An open letter to the RBI Governor: On growth, inflation, rupee challenges

Dear Mr Malhotra,

 

Congratulations. Welcome to the helm of the central bank of the world’s fifth-largest economy.

 

You didn’t throw your hat in the ring. Your predecessor at the Reserve Bank of India, Shaktikanta Das, would probably have felt the same way Bimal Jalan had felt about the choice of YV Reddy as his successor – a signal of continuity and change. Continuity, since Reddy had been a deputy governor; and change, because, as a governor, he would do new things.

 

In this case, continuity, since one revenue secretary has replaced another. And change, since you will explore new ideas.

 

Of course, Das was a former revenue secretary when he moved to the RBI; your passage from the Raisina Hill to Mint Road is direct. But there is no surprise here. In September 2008, D Subbarao parachuted into the RBI headquarters from New Delhi. Like Subbarao, you too, are an Indian Administrative Service topper. Besides, both of you have studied at the Indian Institute of Technology Kanpur, and gone to US universities (you, to Princeton University and Subbarao, to Massachusetts Institute of Technology).

 

The similarities end here. The task ahead of you is very different from Subbarao’s. Subbarao took over the mantle at the RBI a little over a week before the collapse of US investment bank, Lehman Brothers Holdings, which led to the transatlantic financial crisis.

 

Your challenge is different. You have come at a time when the growth-inflation dynamics is changing and the rupee is under pressure.

 

Looking back, in the post-liberalisation era, different governors have had different tasks cut out for them. Das had a very tough assignment. An economy dreaming of soaring to $5 trillion sank into a technical recession as the Covid-19 pandemic hit the world. Das ratcheted the interest rate down to a historic low, flooded the system with money, and tried to tackle the unprecedented crisis with measures that were at times unconventional.

 

Of the rest, S Venkitaramanan, Jalan, Raghuram Rajan and Subbarao faced equally testing times. Jalan moved into the RBI at the height of the East Asian crisis, when the rupee was sinking every day. Rajan faced the taper tantrum, or the spike in treasury yields, after the US Federal Reserve started applying brakes on its quantitative easing programme, a falling rupee, widening current account deficit, and rising inflation.

 

The 1991 liberalisation of the economy happened in the middle of Venkitaramanan’s tenure, while Rangarajan shepherded it in the early days. Urjit Patel’s term, a quarter of a century later, was a baptism by fire as India demonetised high-denomination currency notes in November 2016.

 

Among all, Reddy's was probably the best time. Till the last leg, India had high growth and low inflation. Through his tenure, Reddy kept on raising the policy rate, but that didn't dent the credit offtake and economic growth – something that foxes economists.

 

Many say it was Jalan's legacy. They also saw irrational exuberance at that time. But Reddy continuously tightened the regulatory norms, which were already stringent by global standards. He put in place an array of safety valves to rein in an overheated economy, which came in handy when Subbarao tackled the impact of the 2008 crisis.

 

I am sure that you, like your predecessors, will come up trumps.

 

I would not dare to advise you. This open letter from a central bank watcher is just to flag certain issues and offer some unsolicited suggestions.

 

The Indian GDP grew at 5.4 per cent in the quarter ended September 2024, significantly below the consensus forecast of 6.5 per cent. This is the lowest print in seven quarters, and much lower than the 6.7 per cent growth in the previous quarter. Following this, the RBI, at the December meeting of its Monetary Policy Committee, pared the real GDP growth projection to 6.6 per cent, sharply down from 7.2 per cent.

 

It also upped its Consumer Price Index (CPI)-based inflation estimate for the year from 4.5 per cent to 4.8 per cent. This was done as the CPI inflation jumped to a 14-month high of 6.21 per cent year-on-year in October, from 5.49 per cent in September. The November inflation print, however, eased to 5.48 per cent, in sync with consensus expectations, and was back within the tolerance band of the flexible inflation-targeting central bank (4 per cent plus/minus 2 percentage points).

 

If the growth is falling, a central bank should cut the policy rate to spur consumer demand. And, when inflation is rising, it should raise the rate to temper the demand. That’s what the textbook says. But it’s not that simple. The key is the timing and calibration. And, of course, communication.

 

In October, the RBI changed its stance from “withdrawal of accommodation” to “neutral”. It followed that up in December by cutting the banks’ cash reserve ratio. Should it go for a rate cut in February even if inflation continues to remain high, and tilted towards the upper band of the target? It can, but only if it is convinced that inflation is set to reduce and growth is faltering. Here lies the importance of communication.

 

The movement of the currency is another area of concern. The value of the rupee is falling against the dollar. In order to contain volatility of the foreign exchange market, the RBI has been selling dollars. India’s foreign exchange reserves, which had risen to $704.9 billion on September 27, have dropped to $654.9 billion by December 6. How much volatility should the RBI allow?

 

At times, it feels as though the RBI is like Abhimanyu – it has entered the foreign exchange market, the Chakravyuha, but doesn’t know how to exit. Should the RBI allow the currency to weaken instead of using reserves aggressively to iron out volatility. You may ponder over this. At its peak in September, the pile of forex exchange reserves could cover 12.2 months of imports. Now, it can probably cover imports of close to 11 months.

 

Going beyond the growth-inflation dynamics and the rupee-dollar exchange rate, there are a few issues on the regulatory turf that you may need to give a close look to. One is the implementation of ECL, or expected credit losses regulations. Bankers aren’t too excited about this since they would need to set money aside for expected credit losses, which will hit their profitability. But this is required to lend more resilience to their balance sheets.

 

Also in the eye of the storm are the RBI’s draft guidelines for project financing. These propose to strengthen the existing regulatory framework – by jacking up provisions by at least 12 times during a project’s construction phase – and harmonise the norms across the lending community.

 

You may also like to look into the RBI’s reservations about credit growth in certain segments. For instance, in a growing economy, the demand for personal loans will grow. Should it be in tandem with the overall credit growth? Or, will you allow this segment to be an outlier, keeping in mind the context? All I am saying is that while caution on the growth of such loans is warranted, should the regulator be more flexible in its approach?

 

Finally, in private, many are now discussing the central bank’s autonomy – a favourite pastime whenever a finance ministry bureaucrat is sent to run the RBI, particularly when their passage is straight from the North Block to Mint Road. But history shows that no governor allows autonomy to be compromised. Some governors were perceived to be a Trojan horse who would work on behalf of the government, but it never worked that way. That tradition will continue, for sure.

 

While growth-inflation dynamics have changed and the currency is under pressure, the macroeconomic stability is rock solid, and the banking sector is in the pink of health. I am sure you will enjoy your tryst with the RBI.

 

Wishing you a wonderful stint.

 

Yours sincerely   

The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, please log on to www.bankerstrust.in 

 

X: @TamalBandyo