Real interest rates must come down in the economy to support economic growth and small and medium enterprises, said Sanjeev Sanyal, Principal Economic Adviser in the Finance Ministry. In an interview with SUNNY VERMA, Sanyal spoke on a range of issues including liquidity, rollover of NBFC debt obligations and exit of banks from the Prompt Corrective Action framework. “Once we have structurally anchored inflation at low levels, it is important to bring down real interest rates,” he said. Edited excerpts:

Recent GDP growth numbers show some moderation in second quarter. What do you make of it and what are your expectations going forward?

We were not entirely surprised by the fact that the year-on-year growth number declined for the July-September quarter to 7.1 per cent from 8.2 per cent. Half of the decline is due to the base effect, which was anticipated. However, it is still somewhat below what we expected after allowing for the base effect. A number of factors explain this: global energy prices spiked up, there were disruptions in NBFC lending and there were expectations of rapid tightening by the US Fed.

All of these factors have eased significantly since end-October. Global oil prices have fallen sharply, US Fed is now expected to tighten at a more moderate pace, mainstream bank lending has revived and the roll-over problems of the NBFCs have eased (although NBFC lending may still be constrained). With bank credit growing by over 14 per cent year-on-year and a strong Purchasing Managers Index for manufacturing, the disruptions for those couple of months seem to have eased off and growth is again gathering pace.

Does the recent credit growth suggest that we have overcome problem of liquidity, or are more measures still required?

Revival of bank credit is very welcome. Some parts of the economy, especially SMEs, have faced tight credit conditions for a while. Nonetheless, RBI needs to watch liquidity conditions very carefully, particularly since primary liquidity conditions as measured by the LAF (Liquidity Adjustment Facility) have been tight. But I am sure they are aware of this and will adjust their open market operations accordingly.

What about the liquidity for NBFCs?

The liquidity of the credit market is a related but somewhat different problem. Following the IL&FS episode in September, several NBFCs found that they could not do routine roll-overs in the credit markets. The government acted swiftly to ring-fenced ILF&S and then nursed back the market using facilities such as National Housing Bank’s window. The credit market is now functioning smoothly again and returning to normalcy. Still, we need to keep a close eye on it.

In terms of fresh lending by NBFCs, is that turning around?

It is too early to tell. NBFC lending did slow down in September, October and into November because of the rollover issue. We don’t have enough high frequency data to tell what NBFCs are doing real time, but available information suggests there will be a wide range of behavior in the next few months – some NBFCs will continue to conserve capital while others will expand in order to capture market share. The policy question is – can bank credit grow quickly enough to make up for slower NBFC growth?

Among the mainstream banks, eleven government banks are under the RBI’s Prompt Corrective Action (PCA) framework. Has there been any improvement in performance of some of the PCA banks over last one year?

Some PCA banks are stronger than others. One of the issues that the RBI and the Ministry of Finance are discussing is that at least the stronger ones need to have some path for exit out of PCA. At what pace it happens will depend upon the balance sheet of that specific institution. But the time has come to think about the exit part of the cycle. This doesn’t mean they will be all out of the PCA tomorrow, but there must be a exit trajectory with a practical time-frame.

Analysts feel the government is facing fiscal stress looking at the GST, disinvestment numbers. Will the government stick to the fiscal deficit target of 3.3 per cent of GDP by March-end 2019?

We are committed to fiscal responsibility. While GST collections may have fallen short in some months, the collections will gather pace along with the economy. Also, we will see good collections from other areas. Customs duty collections have gained from rupee depreciation while direct tax collections have been strong due to better compliance. Air India privatisation has been delayed, but other disinvestments are picking up. In recent weeks, the government raised significant sums from Coal India and ETF sales. On the expenditure front, we expect to maintain the pace of infrastructure spending.

Can you elaborate on the government’s thinking on RBI autonomy?

We have always been clear that the Reserve Bank is a valued institution and we value its autonomy. However, that autonomy is not absolute but within the framework of the RBI Act. When we say that there is greater autonomy, it also means that there is greater accountability. The Reserve Bank is accountable to its Board. What is being done is to strengthen this institutionalised system of accountability within a framework of rules. It was the same when the Monetary Policy Committee was set up and given a clear inflation mandate. It institutionalised monetary policy making.

What is the source of stress on the SME sector?

The SME sector has faced several changes in the last couple of years – GST introduction, inflation targeting, the banking sector cleanup, the Insolvency and Bankruptcy Code and so on. The measures are important long-term reforms but it should be recognised that they are disruptive in the short term. The banking sector cleanup, for instance, disrupted the pre-existing pathways of credit. Inflation targeting caused real interest rates to spike up.

Till a few years ago, we were used to inflation rates of 8-10 per cent. In that situation, it was alright to be borrowing at 12-13 per cent. Now we have structurally lower inflation of just four per cent (it has been in that range for four years), it is difficult for SMEs to borrow at 12 per cent. An 800 basis points real borrowing rate is very expensive. It affects not just SME balance sheets, but also causes stress to the financial system. So if we keep real interest rates high for prolonged periods at high levels, we will increase the stress on our SMEs.

Should real interest rates come down?

Economists tend to focus only on the demand side impact of higher interest rates. However, there are important supply-side effects in the longer-term. Excessively high real cost of capital mean that capacities and infrastructure do not get built, the financial system becomes risky and the government becomes more indebted. Therefore, perpetual high real rates eventually lead to high inflation. Once we have structurally anchored inflation at low levels, it is important to bring down real interest rates. This should be done carefully and systematically in order to balance the demand and supply effects.

What is the government’s view on RBI economic capital framework and usage of its reserves?

Every government by virtue of having the right to make money, to do monetary operations, hold foreign exchanges reserves and so on, generates certain revenues – loosely called “seigniorage”. Most governments in the world devolve this to a central bank. Therefore, all these revenues now go to the central bank. The understanding is that after the central bank has paid for its expenses and absorbed some part for capitalization, the rest is returned to the government. There is nothing new about it, it is a routine phenomenon. Even in India, if you look at Section 47 of the RBI Act, this is very clearly stated. The debate is merely about what is the formula for calculating the appropriate level of RBI capitalisation, so that a rule-based system can be devised for the transfers. This cannot be unilaterally decided, and is a legitimate area of discussion between the central bank and the Ministry of Finance. A committee is being constituted to look into it.

Rupee has recovered sharply in recent weeks. What impact do you see on Current Account Deficit?