'Baby steps are the fashion of the day'

Reserve Bank of India Governor Yaga Venugopal Reddy feels that the days of big moves like a bank rate hike is over as markets are now too sensitive to rate signals. Instead, he has taken what he calls "baby steps" to tinker with short-term rates.

In a free-wheeling interview with Business Standard, Reddy discusses a range of issues -- from corporate exposure to stock markets to asset bubbles -- in certain sectors. Excerpts:

Is inflation control the RBI's top priority now?

It is a question of looking at the balance between price stability with financial stability and growth. The Reserve Bank's mandate is to pursue both. In the long-term, both converge.

In the shorter term, there can be some sort of apparent conflict. In the current context, however, more emphasis has been laid on price stability than what we did six months back.

You seem to be concerned about asset bubbles in some pockets?

It is not a serious problem. We are more concerned with the possible impact on the regulation of the situation. We have identified four sectors where the supervisory process has begun -- real estate, exposure to NBFCs, capital markets and venture capital funds.

We are also identifying those banks which have large exposure to these sectors. I will be surprised if there are more than half-a-dozen banks which will be called for some discussion.

Is the economy overheated?

We are not in a situation where the economy is overheating. Much of the demand is for investment which is adding to production capacity and, by and large, the capital output ratio is fairly consistent compared with other countries. But we have to ensure that capacities are created to avoid overheating.

Are bank funds being misused by some corporates?

We have recently flagged off this issue. The corporates are cash-rich. They have multiple sources to raise funds and they are in an expansion mode. Often they raise resources for investment but there can be a lag between raising sources and investing them.

So, they are left with funds and they want to maximise returns on such funds through treasury operations. In doing so, the funds may flow into areas not originally contemplated. The resources are fungible.

Even though technically it may not be banks' money, still they must take a look at such cases because if corporates get into risky ventures, it will have an impact on banks' balance sheets. So far we have not found any instance of misuse of any bank's money by any corporate.

Is the reverse repo rate hike a half-hearted measure?

Baby steps are the fashion of the day. Nowadays, in monetary policies, no one takes big steps.

In the current environment of monetary policy measures undertaken in all countries -- even in ours -- we have been taking small steps as markets are too sensitive. This is the first step. But it is not necessary that there will be a second one if the first serves the purpose.

What is the purpose?

It is to reflect the central bank's determination to keep an eye on price stability. We have tried to capture certain developments that have already taken place in the financial markets.

Globally, there has been a hardening of interest rates. In the current linkages with trade and finance, we have to be in-step. So the question is when should we take the in-step measure. We believe this is the right time.

Why was the bank rate untouched?

Our medium-term view is to keep inflation below five per cent and the bank rate at six per cent. The reverse repo rate hike signals a reaction to current market uncertainties and global developments.

Will the hike in the reverse repo rate increase the market rates?

In the credit market, there has not been much of a change. Interestingly, a few days before the monetary policy was announced, the rates were higher and then (they) came down.

The focus of the policy is on credit quality and price stability. These are the two pillars. The central bank will not let inflation to go out of hand. We want to sensitise the banks to credit quality.

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