Business Today
My remit is about safety, stability and growth of this economy: Raghuram Rajan
In an exclusive interview with Business Today, RBI Governor Raghuram Rajan talks about monetary policy, Indian economy, inflation and more.
RBI Governor Raghuram Rajan

RBI Governor Raghuram Rajan

Raghuram Rajan completed an action-packed 17 months in office as RBI Governor in February. He had inherited a fast-depreciating rupee and stubbornly-high inflation, but made sure to keep his cool and focus on his job. The 52-year-old celebrated economist made a structural shift in the country's banking system by introducing a differentiated licensing regime of payment banks and small banks. On the monetary policy front, Rajan made a fundamental shift by proclaiming the consumer price index (CPI) as the nominal anchor, instead of the wholesale price index (WPI).

"If I look at the goals I had laid out, we have made a fair amount of progress. But it is not mission accomplished," Rajan told BUSINESS TODAY in an exclusive interview.

He was agile and direct with his answers, responding to all questions, including those on the Prime Minister's "Make in India" and "Jan-Dhan" schemes. Excerpts:

Q. Given the current state of global economies, we are placed comfortably. How should India guard against possible risks?

A. (We need) good policies. That's the reason why I keep harping on things like low inflation and low fiscal deficit. We cannot look like an outlier on some of these measures compared to other emerging markets. Else, we will face the turmoil again. Fortunately, we have made a lot of progress on CAD (current account deficit) and fiscal deficit. Similarly, we have made progress on inflation. We are at a fair distance from where we were in July 2013. But, it would be good to have growth back. I think the CSO (Central Statistics Office) report suggests that we are almost there. The February GDP numbers will tell us whether that pertains to this year also, or 2013/14 was a special outlier.

Q. Is import cover the right benchmark to assess adequacy of a country's foreign exchange reserves?

A. It depends on the policies and what one does during difficult times. For example, Russia had significant forex reserves before the turmoil in Ukraine. But, following the sanctions imposed on them, falling oil prices and because the economy was not particularly well diversified, there was a view that the $400-500 billion of forex reserves they had were not sufficient. (Adding to their woes), the currency has plummeted. If you rely only on forex reserves, it is never going to be sufficient. You must treat it as a second line of defence, with policies being the first.

Q. Of late, the RBI has often warned corporate India on the absence of forex hedging. How is the RBI ensuring these companies fall in line?

A. We operate through banks. We have told banks that if they cannot make the companies fall in line, they have to provision some more. The problem, of course, is if somebody insists on trying to treat foreign loan cheap and takes it unhedged, they are essentially playing with fire. We are trying to tell them "watch out". Don't expect us to come to your rescue if there is turmoil.

Q. We have seen a structural shift with the differentiated licensing regime. Will there be more licences in the differentiated category compared to universal banking licences?

{mosimage}'We are
looking at the priority sector regime to make it more relevant'

A. It is easier to give licences to a small bank than to a megabank. I have to be much more careful about a mega bank because, if it explodes, there are large problems. If a small bank explodes there are smaller problems. This could be thought of as a proving ground for bankers. So, in that sense, you may be right that there is more room for giving licences (to smaller banks). I am not saying we are going to relax standards. But our worry over the performance can be somewhat more relaxed in case of small banks because we are less exposed to systemic risk compared to universal banks. However, we are committed to opening up the licence window for universal banks as well.

Q. We saw two niche licences in the universal banking space. Is there a change in approach?

A. There is an advantage in having different banks, but I don't think this was a deliberate part of the licensing process.

Q. How many licences can we expect under the differentiated category?

A. As in the past, we have set up two external committees without any RBI representative. They will opine on who should be given licences. We respect the opinions of the committees we set up. We don't have a preconceived notion of how many licences (we will issue) for each category. It, however, should not be a number that would overwhelm us and the system.

Q. What would be the time frame for assessing their performance?

A. I think, at least, till the teething phase is over. Once the banks are set up and run for a year or so, we will know what the issues are and what we need to do better the next time. That will enable us to reframe our rules if need be. We give around 18 months for banks to set up, plus a year more, for them to run. So, we have two and a half years before we are ready to open the window.

Q. You are also working on a new priority sector regime for banks. What has been the progress on that front?

A. We are in the process of looking at the priority sector regime to make it more relevant to today's economy. This is for all banks. The priority sector basically has two components: What is important for the economy and how to get more inclusion in the economy, and who are the people who are excluded from credit. Given these two objectives, we are looking at the priority sector process to ensure that if any sector is left out, whether they should be brought back. For example, we would have to find out whether we have enough finances to fund public infrastructure in smaller towns, the Swachh Bharat (initiative) and to build toilets. Those are the kinds of thing we have to look out for.

We will not have a separate private sector regime for foreign banks. I was misquoted earlier in the press. Once foreign banks understand the new priority obligations they will have to meet, they would be in a better position to decide on their own (whether to convert into a wholly-owned subsidiary or not).

Q. Given the deteriorating asset quality, Basel-III and capital challenges of banks, how concerned are you on the financial stability front?

{mosimage}'Must minimise
loss to government by shrinking the size of bad loans'

A. I am obviously concerned with the rise in NPAs because it is a real loss to the economy. We need to bring down the level of NPAs and put the assets that are behind these NPAs back to work. If it is a stalled power project, can we get it restarted? Can it produce for the investment that is locked up? This is something we are working on. My general framework has been to make it easy for them to do the kind of restructuring and reshaping needed to make the financial structure viable. But they should not postpone the recognition of losses. Don't pretend. Let's convert the interest due into future repayments and just push the loan out even though I know the real asset does not have any hope of getting the feedstock inputs over its lifetime. It is a non-performing asset today, and it will remain an NPA tomorrow, but because I don't want to confront reality, I should not hide the loan.

Q. The RBI is not very keen to extend the restructuring deadline beyond March 2016. Isn't there a threat to financial stability given that many PSU banks have high restructured books?

A. Financial stability is not threatened because the losses ultimately belong to the government. The government has already underwritten the losses because they are public sector banks. The private sector banks' NPAs are significantly lower. So, I don't think we face a situation like in the West. The issue is, however, to minimise the loss to the government by shrinking the size of bad loans.

Q. You are not in favour of a weak bank merging with a strong bank. The idea of an individually held company for each bank is also not finding favour with PSU banks. Is a single holding company for PSU banks the solution?

A. If there is only one bank, there is no need for a holding company. The single holding company comes in if there are multiple businesses, such as insurance, mutual funds, etc. If an insurance or NBFC affiliate goes bad, it does not pull down the bank. We need to go to the holding company structure from the financial stability perspective. Financial holding is something that the Shymala Gopinath committee had suggested and, according to it, the Basel effort is going to be necessary. But, there is a separate issue. How does the government hold its stake in PSUs? There is talk about having a financial holding company where the government will own 50 per cent, and the financial holding company will own the government's 50 per cent in the bank holding company. That is possible. That would allow the government to disinvest some of its stake. The government will own only 25 per cent in the bank. But a view has to be taken on that.

Q. You made a fundamental shift to CPI as the nominal anchor for targeting inflation with a two-year glide path. What is the progress with the government on a new monetary policy framework?

A. Unfortunately, I cannot say more than that we are in discussion. There has been an exchange of views and it is continuing. As long as the structure is not finalised, we are not prepared to go public with it.

Q. Since it was part of the last Budget announcement, is there a possibility of signing the new framework before February 28?

A. I do not know the precise time. But, the intent is to get the right framework however much time it might take. The important element or objective of the framework is that the medium-term goal for inflation would be 4 (plus-minus 2) per cent. We have to specify after January 2016 how long it will take to get towards that level. If in January 2016, we are at 6 per cent, we are already within that band. But the question is should we go closer to the middle of the band.

Q. What are the challenges in inflation targeting, given the supply-side issues, high food component in CPI and the fiscal deficit?

'We are looking
at the inflationary consequences... not sitting in judgement over the government'

A. These challenges exist in every country. First, we are not going towards pure inflation targeting. We are going to a situation where we have a primary inflation objective, but there would be other objectives also. When I took office, I was told that focusing on inflation is somewhat impossible in India. It is still being told to me despite the fact that inflation is down. I am not saying that we are fully responsible for it. Of course, fiscal consolidation has helped tremendously. The notion that India cannot consolidate fiscally is another thing that is being put out. People talk about fiscal dominance as if it's a permanent state of affair. Things can change. We should not keep echoing supply-side issues and fiscal dominance as if to say that we should allow any level of inflation. Of course, the Indian public likes low inflation and that's what we have been trying to do.

Q. In the monetary policy document, you have used the word "sustained high quality fiscal consolidation". Can you elaborate on it?

A. I can give you an example. If we do better targeting of subsidies. If we target them towards the needy, reduce the leakage and move the savings to public investments. That's a high quality movement because on one hand it is about shrinking wasteful expenditures and, on the other, increasing the expenditure on creating long-term supply by, say, investing in highways, in the railways, etc. That should, over time, bring down the cost structure also. If the RBI is looking at the fiscal policy it is not to pronounce what the government should do. We are not sitting in judgement over the government. We are looking at it primarily from the inflationary consequences. When fiscal consolidation is of high quality, inflationary consequences are good.

Q. Following the savings in fuel subsidy, divestment and the telecom auction, the government is likely to meet the fiscal deficit target of 4.1 per cent for the current year despite weak tax collection. Does that signal a weak trend?

A. The finance minister has reiterated a number of times that he intends to stick to 4.1 per cent. I don't see any reason to question that intention. Of course, accidents can happen. There is always uncertainty. My sense, and our belief, is that fiscal deficit will be met.

Q. Does a higher than 3.6 per cent fiscal deficit target for next year (2015-16) worry you?

A. We are not fixated on particular numbers or particular actions. The government is going to decide what the appropriate package would be. It will put forward the package keeping in mind the effects of growth, inflation, etc. At this point, we will look at what the package is and whether we should get worried about inflationary consequences, or get reassured about fiscal consequences. So, I am not going to say that if 'A' does not happen we will be worried.

Q. You had recently talked about India requiring more institutions to ensure deficits stay within control. Will you elaborate on it?

A. This is more a thought, or sort of public rumination, on the number of countries having independent bodies that look at the Budget. They do not formulate the Budget, but once it is formulated, they express their views on what the consequences would be and how they add up. For example, if a new pension is postulated, the Budget will basically say here is the cost of pension for the year. But what will be the cost, over time, if it has to cover the target population? And, as the population grows, and the real value of the pension grows, as typically is the case, what will then be the cost of the entitlement. In the US, for example, the Congressional Budget Office pushes forward the schemes and see how the short fall can be made up. Similarly, in Germany, there are budgetary bodies that look at the Budget and say whether it is of high quality or low quality. Are the numbers believable? Are the projections reasonable, given growth, inflation, etc. They come up with reports and analysis and place it before the Parliament. This may be useful.

Q. Is there an agreement on the formation of the monetary policy committee?

{mosimage}'The kind of goals
I had laid out, we have made fair amount of progress'

A. Discussions are on with the government. We have to ensure members of the monetary policy panel have no conflict of interest. They should not hold jobs that make them want interest rates to move in a particular direction. They should be independent thinkers in that sense. The notion that there has to be a dominance of either the RBI representatives or outsiders, (is misplaced). Most people from the RBI are appointed by the government. I am a government appointee. My deputy governor in charge of monetary policy is a government appointee. So, in that sense, we all are appointed by the government. I don't think that should be an area where one should be particularly concerned.

Q. Is there a challenge in transferring rate cut benefits to borrowers as almost two-thirds of the banking system is under stress?

A. Transmission takes place through competition. Right? It is funny when people say that banks don't want to cut interest rates because credit offtake is low. It's precisely when credit offtake is low that they should be cutting interest rates to energise credit offtake. However, I think competition will push banks to transmit. If banks are not transmitting, I don't understand this constant clamour for cutting key policy rates. Banks will eventually do it. We need to see some transmission.

Q. Your entry to the RBI was described as 'out of the frying pan into the fire'. How satisfying has been the journey?

A. That's for others to comment on. If I look at the kind of goals that I had laid out, we have made fair amount of progress. I'll not declare mission accomplished at this point. I would say we have made progress and that is important.

Q. You have stabilised the rupee and inflation is also under control. Does that give you more bandwidth to focus on other issues?

A. There are so many issues we need to work on that it reminds me of this rotating gadget which moves, stops and fixes, then again moves, stops and fixes. I tend to think a little bit like that. We cannot take our minds off currency and inflationary issues because issues such as these keep cropping up.

Q. You are quite frank in airing your views. Don't you fear of being misunderstood when you express your views on, say, Make in India and Jan-Dhan schemes, bank mergers, etc?

A. I hope I speak clearly. Thats why I make fewer speeches. I write them down so that theres no possibility of a misunderstanding. Even then, I find there is a lot of difference between what has been reported in the media and what was written in the speech. I have a platform as RBI Governor to initiate certain debates, which, I think, are important. There are economic debates because the economy impinges on the central banker again and again. I think it is important to have these debates. My remit is beyond monetary policy. It is about the safety and stability, and the growth of the Indian economy. Therefore, I speak out on some of those issues. But I'm fairly careful in not creating controversy for the sake of creating a controversy. When I say something, it is intended to describe a situation, or a possible situation, which could hurt us economically. That is the intent of my speeches. So, it should be seen in that light. There is no point beating around the bush. I am talking about technical matters. There can be different opinions about it.

Q. What has been your experience of working with the present government compared to the previous regime?

A. The present government is very engaged, focused and has the intent to put the economy on fast track. It is evident at every level.

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