Low inflation must for meaningful interest rate regime: Urjit Patel


RBI Governor Urjit Patel on Wednesday made a strong case for keeping inflation low on durable basis saying it is “essential prerequisite” for meaningful interest rate structure to increase investments for better growth.

“For us, in India, good policy housekeeping should be the cornerstone. It is easy and quick to fritter away gains regarding macroeconomic stability. But hard and slow to regain them,” he said at Vibrant Gujarat Global Summit in Gandhinagar.

Observing that the RBI has already notified inflation target of 4 per cent, Mr. Patel said the effort should be to achieve the objective of keeping prices under check on a durable basis, given the progress already made.

“Low and stable inflation is an essential prerequisite for having a meaningful interest rate structure or regime whereby decisions by savers and investors help to achieve maximal allocative efficiency in an economy whose investment rate has to increase for better growth outcomes,” he said.

“Concomitantly, we have to continue to press ahead for a more fluid, smooth transmission of monetary policy, as also enhance the formulaic linkage between changes in policy rates and other rates, including administered ones,” he emphasised.

Referring to the issue of fiscal deficit, Mr. Patel said it is necessary to contain it as combined borrowing of the Centre and States are among the highest in the G-20 countries. This is also coming in the way of credit rating upgrade by international agency.

Lower fiscal deficit will also help in better management of risk and curb financial volatility which becomes more important in view of adverse external environment, he said.

Recapitalisation of public sector banks

The RBI Governor also made a case for continuous support towards recapitalisation of public sector banks arguing that “a well capitalised domestic banking system enhances the comfort of the various stakeholders to conduct business in the offshore IFSC as well.”

GIFT has been set up by the Gujarat government as India’s first International Financial Services Centre (IFSC) that brings together world class infrastructure, connectivity, people and technology on a single platform for businesses across the world.

IFSC at GIFT City is probably the first such centre to be launched after the 2008 global financial crisis.

“In some ways, the light-touch regulatory philosophy epitomised by IFSCs came to be questioned in the aftermath of the crisis. However, GIFT City has the advantage of drawing the right lessons in this regard to avoid pitfalls,” Mr. Patel said.

He also pointed that the RBI has been working closely with all IFSC stakeholders on diverse subjects in the recent years to help GIFT develop.

“Today we see intense competition among the major IFSCs trying to position themselves for various business lines, and increase their business potential,” he said.

In addition to the usual attributes there are two other dimensions, the broader economic environment in tandem with associated policies, and the micro ecosystem specific to the IFSC sector, he said.

Fiscal deficit

On fiscal deficit, Mr. Patel said, borrowing even more and pre-empting resources from future generations by governments cannot be a short cut to long-lasting higher growth.

Instead, structural reforms and reorienting government expenditure towards public infrastructure are key for durable gains on the Indian growth front, he said.

“Investment in public transport, specifically railways and Urban MRTS can lead to reduced costs and productivity gains as also help us to lower our oil import bill, and, as collateral benefit, improve air quality in our cities,” he said.

Mr. Patel said that while some government guarantees and limited subventions can help, steep interest rate subventions and large credit guarantees also impede optimal allocation of financial resources and increases moral hazard.

“The mandates for these have to be narrow, and thus perforce be deployed judiciously, within a regulatory framework, which RBI has suggested. Guarantees increase government’s contingent liabilities, and add to risk premia for its own borrowing,” he said, adding that guarantees per se at the end of the day have limited utility in solving important sector issues.

Citing an example, he said for small scale enterprises, perhaps non-pecuniary and transaction costs related to clearances, inspections and the taxation bureaucracy are more important.