Dr Feelgood takes charge
Raghuram Rajan unveils short-term time table for reforms, says India is a fundamentally sound economy
Mumbai: Raghuram Rajan took charge on Wednesday as the 23rd governor of the Reserve Bank of India (RBI) and immediately got down to business, spelling out plans to reform the country’s banking industry and reshape its financial infrastructure.
Rajan, 50, unveiled what he called a short-term timetable on what he wants to do to ensure more dollar flows into the system, accelerate the process of issuing new banking licences and expanding banking services, and tackle rising bank bad loans at banks.
“These are not easy times, and the economy faces challenges," Rajan, who was chief economic adviser before being moved to the central bank, said. “At the same time, India is a fundamentally sound economy with a bright future. Our task today is to build a bridge to the future over the stormy waves produced by global financial markets. I have every confidence we will succeed in doing that."
He underscored the primary role of the central bank was monetary stability—“that is, to sustain confidence in the value of the country’s money".
Rajan takes over as RBI chief at a time when the Indian economy is in a downturn and the rupee in a prolonged slump. The economy grew 4.4% in the quarter ended June, the slowest pace in four years, and the rupee has depreciated 18.5% against the dollar so far this calendar year, a decline hastened by a flight of funds on concerns that the US is preparing to wind up its economic stimulus programme.
“Rajan is proactive and his maiden speech will instil a lot of confidence in the market," said A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd.
Ajit Ranade, chief economist at the Aditya Birla Group, said Rajan “comes across as a man who wants to get things done. He made it clear that monetary policy will be his top priority which means he will protect the currency".
Rajan, in his maiden speech as RBI chief, announced the setting up of a number of committees that will look into issues ranging from new banking licence to financial inclusion, or providing banking services to the unbanked poor, and revamping the monetary policy framework.
Such reforms could induce risks in the system, but this is better than inducing other risks by not undertaking reform, said Rajan.
At the same time, “we have to be careful not to inject more uncertainty in the ecosystem than we can handle", Rajan said at the central bank’s headquarters in Mumbai.
On the anvil are measures to internationalize the rupee and freeing up financial markets, which will allow the markets to absorb some of the risks which otherwise threaten to destabilize banks. To ensure this, the markets need depth, Rajan said.
“We cannot create depth by banning position-taking, or mandating trading based only on well-defined legitimate needs. Money is fungible so such bans get subverted, but at some level, all investment is an act of faith and of risk-taking," said Rajan, hinting that the central bank could very well be unwinding all that it has done in the recent past to curb speculation in the currency markets.
The restrictions put up by RBI on domestic banks and companies, either by detailed documentation or outright bans on taking positions in the derivatives segment, force companies to punt in offshore markets.
“Better that investors take positions domestically and provide depth and profits to our economy than they take our markets to foreign shores," Rajan said.
“Together with the government and regulators such as Sebi (Securities and Exchange Board of India), we will steadily but surely liberalize our markets, as well as restrictions on investment and position taking," he said, cautioning that the pace will be measured “given the current market turmoil".
To start with, RBI has enhanced exporters’ ability to hedge their exposure through forwards contracts. The exporters were permitted to re-book cancelled forward exchange contracts to the extent of 25% of the value of cancelled contracts. The limit has now been enhanced to 50%. Importers who did not have any such facility to start with, can now dig into 25% of their cancelled contracts.
Banks are also allowed to swap their dollar deposits with the central bank at a special concessional rate of 3.5% for deposits of at least three years.
Also, the current overseas borrowing limit of 50% of the core capital of banks has been raised to 100%. Borrowings mobilized under this provision can be swapped with RBI at the option of the bank at a concessional rate of 1 percentage point below the prevailing swap rate.
The schemes will be open up to 30 November.
To protect the households from the pinch of price rise, RBI will issue inflation-indexed savings certificates, linked to the consumer price-based index, by end-November.
RBI already has inflation-indexed bonds linked to the wholesale price-based index of inflation.
To develop the money markets and the government securities market, RBI will introduce cash settled interest rate futures (IRF) on 10-year bonds. IRF, although allowed as long as a decade back and finetuned in 2009, never took off as traders rued the absence of cash settlement of the contracts.
Eventually, RBI allowed cash settlement on shorter maturity paper, but the segment is languishing as physical papers has to be transferred in such a deal, making trading unattractive.
The central bank will also examine the introduction of interest rate futures on overnight interest rates, Rajan said.
He said the first monetary policy under his term will be delayed and will be announced on 20 September, instead of the originally planned 18 September. This will allow the central bank to respond after the US Fed announces its monetary policy on 18 September.
Rajan refused to elaborate on his future policy stance— whether growth or inflation will be more important to the new governor, before the next policy review.
RBI has appointed a panel under deputy governor Urjit Patel to revise and strengthen the monetary policy framework. The panel will submit its report within three months.
“We need faster, broad- based, inclusive growth leading to a rapid fall in poverty," said Rajan, adding that competition between banks will lead to better customer benefits. Towards more competition and freedom in decision-making, Rajan said RBI will soon allow banks to open as many branches as they want in every part of the country.
If a properly managed bank fulfils certain inclusion criteria in underserved areas in proportion to their expansion in urban areas, banks will no longer “have to approach the RBI for permission to open a branch".
RBI will also consider “on-tap" licensing of banks, and will come up with a detailed road map of reforms and regulations for freeing entry and making the licensing process more frequent. RBI recently released a discussion paper to that effect wherein it asked from suggestions from stakeholders for round-the-year licensing of banks.
A panel headed by former RBI governor Bimal Jalan will scrutinize the applications for new bank licences, the first of which could be issued as early as in January.
RBI will also encourage qualifying foreign banks to move to a wholly owned subsidiary structure, where “they will enjoy near national treatment".
Rajan also said banks should hold less government securities on their books than what is required from a prudential perspective. Banks are mandated to hold 23% of their deposit base in government securities, but in effect they do hold about 30% of their deposits in government bonds in the absence of healthy credit growth.
This, according to former deputy governor Rakesh Mohan, leads to “lazy banking" that Rajan sought to break.
This cannot be done overnight, but should be done gradually as government finances improve. The government runs its finances by borrowing from the bond market in which government-owned banks are the major buyers. More penetration of other financial institutions such as pension funds and insurance companies will help coaxing banks out of lazy banking.
Rajan also indicated a possible relaxation in the present requirement for lending to the so-called priority sector, which comprises agriculture, education and weaker sections of society. Banks are required to give 40% of their loans to the priority sector.
“But that mandate should adjust to the needs of the economy, and should be executed in the most efficient way possible. Let us remember that the goal is greater financial access in all parts of the country, rather than meeting bureaucratic norms," Rajan said.
Gaurav Kapur, senior economist at Royal Bank of Scotland Plc.’s India unit, expects the new governor to shift the focus of monetary policy towards inflation targeting.
“He has energized the financial sector by setting a clear timeline for new bank licences and suggesting licenses should be on tap with some caveats," Kapoor said.
“He also has hinted that inflation, whether coming from demand or supply side, will be targeted. There are also some unconventional measures like allowing swaps on FCNR deposits and allowing banks to swap their capital from abroad with the RBI."
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