority etc. New institutions have to be set up, the FSLRC report does a wonderful job of laying it out.

We shouldn’t treat it as a Bible that this is the Gospel truth, we should subject it to the same kind of enquiry that they would want the regulators themselves to subject their own actions too.

So let us subject the FSLRC, let us debate these, does it make sense and where there isn’t much argument supporting their rationale, let us question whether we need to change the status quo, whether there are much many gains from it. That is all I am saying.

I am saying debate it, don’t treat it like the Gospel truth especially because there were significant members of that committee who dissented against the report. Now we get the sense, the FSLRC is some sort of monolithic wonderful, perfectly accepted document, it is not. It is yet to be fully debated. So let us debate it.

Q: Has the Finance Minister bought that argument?

A: I think the finance ministry is moving ahead on certain aspects of the FSLRC report. I think the regulators themselves have moved ahead on things like the non-legislative recommendations including for example, we are moving towards a consumer protection code.

There are a lots of good things that we have taken up and I think we will take up more but I am saying there are certain aspects which there is still regulatory concern and before it is rolled out in full, let us debate it.

Q: Let me end where I began. The Monetary Policy Committee (MPC), on that is the finance ministry seeing your point of view that it should be committee, it should be collegial and that you should have the hand in appointing that collegium?

A: I think discussions on those issues are at an early stage. It would be premature to comment on it but I am hopeful that we should reach some kind of a consensus after which government will make up its mind.

Q: When should we expect the committee, is it in a year?

A: Those are part of the discussions. The Finance Minister announced this in his previous Budget so hopefully the announcement on the modalities would come before the next Budget.

Q: You are hopeful that they have bought the idea, it should be a committee member?

A: It is ongoing. I don’t want to comment on the precise discussion.