India is not sailing in the same boat as Turkey or Indonesia: Raghuram Rajan

The fact that the currency has appreciated over the last few months will also play out and you see some of the advanced warning that will play out in the PMI survey data. Those are forces that should play out and should cause a reduction in inflation. What are the hawks basically going on about it is that you have to raise interest rates to such a high level that expectations will strongly be that inflation will come down. Now the problem is that kind of discussion is based on developed economies where the expectations channel works quite well. In India it is less clear that expectations are based on forward-looking signals. The output gap affects are probably as strong, if not stronger, than the inflationary expectations. In other words, suppose I raise interest rates to 18% today. How is it going to feed through? It seems it feeds more through much lower demand rather than through suddenly people waking up and saying the central bank is really serious about inflation, therefore we should all curb our wage demands and therefore, this should bring down inflation. Both have roles, but it seems to me the output gap has probably a greater role. We want to see how that works. That is why we emphasised this is not a pause, this is not a stop. This is basically waiting for data. Now when I said single data point, what we had was essentially a single data point -- vegetable prices.

ET Now: It has been going up for quite some time, we have had this kind of persistent food inflation now for more than 24 months. Once it was potato, now it is onion, only the trigger changes.

Raghuram Rajan: Let us see. Let us wait for some more time. At a point like this, we have to be very responsible in how we take interest rate measures. Let us take the data fully. What we have said very clearly is we are waiting for the next round of data and if we think inflation is still high, we will act accordingly. But at this point when the economy is relatively weak, you do not want to be trigger happy. You want the data to clearly tell you something. We will act accordingly. We have said that very clearly.

ET Now: It seems to be counter to what you had said earlier that regardless of what the source of inflation is, ultimately demand and supply have to be brought in balance, so you are going to definitely crunch demand whatever it costs to bring them in balance, that is the interpretation.

Raghuram Rajan: Yes, the interpretation can be what it is. We will not be railroaded by the markets or by investors.

ET Now: No markets would like you to keep a lower interest rate perhaps.

Raghuram Rajan: No, there are different markets. There are bond markets. There are equity markets. There are money markets. There are analysts. We raised interest rates in September when nobody expected us to raise interest rates, and markets took it very badly. But we did it nevertheless. I do not want to essentially do things without thinking very clearly about it. Without having a firm basis to act. What we are doing is waiting for the next round of data. We have said again and again that we are firmly against inflation. As far as expectations go, that should anchor expectations a little more. We also think the output gap effects are going to start kicking in and we will calibrate our actions based on what we see. People are bringing in their experiences from all over the world and saying this is what it should be, but how expectations form in India and what are channels of formation, you cannot be very theoretical about it. That is why we are being very practical. Let us see what is happening. We will act accordingly. We do understand that you want to be ahead of the curve. We think we bought a little bit of time by moving before anybody expected us to move and if necessary, we will move more.

ET Now: In fact, that brings me to what Stan Fischer recently said. He said the Fed is not saying what it wants to because it does not know, he says the problem is that in central banking today you cannot afford to be too concise/precise. Do you think he was speaking about all central banks where all feeling our way and/or is there something that, is there is a danger of being too precise and saying this is what you are going to constructive ambiguities, how it should go?

Raghuram Rajan: I do not think you are being ambiguous for the sake of being ambiguous. There was theory that you should be that way, but we have to be very careful that we do not say more than we know. We want to see how the disinflationary process plays out. As I have said before, there are a number of reasons we expect there to be some disinflation playing out in the system. Let us give it a little bit of time. I have also said that the pace of disinflation has to be appropriately calibrated to the strength of the economy. We are in a different environment. If growth was strong, there would be no question. We would raise interest rates given that growth is very strong. With growth weak, we have two effects – one, there is a disinflationary effect coming from the weak growth and second, you want to be careful about over tightening. After all we are a developing economy, our safety nets are weak. So we have to be calibrated and we will be.

ET Now: Would you push in for government to lower its holding to below 51%?

Raghuram Rajan: I think there are a number of issues that need to be worked on, not just ownership. It is not the ownership which is critical. You can have different kinds of banks, it is the way governance is done.

ET Now: Absolutely that arm’s length relationship….

Raghuram Rajan: With given ownership and we have to find ways to do that. There are ideas floating around. In my BANCON speech, I did say that this was the next sort of area that we needed to work on, which is have a dialogue with the public sector bankers, with unions. People like that and get a sense of how we move forward. Given the coming competition in the banking sector, private sector banks are gearing up to expand, and foreign banks eventually will expand. There is a tremendous change coming in. Public sector banks have done a lot in the past. Some of them have state-of-the-art technology. They need to gear up to use their capabilities to meet the competition and that means we should not leave them with hands tied behind their backs to fight. Everybody in the public sector banks has to recognise we cannot continue limiting competition, that competition will come. When I talk to union people, I come away refreshed that the younger sort of crowd, with is now the main sort of stream there, is fully convinced that they need to change.