 "Raghuram Rajan, RBI")
Rajan stabilised the rupee, reined in inflation, attacked banks’ stressed assets, reconstituted the monetary policy framework and allowed payments banks and small finance banks
Raghuram Rajan came with definite plans that could be executed in his three-year term as the governor of the Reserve Bank of India (RBI). By his admission, he managed to deliver 95% of them and the rest require skilful handling to be seen through.
The verdict on Rajan’s tenure is unambiguous: it has been a great success.
But there are critics, not to mention some that went overboard in attacking his personality rather than his work, but most of the criticisms are the ‘what if’ kind. What if the global conditions were not so favourable for inflation to come down? What if the global markets did not remain so indifferent after the US Federal Reserve actually did raise interest rates? What if the Brexit aftermath were nastier?
These critics put Rajan’s good luck before his foresight, failing to answer this critical question: what if one of the world’s foremost economists had actually envisaged such outcomes and positioned India’s financial system accordingly?
For neutral observers though, his regime was one that built the Reserve Bank of India’s credibility at a time when all other central banks were fighting to preserve theirs. Rajan was not named the ‘best central banker’ by so many institutions of repute for nothing.
Rajan’s three year term was action packed both for the central bank and the commercial banks, and one may argue that his influence reached beyond the scope of his work. India’s crony capitalists, who took the banking system for a ride for years, felt a cold wave passing through their spines as the meek bankers started drawing blood. Rajan’s deep surgery to clean up banks’ balance sheets forced them to show a non-compromising attitude towards defaulters, drawing them to courts, sell assets of errant promoters, and even take over companies.
The bad debts in banks’ books jumped to about Rs 6 lakh crore by March 2016 from Rs 2.28 lakh crore they reported in December quarter of 2013, the first full quarter under Rajan. Banks continue to report high bad debt and Indian Overseas Bank recently declared that its gross bad debt ratio crossed 20% of its loan portfolio.
Analysts say that most of the pile-up in bad debt pertains to loans given during 2004-2010. Most of these loans had already turned sour by 2011-12 but banks decided to hide them under the carpet, often by using the same tools given to them to arrive at a resolution of bad debts.
Bankers may be struggling to give a proper reason for this huge pile up of bad debt, but in private they all acknowledge that the debt clean up should have started much earlier.
“This is the sad reality of Indian banks. Asset quality review should have been conducted back in 2011 so that we could have arrested the rot before spreading,” said the managing director and CEO of one of the largest bank of the country in a conversation with Business Standard.
In fact, State Bank of India chairman Arundhati Bhattacharya acknowledged Rajan’s contribution in building credibility of the central bank. “Dr Rajan is a person of very high calibre, who has built ably on the reputation of our central bank and given it a very large measure of credibility,” Bhattacharya said in a statement on June 18, soon after Rajan wrote to RBI staff about his decision to leave.
“It’s a pity to lose him,” said a surprised Deepak Parekh, chairman of Housing Development Finance Corporation (HDFC).
Rajan’s constant battles in the central bank were also guided by the same philosophy. “The battle we are really fighting today is for credibility. Credibility that at the first sign of trouble, we don’t abandon our policy regime, that we stick to it. Once we gain the credibility, even if the economy is hit by shocks, you won’t have a significant movement in flows in and out or a significant change in inflation,” he told reporters at an interaction. The war on credibility is yet to be won, but surely the outgoing governor managed to break the resistance.
On the first day of assuming office on September 4, Rajan said he would form a committee under deputy governor and monetarist Urjit Patel to review the monetary policy framework. The committee brought out its recommendations in January 2014 that took central bank credibility to a new level. Now the monetary policy will be decided by six members and not just the governor. By bringing an element of transparency in the process, the chances of government interference gets minimised to a large extent.
On top of that, the recent acceptance of 4% inflation target, with 2% band either ways, will keep the committee on its toes as not meeting the target would involve them to give in writing why they failed. This takes the credibility of the policy to a different level.
But inflation crossing 6% last month, and the target to bring it down to 5% by March, is something that is going to be an acid test for the monetary policy committee and Rajan’s absence would be sorely felt.
Rajan’s own name was credible enough for the market to arrest a rupee slide. The rupee touched its all-time low of 68.87 a dollar on August 28, 2013, but after Rajan took charge and announced his agenda for his term, the markets took note. So much so that the central bank started taking off one after another restrictive measures in the currency market and the exchange rate did not even stir.
“I think to some extent personalities matter. In times of crisis, personality takes precedence,” D Subbarao, Rajan’s predecessor at the central bank, told Business Standard in a recent interview. In fact, to make measures like mobilising dollar deposits from the market, Subbarao decided to capitalise on Raghuram Rajan’s name.
RBI mobilised about $34 billion of deposits under foreign currency non resident bank deposits and tier-1 bonds for banks and the rupee entered into a narrow band, only depreciating in a predictable manner every year. But Rajan did not let companies take advantage of that and forego hedging. He was quite straightforward that the central bank was not there to bail out companies in financial distress. The hedge ratio improved even as the rupee remained stable.
The impact of the redemption could be $20-26 billion between September and November this year, according to RBI. The central bank has provided for it by buying in the forwards market and at the same time, Rajan built up a record foreign exchange reserve for the country — $365.5 billion as on July 29.
But where Rajan failed repeatedly was to make banks pass on interest rate cuts. And analysts do not blame banks for that. Even when the liquidity deficit hit a record Rs 2 lakh crore, Rajan insisted on pumping short-term liquidity, hoping banks will make do with it. He steadfastly refused to reason with banks that longer term liquidity would be needed for banks to tide over a deficit. Banks predictably did not entertain Rajan with stronger rate cuts.
Rajan quickly realised his mistake and introduced the new liquidity framework, under which banking system will never be left dry of liquidity. RBI also said it would continue to inject durable liquidity through secondary bond market purchases and tweaked how lending rates are calculated in the system. Banks obliged with rate cuts, but are still short of passing the full 150 basis points cut that RBI executed between January 2015 and now.
Effective monetary transmission is something that Rajan’s successor would take from him, but for the rest, the landing has already been softened and credibility of the RBI is firmly established.
RBI under Raghuram Rajan (2013–2016)
* Sept 2013: On his first day as the 23rd governor of RBI, Rajan announces steps to stabilise rupee and reconstitute the monetary policy framework
* Jan 2014: Releases framework for revitalising distressed assets in economy
* Feb 2014: Introduces joint lenders’ forum, special mention account, and corrective action plan (CAP) for resolution of stressed assets
* Apr 2014: Extends full banking licence to Bandhan and IDFC
* July 2014: Launches 5/25 scheme allowing banks to reset and roll over project loans after every five years and match the repayment schedule with the cash flow of the company
* July 2014: Issues draft guidelines on payments banks and small finance banks
* Feb 2015: Releases names of applicants of small finance banks and payments banks
* Feb 2015: Agreement with government on monetary policy framework, targeting inflation at 4% +/- 2%
* Apr 2015: Ends forbearance in April 2015, starts asset quality review
* June 2015: Introduces strategic debt restructuring (SDR) scheme, which allows banks to convert a defaulting company’s debt into equity and take majority control. Banks empowered to change lenders’ management
* Aug 2015: In-principle approval to 11 entities for payments bank licence
* Sept 2015: In-principle licences to 10 entities for small finance banks
* Dec 2015: RBI tells banks to clean their balance sheets by FY 17
* June 2016: Announces scheme for sustainable structuring of stressed assets
* June 2016: Says will not seek an extension as RBI governor
