I’m pleasantly surprised by the economy’s ability to react: Raghuram Rajan

RBI governor says news on the Indian economy will only start getting better from now
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First Published: Tue, Oct 08 2013. 11 53 PM IST
RBI governor Raghuram Rajan. Photo: Abhijit Bhatlekar/Mint
RBI governor Raghuram Rajan. Photo: Abhijit Bhatlekar/Mint
Updated: Tue, Oct 08 2013. 11 53 PM IST
Mumbai: The news on the economy will only start getting better from now, Reserve Bank of India (RBI) governor Raghuram Rajan said in an interview on Tuesday, his first to an Indian newspaper since he took charge at the central bank on 4 September. Rajan listed the factors behind his assessment—rising exports in the second quarter, the possibility that the problems in US would be temporary and that lawmakers in that country would arrive at a fiscal deal, stronger agricultural production, and the revival of many projects that were stalled.
Rajan added that the first signs of revival would likely surface in the sector that went down first—large infrastructure projects.
It was in 2010-11 that “the first large projects started stalling”, he said. When these projects are revived, Rajan said, benefits will accrue from the projects themselves, the liquidity that is released into the market, and the spillover effect on suppliers. The first set of stalled projects were revived in January, he said, and the impact is beginning to be seen now.
In Rajan’s scheme of things, the two central pillars of monetary policy are controlling inflation and maintaining financial stability; growth is incidental because control over inflation creates the best environment for growth. Inflation is his primary concern, but the fight against inflation will take into account the state of the economy.
India needs two transformations, Rajan said: “More investment, and less consumption, at least of some kinds; and more savings, financial savings”. Edited excerpts:
Has the economy bottomed out? Is the worst behind us?
I think the news from now on will start getting better. The good news of the second quarter of the year was the rising exports. I worry that if the problem of the US continues or gets worse, that could impact exports a little. But if the US slowdown is temporary, and I think they (members of the US Congress) will eventually do some fiscal deal, then I would think that we have two or three positives in the second half of the fiscal year.
One is stronger agriculture production, which looks very healthy and all the related stuff—fruits, vegetables, poultry, etc.
Second, the projects that had slowed down or stalled are coming on stream. Power should start picking up; we have already seen pretty strong power production in the last core IIP (index of industrial production) numbers.
And third is exports.
These three legs could help lift us. We have already seen auto exports pick up quite strongly. One of the things I am actually quite pleasantly surprised at is the capacity of the economy to react. For example, take the highly indebted corporate sector. You have seen large indebted companies now selling assets. We need more of that. Because it’s not that the system as a whole doesn’t have liquidity. There are companies sitting on tonnes of cash. Could they buy from these guys? Could foreign investors come in? Could the asset reconstruction companies be started up once again to buy more bad loans from the banks? These are things we need to find ways to energize.
So this would be one way to energize the investment cycle and make consolidation happen, rather than greenfield projects?
Exactly. If the liquidity-strapped entities get financial space once again, they can then start bidding for projects; they can start fulfilling some of their past commitments. Those things will happen. One of the interesting things that happened—and this is a casual inference, I don’t have strong data to back it up—is that when these entities are trying to refocus, they are selling foreign assets. Maybe those are the assets which are more liquid and have a strong valuation but they do seem to be keeping some of the internal assets. Again, the simple answer could be that those markets are relatively weak and that you don’t get much for it now and so they are selling stuff that you get more for, but it could also be that they could be seeing more potential in these domestic assets.
So, in a way it also takes care of the problems of non-performing assets (NPAs)? Is there a kind of multiplier effect you are looking at?
There are some NPAs which are unviable. But many of the NPAs are assets that are stalled. They have a viability. It’s just that the loans need to be restructured in a way that gives them the longer term viability. You have to distinguish between the two.
I would guess that the majority of the situation of the latter is that where the projects start off with equity and loans of too short a maturity in the good times. And as the delays crept in and the demand was weak, things got stretched out.
Really, when the economy comes back, there will be both demand for the goods the project is producing but also there will be an incentive to accelerate and complete these projects. And that will, of course, restore some value to the balance sheet that has been eroded because of the NPAs.
When the economy starts stabilizing and recovering, where will the signs be visible? Which sectors do you think will signal revival?
I think the sectors that went down first—if you look at the slowdown, it started with stalling of large projects. The economy was still doing well in 2010-11 and that’s when the projects started stalling and the economy started slowly coming down after that. As these projects revive, we will see the spillover effects—both through the products and through the liquidity that is released.
You have cut the marginal standing facility (MSF) rate once again, for the second time in less than three weeks. And you have left the repo rate untouched. It seems you are happy with the currency market and less worried on the inflation front. But the currency market is still truncated as the oil marketing companies are buying dollar directly from RBI. (The MSF rate is the rate charged on special overnight infusion of funds into banks. It was cut by half a percentage point on Monday.)
I would break this up into two. Remember when we issued the monetary policy statement last time we had said that we would follow a two-paced approach. One pace for liquidity measures, another for monetary policy. We said we intended to return to normal monetary policy where the repo rate was the effective policy rate and effective short-term rate in the market. We are not yet there because the MSF is still the short-term rate. We said that in the interim period, we would be looking at the exceptional liquidity measures with a view to unwinding them as the market stabilizes.
You are right in saying that we feel the market has stabilized somewhat and remained stable even after the monetary policy announcement, which gave us the confidence to do a little more. Are we complacent? Have we seen the end? No. We are still in a position where we are unwinding at the pace of our comfort with the stability of the rupee.
You are absolutely right that we have to reintroduce the oil demand back in the market and stability after that will be a true sign of stability. Nevertheless, the rupee has stabilized enough that we feel confident that we could use the MSF somewhat. Again we will wait and see. We are watchful and we will do what is necessary.
On the repo rate, that’s something that typically gets decided upon on monetary policy dates. We have inflation data and production data coming. And more data will come over time before we will have to decide monetary policy at the end of the month. I don’t think yesterday’s announcement has any implication on the monetary policy.
Is the term repo a pure liquidity-easing measure or a signal that you are creating a term money market? (RBI on Monday introduced a weekly ‘term repo’ window at which banks can borrow funds for tenures of seven and 14 days.)
I think the latter. We are also using this opportunity to develop the market. There has been a lot of discussion out there on the need to have a term money market. In order to create a term money market, the RBI can also play a role by offering risk-free rates over the short term. So, we are trying to develop the market. We will see how it goes.
I am sure we will have to make adjustments over time to get the full short-term curve and we will introduce more changes as and when needed to ensure we develop that curve. But this is as good a time as any to start developing that kind of market.
The 20 September policy review gave the impression that you are an inflation hawk. You hiked the repo rate and said there could be more hikes but you have been saying we are in a neutral zone. What’s the actual policy stance?
What I have said since then and I keep saying is that yes, inflation is a big concern for the Reserve Bank; that we intend to fight inflation. When we fight inflation, however, we keep in mind the state of the economy. Because of the lower level of output relative to potential, we also have disinflationary forces at work. Disinflation is not a one- month or two-month process. The timing of how you disinflate and what kinds of interest rates you need to do that kind of disinflation depends on the state of the economy. If the economy is very weak, those disinflationary impulses will help you in the fight against inflation. So you calibrate the interest rate keeping in mind the state of the economy and the level of inflation.
I continue to say inflation is a primary concern. But the fight against inflation will take into account the state of the economy.
As a stance, are you in the neutral zone?
I think we are looking at the data. If I wanted to raise interest rates and if I thought I could surely raise the interest rates, I could have done a 50 basis points (hike) in the first time around or even more. What I am saying is that we are looking at the data and we will see the net effect and then we will decide what the next step will be.
You are talking about inflation and, on the other hand, we are seeing that the government is willing to give money to banks to do consumer lending. There has been fairly robust credit growth this year. Won’t the government move stoke inflation?
Credit growth looks very strong but you will have to be a little careful. What is happening is that some of the money that corporates were borrowing from the money market have shifted to banks because our liquidity measures have raised the short-term interest rates. Another source of credit growth is the oil marketing companies.
The discussion with the government seems to have been distorted. The discussion is primarily about the government willing to recapitalize banks more than they said they would. That, as a regulator, we think is a good thing. The incidental effects of further recapitalization will be a lower cost of funds for the banks to the extent that they have seen as safer and, therefore, could lead to smaller constraints on bank lending. This doesn’t necessarily mean, in some sense, RBI telling banks to go out and lend.
Our main concern is that given there are bank loan losses, NPAs that have been rising, more recapitalization would be a good thing. Clearly the government has to bring the banks up to the required capital levels, maybe (offer them) a little more cushion, given the need for confidence-building in the market related to the banks. It could give more to certain banks and less to others based on their performance.
If it is only on the basis of need, it would be a moral hazard; if it is based on performance, it will increase the efficiency of the banking sector. That is a government decision. At this point I would say these are all just open discussions.
So there is no linkage between government giving money and consumer lending.
It’s very hard to do that linkage. I don’t know what the government’s plans are on that. But it is very hard to link it to that in an explicit way. Incidentally, it might have the effect of lowering the cost of funds for banks if a better equity cushion reduces their cost of debt and allows them to lend more. Because they get more capital, they can borrow more. There is a leverage effect. Those could all affect credit. But our main concern from a regulatory perspective is recapitalization of the additional capital.
It was a finance ministry press release that said the government wants banks to lend. It’s a sort of ideological question. It feels like a throwback to the directed credit of the 70s; it’s very counter-intuitive to the kind of progress made in the financial sector where banks were given more freedom to lend.
I don’t know the process and there could be some noise in the process. As far as our understanding between us and the government is that it is precisely a process of perhaps infusing more capital into the banks, which, as the economy recovers and as economy picks up will allow for more productive lending.
We are not against all lending. I think at this point there are some sectors which are extremely weak and there are also investments that need to grow. For example, investment lending to MSMEs (micro, small and medium enterprises) could help. Because they are liquidity-constrained right now. You can have valuable growth. Remember, part of our inflationary problem is not just demand, it’s supply. You need the supply side also to emerge stronger, which means more production.
We really need two transformations in this country— more investments and less consumption of certain kinds. There is still fair amount of inflation on certain kinds of household products, of course, vegetables, fruit and things like that. I am not saying that you want to limit consumption of food. But those are the places there is a fair amount of inflation.
Apart from the shift in inflation, you also want more financial savings—away from gold, towards financial assets.
Those two transformations we need to make over the next few years, and to that extent it is a little more complicated than saying I want to suppress aggregate demand. Suppressing aggregate demand would mean you also suppress aggregate supply. You want to channelize towards demand that also increases supply, which means investments. Combating inflation would mean trying to modulate certain kinds of demands.
How worried are you about the health of the banking system and the rampant incidence of loan restructuring?
The absolute level of restructured assets and NPAs together is around 10% and that’s not a comfortable level. But it does not mean that the entire 10% are total loss. A fraction of the restructured assets turn to NPAs and a fraction of these are total write-offs.
Nevertheless, the point is that if you continue rolling over in situations where the projects are unviable, or the project will benefit from fresh blood, or the project needs additional capital which will allow completion...
My worry is twofold. If we sit on these restructured assets without closer monitoring and action, we will see further erosion in value. And that we need to combat. We need to figure out what we need to do… That will put these projects on firm footing where necessary or liquidate where necessary.
Second is a related issue. Public confidence in banks and the perception about the legitimacy of things like recapitalizing banks has a lot to do with whether you think the money has gone in the right direction. If what happens is that we bail out promoters who have siphoned out the money or who have too little equity but retain full equity holding, so that when the project is back on stream, they get all the upside and the downside is borne by banks that did the restructuring.
What’s your message to the banks?
My message is that when we do a restructuring, the pain has to be borne fairly. Those who have equity upside should either put in substantial amount of new equity or share in the upside without making the bank write down more.
You do a restructuring when you wipe out the equity completely. Debt is supposed to take over. Now, in truth, what you also have is a situation where promoters bring something to the table—management skill etc. If they do that and they bring in additional equity, they should continue managing the company.
You are signalling an ideological change in the way you do business in India.
I think this is the message that has been out there for sometime. I am just emphasising (that). The finance minister has said that there is no sick promoters; only sick companies. I think it is the same message. We have situations where groups are sitting on plenty of money but that money is not feeding into projects that are in difficulty. Restructuring is a legitimate activity. You make mistakes. We want the real assets to be working. But in doing that, it is also a fairness issue. And the public will get totally very angry if they see the fairness issue is not being met.
Ideologically, you were opposed to corporate entry into banking. You have 26 applicants for new bank licences. Will every fit and proper candidate be given a licence? Or, even among the fit and proper candidates, there will be a process of elimination?
There are a few aspects to it. One is fit and proper—in the sense from past behaviour. Bank is a position of trust. We have to be very careful that that position of trust is not abused and the best way to determine that is to look at past behaviour and actions.
The second is the business model. You may be the most trustworthy person but do you have the business model that is viable to run this bank?
And the third, once you look at both those aspects, how much do we think we want to bring in of each of these in order to get a wider playing field? One of the things that I want to emphasis early on is that I don’t think this is the last time we are opening up. We have time to open, see how things work, and then go on.
How many licences will be given will really depend upon the comfort of the external committee and our committee. It will be a combination of fit and proper and the business need of the economy.
What kinds of different models of banking are you looking at?
Banks that might focus on different segments; banks using different technologies; there could also be banks that can focus on using different kind of products on the asset side and on the liability side. Not everybody needs to do plain vanilla banking. I think there are possibilities even reflected in the 26 applicants that we have. I would take a view based on these aspects.
Previous governors have looked at multiple variables for use in monetary policy. What is your vision?
Ultimately, there is no question that monetary policy has to focus on doing a couple of things, rather than doing everything. There are two central pillars and one that is coincidental to them. Two central pillars are, to my mind, inflation and financial stability. Both those things are important. Growth is incidental because by controlling inflation you create your best environment for growth.
I think it is a learning that you would have that sustainable growth is generated by the real sector. What you are trying to do is modulate inflation in such a way that is consistent with that goal. Now, what you have to worry about in a country like India is the channels of transmission. And which inflation you are measuring.
The problem is that we have a variety of measures of inflation. Some of which captures something; some of which captures other things. It’s very hard to say this is the one measure we will focus on. Yes, market will want to know which is the measure you are focusing on. And over time, as we get better tools, we will be able to narrow that down. The Urjit Patel committee (set up to review and suggest measures to strengthen monetary policy framework) will try to figure out how to narrow them down.
But, in the meantime, you will have to take the message from different elements. For example, if I focus only on WPI (wholesale price index) inflation, I will miss out services inflation, which is a big part of inflation. In fact, services inflation is the non-traded inflation which is likely to be higher in a country, unlike manufacturing inflation, which is more created and, therefore, remains constrained by international inflationary forces.
So to some extent it is not surprising that core WPI inflation, which is non-food manufacturing, is at 2% because, after all, that is being influenced by global forces. You can’t have an inflation rate, given that you can import easily, that is higher than global inflation on those goods. But services inflation can be quite different.
So we have to, by necessity, look at different inflation measures and understand what they mean for what we are trying to do.
In a complex economy, regulation becomes more nuanced.. The case of National Spot Exchange Ltd is an example… There are grey areas between two regulators.
We have to cooperate among regulators. We have to keep talking and figuring out how to plug in lapses. For example, U.K. Sinha (chairman of Securities and Exchange Board of India) and I have initiated regular discussions. We meet on a frequent basis and talk about issues and what we each have to do. It helps both in market development and also figuring out plugging the hole. India is a large country with complicated set of authorities. For example, in certain cases, the state government is the primary regulator of the fringe companies. There, we have to work with them and tell them how to go after some erring companies. We have to rely on the local police.
So, you are not creating an institutional mechanism like the Financial Stability and Development Council.
Sometimes institutional mechanism works and helps create a dialogue, but it also needs a sense of commitment to go out and do it. Sometimes we need informal coordination. Some of the issues associated with this spot exchange have been flagged for some time. We have to see why it slipped through the cracks and we will learn from that.
When do you plan to pass on the debt management work to the government?
On debt management, my sense is there is no strong theoretical reason either way. Should it be at RBI or should it be at the finance ministry? Right now the expertise lies with RBI. We have been doing it. Let us see how things go on. I don’t think it is a huge issue, the world will not change.
You have reservations about giving up debt management…
I will not say I have reservations; it doesn’t seem to me there’s a strong case either way. Certain people make it out as a huge conflict of interest and, therefore, it should move that way; I am not persuaded by that. At the same time, would I bang on the table and say that it is better at the RBI? No, I would not say that. It is that the expertise currently lies with the RBI and we have been doing it. This is an issue I am not going to spend sleepless nights over.
How has your relationship been with the finance ministry?
On the larger issue of interaction with the finance ministry, I think as with any country, this is a relationship that has to be based on mutual respect and I think it is. People say is the RBI independent? My verification of the point that the RBI is independent is precisely the fact that the finance ministry vents every once in a while about how the RBI is going its own way. That would suggest a degree of independence that we should take comfort from. That they don’t always see eye to eye.
That said, should we air grievances in public or keep them private, that’s a debate one will have. I think that over the years there has been a lot of respect even if there has been disagreement between the RBI and the finance ministry. An example is that (former) governor (Y.V.) Reddy is now the person in charge of the finance commission. If you did not respect what he was doing as governor of RBI, you would not make him the chairman of the finance commission.
What I think is that the objectives are the same—economic growth, low inflation. I think the timing and the actions can differ. It’s not even about timing; it’s about the value or relevance of certain actions. There are difference of opinions among economists, without any biases, let alone two government authorities who have slightly different timing and weights.
As a governor would you prefer to have an inflation mandate? Even informally?
I think we have an informal inflation mandate. That’s in the RBI Act which basically says we will have to worry about the value of the currency. To some extent, going back to your first question, am I confident about the currency? My own sense is that the way to boost the value of the currency is to assure people about inflation in the medium term. Because after all, more the inflation, more the currency will have to depreciate, in order to maintain competitiveness.
I think whether you have an inflation mandate or not, what matters is your ability to carry out your actions to deliver on that mandate. You may have a mandate but you will have a constraint on the action. So, I think ultimately it is about effective independence, rather than theoretical or presumed independence. And effective independence depends on mutual respect. I think that exists.
Anup Roy contributed to this story.
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First Published: Tue, Oct 08 2013. 11 53 PM IST
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