The Indian rupee has been falling very sharply in recent months. G. Gopalakrishna, executive director of the Reserve Bank of India (RBI), says that the central bank’s principal job is to monitor volatility, not value. Gopalakrishna has been a central banker all his working life; he joined the RBI in 1980. He is currently executive director of the Deposit Insurance & Guarantee Corporation, an RBI affiliate. On a related issue, he says that full convertibility of the rupee is not on the horizon.
An edited transcript of the conversation follows.
India Knowledge at Wharton: Four years ago — in March 2008 — the Indian rupee was 40 to the dollar. Today it is 54 to the dollar and many people expect it to move lower. Why has this happened and what do you expect will happen over the next year?
G. Gopalakrishna: The Reserve Bank has no targeted exchange rate. What we monitor is only the volatility. As we do not have any fixed target, it doesn’t affect our policies.
India Knowledge at Wharton: So do you think that Reserve Bank will intervene to strengthen the rupee in any way? Or is that not part of the RBI’s mandate?
Gopalakrishna: As I said, the RBI does monitor volatility. And whether the RBI has intervened or not, we normally publish our data after a gap of two months. The RBI has intervened in the past. But [the rupee] is not a managed currency; it is a free-flow currency.
India Knowledge at Wharton: From the days of the S.S. Tarapore report, the RBI has been looking at full convertibility of the rupee. Why do you think that has not yet happened?
Gopalakrishna: The Tarapore committee [provided] a roadmap, a very clear roadmap [stating] under what circumstances the rupee could be made convertible. One [criterion] was the fiscal deficit; the second was the NPLs [non-performing loans] in the system. These two have not been achieved. So I don’t think the time is opportune for us to make the rupee a convertible currency. And this is what the RBI governor said recently.
India Knowledge at Wharton: There was a move some time ago to use a part of India’s reserves to set up a sovereign wealth fund.
Gopalakrishna: Very true.
India Knowledge at Wharton: What’s the status of that?
Gopalakrishna: Unlike China or Singapore, most of the currency in our reserves is not out of the current account surplus. It is mainly because of remittances. So we feel that we can’t compare ourselves with China, which has a current account surplus. About three years ago, the government and the RBI decided that at least part of the reserve could be used for financing infrastructure, which is the need of the hour. Accordingly, some US$5 billion was earmarked for infrastructure. This has been given to IIFCL — the Indian Infrastructure Finance Company Ltd — for on-lending.
India Knowledge at Wharton: Since we are speaking of currencies, maybe we could move a little bit away from India for a while. What is your view of the crisis in Europe and especially the euro? Do you think the euro will survive?
Gopalakrishna: As a student of international economics and as a central banker, I feel that what is happening in Europe is going to affect the entire world, including India. We do not have a lot of banks operating in Europe [but] many European banks are operating in India. Liquidity is a big constraint. Many Indians banks also are not able to get the existing lines of credit. So we feel that Europe is going to be a big problem, not only for itself and for others, including the U.S. It has to be fixed.
India Knowledge at Wharton: Do you think the euro will survive as a currency?
Gopalakrishna: The initial feeling was that Greece would [leave the eurozone] and that it would be followed by other countries and that may lead to a break up of Europe and the euro. Now the general feeling is that the U.S. and others will not allow this to happen. So somehow [the Eurozone] is going to be sustained.
India Knowledge at Wharton: Let’s turn now to the Indian economy. What is the RBI’s role in managing the economy? And what are some of the instruments that the Reserve Bank uses to do that?
Gopalakrishna: As a monetary authority, the central bank [decides] the interest rate and [conducts] open market operations. During the past three years, the RBI has been using this very effectively to control the high inflation.
The biggest challenge for the Indian economy, and for the RBI, is commodity prices. Since India imports almost 70% to 80% of its oil, anything happening in this sector will have an impact on India. So we are closely monitoring [the situation]. The second issue is the fiscal deficit and the RBI has been continuously advising the government [on that matter]. The biggest challenge for the Indian economy is the supply side constraint, which is causing a lot of issues. Not that we do not have adequate food, but the pattern has changed. There is more demand for proteins with the implementation of civil welfare measures and more cash available to the common man. The demand for protein food items has increased and that is partly the reason why inflation is still very high in India.
India Knowledge at Wharton: Since you were speaking about inflation, the RBI increased interest rates 13 times between March 2010 and October 2011. And the rate has gone from 4.75% to 8.5% to control inflation. RBI governor D. Subbarao’s inflation target was 4%. Has the RBI now settled for a new normal of 6% to 7%?
Gopalakrishna: We have always advocated that our comfort level is below 5%. But we have to look into both growth and inflation. In the past two years, the RBI has been continuously increasing the interest rate. Now is the time for us to look back.
It is also a fact that growth is a big issue today because the entire economy is slowing down. So we feel that the present decrease [RBI cut rates by 0.5% in April] will have some impact on the economy.
India Knowledge at Wharton: Do you have a sense of why, in spite of all the increases in interest rates, it was not possible to control inflation? And do you think that the increase may have actually hampered growth rather than curbing inflation?
Gopalakrishna: It is a debatable issue. Our analysis shows that in the beginning of our action we did find that inflation was coming down. The non-core [items] — mainly oil prices — are a big challenge for India. [But] we feel that the 7% target is achievable.
India Knowledge at Wharton: There are many people who believe that the Indian government, especially the central government, doesn’t do everything that it should to manage the Indian economy and just leaves it to the RBI. Would you agree with that? And if so, how do you think the economy will come out of this difficult situation?
Gopalakrishna: To manage a country, both the fiscal side and the monetary side have to work together. In recent times there have not been any positive signals from the government side.
India Knowledge at Wharton: What’s holding the government back?
Gopalakrishna: In India, it is the issue of coalition politics. The government of the day has to respond to the various demands of the coalition [partners]. It is likely that some of these issues will be overcome in the days to come.
India Knowledge at Wharton: Banks are looking at new sectors of growth. What do you think is the potential of areas like mobile banking? Can you give a sense of what is happening in the mobile banking space in India?
Gopalakrishna: It’s a quite useful question for a central bank. In India, we have adopted what is known as a bank-led model as [compared to the] mobile companies-led model that has been adopted in some small countries like Kenya and the Philippines. The RBI has also relaxed a lot of restrictions that we had originally placed on per day and per bank transactions. We feel that with the present drive of financial inclusion, mobile payment is going to be a very useful vehicle for spreading banking.
India Knowledge at Wharton: I would like to end with a few questions on deposit insurance. Are all Indian bank deposits insured?
Gopalakrishna: All Indian banks are covered. We do have a small segment of non-banking finance companies — NBFCs, we call them — which are allowed to accept deposits but are not covered. This is also the fact in most other countries.
India Knowledge at Wharton: The insurance cover was raised to Rs. 1 lakh — I believe that’s US$2,000 — on May 1, 1993. Is that enough? And if it’s not, why hasn’t it changed and when might that happen?
Gopalakrishna: It’s a very useful question for the deposit insurer. It is a fact that after 1993, the coverage has not been increased. One reason is the feeling in the country that as most of the banks are in the public sector, there is a subtle guarantee — that all deposits are safe [because] the government is the owner of these banks. But the feeling today is also that the coverage is very small compared to the per capita income of the country. In 1993, the deposit insurance cover was almost eight times the per capita income. Today, it has come down to less than two times. There is a need for enhancing the coverage. There is also demand from bank consumers that deposit insurance be raised. Our proposal for enhancing the coverage is with the government awaiting approval.
India Knowledge at Wharton: How much and when?
Gopalakrishna: There is a demand [to increase it] from Rs. 1 lakh to Rs. 5 lakh [US$2,000 to US$10,000 at Rs. 50 to a dollar]. It could be in between somewhere.
India Knowledge at Wharton: You know, when banks are in trouble, very often the RBI solution is to merge the troubled bank with a healthy bank. So deposit insurance doesn’t really come into play.
Gopalakrishna: Very true.
India Knowledge at Wharton: Do you think that deposit insurance in India only has a role in the failure of very small banks?
Gopalakrishna: I think it is a fact that after 1961, no bank has been allowed to fail in India. Most of the time, the government has merged the weak bank with a stronger bank, a healthier bank. And there is a feeling that there is no need for deposit insurance coverage or enhancement of the coverage in India because there is no bank failure in India. But it’s not true in the case of the smaller banks.
India Knowledge at Wharton: So in India, no bank is too small to fail?
Gopalakrishna: That’s not correct. I think what we are doing may not agree with international practice. Banks should be allowed to fail if they are not strong enough. And we feel that deposit insurance has a major role, particularly for small depositors.