We can’t be seen as a paper tiger: RBI’s Raghuram Rajan
RBI governor Raghuram Rajan talks about corporate governance, rising bad assets and his relationship with the govt
Mumbai: The Reserve Bank of India (RBI) wants to reach its target of limiting retail inflation to 6% by 2016, but that doesn’t necessarily mean monetary policy has to be tight all the way, governor Raghuram Rajan says. “We are trying to forecast hitting by 2016 January. If we think that we will reach either earlier and it will stay that way, or we will go below it, then there’s always a scope (of a rate cut). But remember, it could also go the other way," Rajan warns in an exclusive interview, in which he also speaks on corporate governance issues in state-owned banks, rising bad assets and the central bank’s relationship with the government. Edited excerpts:
Is inflation targeting as an objective of RBI acceptable to the government?
We will certainly discuss the central bank’s objectives with the government over the year, as announced in the budget speech. For example, we at RBI can’t decide what level of inflation the public is going to be happy with... The elected representative of the people speaking through the government has to tell us that. But once it is decided, we should be left to achieve that objective. As for the process to achieve these objectives, I am sympathetic to the idea that the governor should not be alone in making these decisions. The governor could be flawed, could have problems, have an incorrect perception about the economy and committees tend to be better at making decisions in some cases. So we should go towards a monetary committee which makes the decisions. We have to make sure that members of that committee don’t have conflicts of interests.
How worried are you about the state of affairs in public sector banks, particularly after the arrest of a bank chairman involved in taking bribe?
It’s hard to tell how much corruption there is, but whatever there is, I think it is too much. We should try and ferret out corruption ourselves, but we are not equipped for it. I am focusing on forensic accounting training. We can punish bad stuff when we see it, as swiftly and as hard as we can. We cannot be seen as a paper tiger. You have seen what we did in the Deccan Chronicle case (RBI penalized 12 banks ₹ 1.5 crore for not following norms in advancing loans to Deccan Chronicle Holdings Ltd).
Punishment is welcome, but how does the regulator purge the state-run banking system?
You are demanding a huge amount of honesty in the system when you put people in charge of ₹ 5-10 trillion of assets, give them absolute command, and tell them they are here for one or two years. If you give them that kind of structure—low salary, absolute command and a limited time period—you are creating a perverse incentive. The people who stay honest in the system are showing that it can be done, but the system has to be such that you recognize the temptation and you don’t require somebody to be above average in terms of honesty in order to stay honest in the system.
So governance in public sector banks is an issue?
Yes, we really have to look at the governance as well as compensation in a very careful manner. We need a bank board which is more proactive. The allegation is, there are a number of board members who get loans from the system. If that’s true, the board is not acting as a watchdog; it’s acting as a facilitator. We need to look at the composition of the board and strengthen the presence of both the informed as well as people who are willing to speak up, and people of integrity. Give the MD (managing director) a longer tenure, separate the MD from the chairman, and keep the non-executive chairman as a second layer of oversight. Even if the government as the majority shareholder makes the decision to appoint the MD, let the board have the power to decide on the renewal, having seen the performance of the MD.
Could privatization of public sector banks be the solution?
I think right now PSU (public sector) banks are functioning with one hand tied behind their back. Let’s unloose that hand and let them compete. But in the meantime, if I had absolute power, I would perhaps let one small public sector bank be privatized and see what happens. Learn from that. Privatization doesn’t necessarily mean selling the government stake to a promoter. It can also be a publicly held company as opposed to a promoter-driven company. Don’t pick your worst performing public sector bank. Pick a good one where management, governance and culture are good. To my mind, however, ownership is relatively a small aspect if you have the right governance.
Is the worst over for bad loans?
I want to see more growth before I can be confident about the bad loan problem. I think it will eventually diminish just because the projects that were lent to will come on stream; some of them will be unviable, but will be taken over, the debt recovered. The losses are not as big as the share of restructured loans by any means and growth will help banks reduce those losses, and also because they are growing their balance sheet the losses will reduce as a fraction of the balance sheet. Many of these loans are with the public sector banks. Where I do worry is, what will be the impact on the taxpayer—we shouldn’t hand the taxpayer a big bill. That’s why we should push towards resolving these bad assets very quickly.
Now that you have spent some time with two consecutive governments, what is your take on RBI’s relationship with the government?
RBI has had cordial relationships with both the governments and sometimes there’s a view in the press that there should be differences. Indeed, there are issues where we are not on the same page, and we try to persuade. Eventually, because decisions have to be made, one side goes along with the other.
There are, of course, occasional differences between how the government views something and how RBI views something and those differences in horizon as well as some differences in background will prompt discussions. The classic example is the central bank’s views on growth, inflation and interest rates.
In an environment where people believe that growth is very, very important and inflation is very, very important, but if they are not fully convinced that interest rates are bringing down inflation, they may emphasize the adverse aspects of inflation to growth and say let’s get growth up. And the central bank responds that inflation is still very high and if you relax now and let growth go up, you will have to fight even harder to bring inflation down later on and so let the interest rates do their job.
At such times, the central banker’s job is that of persuasion. You have to persuade against a whole bunch of other people who are trying to persuade the government of the opposite. Every industrialist who wants interest rates to go down. From the public’s perspective, who do you believe—the industrialists who clamour for low rates as it’s hurting industry or the central banker who says that this is good in the long run?
This is where credibility matters; you have to show that you understand the markets and having a track record helps. This is why people like (former US Federal Reserve chairman Alan) Greenspan, who had a long track record of making a difference, had a lot of credibility with the public and policymakers because they have seen the markets and the industry for a long time.
But you were the harshest critic of Greenspan and his loose monetary policy. What are your concerns at this point?
The politics are broken in many countries partly because of the deep troubles created by the financial crisis and partly because of longer-term phenomena. The aging of industrial country populations has brought the pension problems and the problem in funding healthcare much closer. The governments have limited room, and the change in technology as well as globalization have put the jobs of many people in the middle class and lower middle class at peril.
So, you have the stagnant income, entitlements under threat, and politicians are paralyzed. This is certainly the situation in the US, but I think similar things are playing out in Europe too, in the background of huge government debt built up during the crisis. With the governments not able to act in a positive and decisive way, what you have is tremendous pressure on central banks to provide whatever oomph is needed in the economy.
The US is keeping interest rates pretty low and housing was picking up quite strongly till recently, but perhaps it shouldn’t be picking up because the previous problem was inflated housing and it collapsed. Is housing the answer to everything? Are you in danger of boosting a sector which should not be pushed up yet again? My worry is, through the low interest rates and aggressive monetary moves, industrial country central banks are prompting asset price bubbles, or activity in areas which are not warranted and are not letting the economy go to the right place. Part of the reason is political paralysis, but by over-compensating, central banks may be skewing things even more....
Another worry is that rather than creating domestic activity, the central banks end up trying to depreciate their exchange rate with their accommodative policies. But you cannot all depreciate against everybody and when everybody is doing the same thing, the world gets into a low-level interest rate equilibrium where asset prices and stock markets are being boosted, but real activity is not picking up. And, of course, exit is difficult because central banks fear raising rates before others because they will see their exchange rate appreciate strongly.
With US interest rates set to go up, do you see money flowing out of emerging markets including India?
Well, there will be some outflow, but I hope we are now much better protected than we were last summer. I am hopeful we don’t have a severe reaction to that, but I do worry about the global equilibrium that we are lapsing into.
So you won’t touch the policy rate till retail inflation drops to 6% by January 2016?
Let me be careful about what you just said. The objective is to reach 6% by 2016, but that doesn’t necessarily mean monetary policy has to be tight all the way. We are trying to forecast hitting by 2016 January. If we think that we will reach either earlier and it will stay that way, or we will go below it, then there’s always a scope (of a rate cut). But remember, it could also go the other way.
Tamal Bandyopadhyay, consulting editor of Mint, is adviser to Bandhan Financial Services Pvt. Ltd, India’s newest bank in the making. He is also the author of Sahara: The Untold Story and A Bank for the Buck.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!