 "If you flaunt while owing a lot, it suggests you don't care: Raghuram Rajan")
Reserve Bank of India Governor Raghuram Rajan feels the markets are volatile because they don’t really know the true level of their fundamentals; they are trying to find a level. In Davos for the World Economic Forum, Rajan also tells Shekhar Gupta on NDTV’s Walk the Talk show that some big bank defaulters, in fact, increase the cost of borrowing for everybody. Edited excerpts:
This morning here in Davos is cold, and so is the market mood...
The markets have been very volatile this time. What we really have is a world economy where central banks pump up market prices quite a bit. I don’t think markets really know the true level of their fundamentals; they are trying to find a level. Every time there is news that can possibly cause economic worries, there are jitters and volatilities. Today it is China and whether it will depreciate (its currency); and whether the oil funds will withdraw money from the market. Tomorrow it will be something else. Until we have more stability, partly with monetary policies becoming more normal, we may keep seeing this volatility.
No, we pumped ourselves to the top. The hope among policymakers is that since we have pumped the stock markets up, now we have to elevate the economic activity to match that level. But that’s a big hope; economic activity hasn’t kept pace and, of course, there are concerns over China slowing right now and Brazil in deep recession. These are the issues the market is worried about.
I listened to one of your lectures where you made a point that an individual can today borrow at a rate 300 basis point lower than corporations...
There are two components to interest rates — one is the risk-free rate that we set, and another is the risk premium that banks demand. If somebody is borrowing at 13 or 14 per cent, with the policy rate at 6.75 per cent, the bank is charging six-and-a-half percentage points of risk premium. That happens when a bank distrusts you. In good times, you take the upside, you take equity. But in bad times, you ask how much the bank will cut; what haircut it will take.
Haircut, which is now called ‘mundan’...
‘Mundan’, exactly! You say to the bank, “Look, I know I have to pay you. I even know you have pledges against my assets, but try me in court and I’ll see you 10 years later. Rather, why don’t you take a one-time settlement?
I know of suicides in the mining industry. Mining shut down, so small-town contractors who had borrowed couldn’t repay now and were exposed to shame.
This is the problem with debt. In order for you to get low interest rates, the lender has to be able to repossess effectively. So, the answer is not softening the debt contract but making it work effectively for the big guy. For the small guy, we need to find ways of dealing with the problems in a way that businesses don’t shut down. Perhaps we can work out with the entrepreneur who has some prospect, without killing the business. Broadly, we have to fix our own house to make sure large entrepreneurs repay on time when they get into trouble. We are working on that.
Are you going to do more on this?
The government has come up with the bankruptcy code, which I think will make a big difference. In many countries, it is the threat of taking the borrower to bankruptcy which leads him to deal with the bank outside.
You used to say during the 2008 crisis.... the phrase ‘too big to fail’... We have borrowers who are too big to repossess...
Well, yes, we’re trying to change that — this is not about the big business, successful businessmen, businesswomen, businesspeople. This is not a Robin Hood issue but of wrongdoers who raise the cost of borrowing for everybody.
And frankly, they seem to be suffering no pain...
If you flaunt your yacht, massive birthday bashes, etc, even while owing the system a lot of money... it seems to suggest that you don’t care. I think that is the wrong message to send out. If you are in trouble, you should show that you care by cutting down your expenses.
In fact, it is interesting that you say this; even the theme at Davos this year is so much about equity, and fairer wages...
Absolutely, I think we have to celebrate entrepreneurship. We have to encourage more of the kinds of businesses we are seeing emerging in India. I think ‘Startup India’ is a great programme, but we also need to make sure established businesses do what they need to. Many of them are, but if the guys who are not behaving behave, with them, and all the young entrepreneurs coming on stream, we have a world-class system.
So, if you fix this, it is the key to reducing interest rates, right?
Yes. The risk-free rate will come down as inflation comes down; that is our endeavour. People keep writing to me “Why did you cut the interest rate? I tell them they are actually better off today than earlier. Earlier, they used to get a nine per cent interest rate when inflation was 11 per cent. So their principal was actually reducing by 11 per cent every year; they didn’t notice. Today, they get seven per cent interest rate but inflation is 5.5 per cent. So, their principal is not eroding; they’re actually getting the interest rate over and above the inflation rate.
We know your diagnosis for the world and India. What’s your treatment?
The treatment for the world is that central banks say, “We’ve done enough. Let’s now let things normalise.” As central banks do more, they put pressure on other central banks to follow suit. You’ve seen the Chinese sending out the message they are depreciating the renminbi. I think part of the reason is, they see the euro and yen depreciating against the dollar, and they think why not us? I have been making the statement that we are not in the business of depreciating the rupee. But we do feel the pain when the euro or the yen depreciates against us, because that hurts our exports. We need a more predictable world where exchange rates are not the method.
Do you think this fixation in India with the value of the rupee is overdone?
We keep looking at the rupee’s worth against the dollar; that’s wrong because the dollar is the strongest currency in the world, and it has been appreciating. When we look at the rupee, people keep talking about an all-time low against the dollar. But if you look at the rupee in real effective terms — adjusting for inflation relative to the rest of the world — in the past couple of years, we’re absolutely flat.
Do you think the central banks globally should be as disciplined as you and willing to say no as you do?
Countries have to do more structural reforms. From India’s perspective, I think we are broadly on the right path. We can’t have the kind of massive reforms we did in the 1990s. But what we can do are a lot of small reforms that build into large ones. For example, in the financial sector we have two new banks; 21 new ones are coming up next year.
I featured the Bandhan Bank founder on this show. I went to his village in Tripura. What a brilliant story that is...
Absolutely. He’s a dedicated man. He says we have to charge the right price. He says he can’t make it work below the 23-24 per cent he used to charge. But now, since he is allowed to take deposits, he can bring it down into the teens and keep working to bring it lower. He’s about giving people loans, easy access at the right price. I think we need to do this across the board; bring more people into the system.
How do you fix India’s banks? They are under stress, particularly the government ones.
We are in the process of cleaning up. We spent time giving them powers to take action. Now they have the flexibility in dealing with loans. We’re telling them to put the assets back on track. But for that they might have to put new managements. They might have to write down debt a little bit to give an entity space to grow. It means you recognise it as non-performing asset. Don’t put bandages. We’ve done enough of that. We’ve had this process of extending and pretending. If you take the real pain now, it will create enormous gain down the line. When the balance sheets are clean, you can fund growth.
Nouriel Roubini says India is in a sweet spot. The idea is that India is a big net-importer of commodities. The prices have fallen. How do we make the best use of it?
I think we’re making appropriate use. People say oil prices have fallen so much, hasn’t this helped in inflation? Remember that the government has also taken some excise which is reasonable because you don’t want people to over-consume in the short run. You need to be careful. Passing on some but not all is appropriate.
If I ask you the tricky question, where would Dr Rajan be next year?
Hopefully not in this cold.
If India wants you to stay on, will you stay on?
I will answer that later, but we are in a good position; we need to keep working on it.
This morning here in Davos is cold, and so is the market mood...
The markets have been very volatile this time. What we really have is a world economy where central banks pump up market prices quite a bit. I don’t think markets really know the true level of their fundamentals; they are trying to find a level. Every time there is news that can possibly cause economic worries, there are jitters and volatilities. Today it is China and whether it will depreciate (its currency); and whether the oil funds will withdraw money from the market. Tomorrow it will be something else. Until we have more stability, partly with monetary policies becoming more normal, we may keep seeing this volatility.
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Is it because we don’t know how we got to the top that we are afraid to be there?
No, we pumped ourselves to the top. The hope among policymakers is that since we have pumped the stock markets up, now we have to elevate the economic activity to match that level. But that’s a big hope; economic activity hasn’t kept pace and, of course, there are concerns over China slowing right now and Brazil in deep recession. These are the issues the market is worried about.
I listened to one of your lectures where you made a point that an individual can today borrow at a rate 300 basis point lower than corporations...
There are two components to interest rates — one is the risk-free rate that we set, and another is the risk premium that banks demand. If somebody is borrowing at 13 or 14 per cent, with the policy rate at 6.75 per cent, the bank is charging six-and-a-half percentage points of risk premium. That happens when a bank distrusts you. In good times, you take the upside, you take equity. But in bad times, you ask how much the bank will cut; what haircut it will take.
Haircut, which is now called ‘mundan’...
‘Mundan’, exactly! You say to the bank, “Look, I know I have to pay you. I even know you have pledges against my assets, but try me in court and I’ll see you 10 years later. Rather, why don’t you take a one-time settlement?
I know of suicides in the mining industry. Mining shut down, so small-town contractors who had borrowed couldn’t repay now and were exposed to shame.
This is the problem with debt. In order for you to get low interest rates, the lender has to be able to repossess effectively. So, the answer is not softening the debt contract but making it work effectively for the big guy. For the small guy, we need to find ways of dealing with the problems in a way that businesses don’t shut down. Perhaps we can work out with the entrepreneur who has some prospect, without killing the business. Broadly, we have to fix our own house to make sure large entrepreneurs repay on time when they get into trouble. We are working on that.
Are you going to do more on this?
The government has come up with the bankruptcy code, which I think will make a big difference. In many countries, it is the threat of taking the borrower to bankruptcy which leads him to deal with the bank outside.
You used to say during the 2008 crisis.... the phrase ‘too big to fail’... We have borrowers who are too big to repossess...
Well, yes, we’re trying to change that — this is not about the big business, successful businessmen, businesswomen, businesspeople. This is not a Robin Hood issue but of wrongdoers who raise the cost of borrowing for everybody.
And frankly, they seem to be suffering no pain...
If you flaunt your yacht, massive birthday bashes, etc, even while owing the system a lot of money... it seems to suggest that you don’t care. I think that is the wrong message to send out. If you are in trouble, you should show that you care by cutting down your expenses.
In fact, it is interesting that you say this; even the theme at Davos this year is so much about equity, and fairer wages...
Absolutely, I think we have to celebrate entrepreneurship. We have to encourage more of the kinds of businesses we are seeing emerging in India. I think ‘Startup India’ is a great programme, but we also need to make sure established businesses do what they need to. Many of them are, but if the guys who are not behaving behave, with them, and all the young entrepreneurs coming on stream, we have a world-class system.
So, if you fix this, it is the key to reducing interest rates, right?
Yes. The risk-free rate will come down as inflation comes down; that is our endeavour. People keep writing to me “Why did you cut the interest rate? I tell them they are actually better off today than earlier. Earlier, they used to get a nine per cent interest rate when inflation was 11 per cent. So their principal was actually reducing by 11 per cent every year; they didn’t notice. Today, they get seven per cent interest rate but inflation is 5.5 per cent. So, their principal is not eroding; they’re actually getting the interest rate over and above the inflation rate.
We know your diagnosis for the world and India. What’s your treatment?
The treatment for the world is that central banks say, “We’ve done enough. Let’s now let things normalise.” As central banks do more, they put pressure on other central banks to follow suit. You’ve seen the Chinese sending out the message they are depreciating the renminbi. I think part of the reason is, they see the euro and yen depreciating against the dollar, and they think why not us? I have been making the statement that we are not in the business of depreciating the rupee. But we do feel the pain when the euro or the yen depreciates against us, because that hurts our exports. We need a more predictable world where exchange rates are not the method.
Do you think this fixation in India with the value of the rupee is overdone?
We keep looking at the rupee’s worth against the dollar; that’s wrong because the dollar is the strongest currency in the world, and it has been appreciating. When we look at the rupee, people keep talking about an all-time low against the dollar. But if you look at the rupee in real effective terms — adjusting for inflation relative to the rest of the world — in the past couple of years, we’re absolutely flat.
Do you think the central banks globally should be as disciplined as you and willing to say no as you do?
Countries have to do more structural reforms. From India’s perspective, I think we are broadly on the right path. We can’t have the kind of massive reforms we did in the 1990s. But what we can do are a lot of small reforms that build into large ones. For example, in the financial sector we have two new banks; 21 new ones are coming up next year.
I featured the Bandhan Bank founder on this show. I went to his village in Tripura. What a brilliant story that is...
Absolutely. He’s a dedicated man. He says we have to charge the right price. He says he can’t make it work below the 23-24 per cent he used to charge. But now, since he is allowed to take deposits, he can bring it down into the teens and keep working to bring it lower. He’s about giving people loans, easy access at the right price. I think we need to do this across the board; bring more people into the system.
How do you fix India’s banks? They are under stress, particularly the government ones.
We are in the process of cleaning up. We spent time giving them powers to take action. Now they have the flexibility in dealing with loans. We’re telling them to put the assets back on track. But for that they might have to put new managements. They might have to write down debt a little bit to give an entity space to grow. It means you recognise it as non-performing asset. Don’t put bandages. We’ve done enough of that. We’ve had this process of extending and pretending. If you take the real pain now, it will create enormous gain down the line. When the balance sheets are clean, you can fund growth.
Nouriel Roubini says India is in a sweet spot. The idea is that India is a big net-importer of commodities. The prices have fallen. How do we make the best use of it?
I think we’re making appropriate use. People say oil prices have fallen so much, hasn’t this helped in inflation? Remember that the government has also taken some excise which is reasonable because you don’t want people to over-consume in the short run. You need to be careful. Passing on some but not all is appropriate.
If I ask you the tricky question, where would Dr Rajan be next year?
Hopefully not in this cold.
If India wants you to stay on, will you stay on?
I will answer that later, but we are in a good position; we need to keep working on it.