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Business News/ Politics / Policy/  Don’t want to keep fighting inflation every two years: RBI’s Raghuram Rajan
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Don’t want to keep fighting inflation every two years: RBI’s Raghuram Rajan

RBI governor says central bank in talks with markets regulator Sebi to ensure access to funds is cut off to wilful defaulters

Raghuram Rajan said RBI and Sebi are trying to ensure that wilful defaulters are prevented from accessing all kinds of funds and not just bank funding. Photo: Abhijit Bhatlekar/MintPremium
Raghuram Rajan said RBI and Sebi are trying to ensure that wilful defaulters are prevented from accessing all kinds of funds and not just bank funding. Photo: Abhijit Bhatlekar/Mint

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan said on Wednesday that the central bank is in talks with the capital market regulator to ensure that access to funds is cut off to wilful defaulters—borrowers who don’t pay back loans although they have the capacity to do so. “If somebody has damaged the system, the fear should be that they will be cut off from accessing new funds from the public—whether through markets or banks," Rajan said in a conversation with business publications one day after he unveiled the latest monetary policy. On Tuesday, RBI kept its benchmark policy rate unchanged at 8% and said that risk to its medium-term consumer price inflation target of 6% by January 2016 remains on the upside. “As and when the interest rate cycle turns, it’s better that it turns decisively in one direction," Rajan said. Edited excerpts:

How long will you be able to sustain your inflation fight?

Inflation is a disease that we have to get rid of if we want sustainable growth. Moderate inflation is fine but the high levels of inflation that we have, of close to 10% and sometimes above, is detrimental to growth in many ways.

The problem in the last few fights around inflation is that every time we look like we are succeeding, the clamour for rate cuts rises. It is true that we don’t want higher rates for longer than we need to have but we don’t want to keep fighting inflation every two years, which is what we have been doing over the last few years. Our point is that let us reliably bring down inflation.

Are we being too tight relative to the growth situation? I don’t think so. My sense is that you are starting to see the industrial growth situation starting to pick up. I would very much doubt that it is the cost of capital which is the primary factor keeping the investment at bay. Lower cost of capital will obviously help. But even if we cut the policy rates, it’s not clear that banks will cut deposit rates until inflation comes down. So to say that the policy rate is the problem is not correct.

Is there a disconnect between the policy statement and what you have articulated in terms of the longer-term trajectory on rates?

At the back of our mind, while crafting yesterday’s policy statement, was also the view that there were some in the market who would had misinterpreted our June statement to suggest that there was a bias towards being more accommodative. I think that was misinterpreting the statement. We were basically pointing to the fact that there was substantial uncertainty on both sides. Around 8% (consumer price inflation rate), those uncertainties have become more balanced in the sense that there was a heightened risk to the upside then—now the risks are more balanced. So there is some improvement in the short term. Also because time has passed, we are closer now to the medium-term goal of 6% and we also need to pay attention to that. That does require additional disinflation over and above the 8%—we are saying we need to start thinking about how to meet that too. These are not two separate goals. First we meet the 8% goal, then we party for a few months and then we think about the 6%. It’s part of the process. Central banks can’t be schizophrenic and volatile in their interest rate movements. As and when the interest rate cycle turns, it’s better that it turns decisively in one direction.

What are the legislative changes that RBI is working on with the Securities and Exchange Board of India (Sebi) to tackle wilful defaulters?

We are trying to ensure that wilful defaulters are prevented from accessing all kinds of funds and not just bank funding. If somebody has damaged the system, the fear should be that they will be cut off from accessing new funds from the public—whether through markets or banks. We are looking at some legislative changes on the powers of creditors over recovery. For example, what more names should be notified under the Sarfaesi (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act. We are also looking to see if we can allow asset reconstruction companies (ARCs) to intervene earlier and perhaps get powers similar to banks. We are looking at our own definition of non-cooperative defaulter and trying to see how we can make it operational. Non-cooperative defaulters may not be in violation of the laws but we have this genre of promoters who hold up collections at every court using every instrument. That’s perfectly legal but from the perspective of the financial system it’s a problem because it can take years to collect. So we are saying that you are not a criminal but you are a financial risk. From that perspective, can we increase the cost of any new loans made to that person? Hopefully that makes the person think twice. So there is a financial stability angle there.

ARCs are asking for powers to change managements permanently. Is RBI open to that? And are ARCs themselves capitalized enough and in a position to recover or restructure these assets effectively? Are we just transferring the bad loan problem?

We want ARCs to move more towards resolution rather than recovery. One part of that may be changing management permanently. We will examine that and take it up to the government if some changes are possible. On the issue of assets being parked with ARCs, we have increased the amount of skin in the game needed from ARCs so that it becomes costly for ARCs to participate in parking (of assets). The upfront investment needed by ARCs has been increased. So you make it more difficult for simple parking to take place. There was some of that happening but now you have made it tougher. In terms of bringing new capital, we are open to new players entering the business, taking over existing ARCs and recapitalizing ARCs. With all this, the ARCs will become more effective and new players will enter. Some foreign PE (private equity) firms are very interested and we are open to that.

The Syndicate Bank scandal (in which chairman and managing director S.K. Jain was arrested for demanding a bribe to extend credit to a borrower) has thrown up the issue of middle men. What is RBI’s perspective on that? Also, in terms of governance reforms for public sector banks, how acceptable will some of those proposals be?

What we have seen in the last few years is a deterioration in the health of the public sector banking system and a rise in the non-performing assets. Now some of this is because of bad luck. They went into infrastructure in a big way just before the economy turned. But some of it was also because of poor evaluation. One of the problems that public sector banks are facing is a gap in the middle management because of hiring freezes. As a result, the talent pool is more limited. On top of that is a situation where you have decision making power over enormous resources even while pay is somewhat limited. A lot of people in the public sector are very trustworthy and deal with that as a public trust, but some don’t. What we have to do is see that the public sector governance standards are on par with the best. This means a number of things such as strengthening the boards and improving board power. Similarly for management, we have been recommending that the post of chairman and managing director be separated. You also need managing directors for longer terms over which they can develop the bank. A three-to-five year term makes more sense. For the renewal of a term, the board must be involved. And finally, if you have to bring more private sector talent in, the differentials in salary have to narrow.

As far as middle men are concerned, there are some good middle men and some not so good middle men. A good middle man acts as a broker. But if the point of a middle man is to pay bribes, that is obviously not ok. It’s part of the whole set of governance issues that we need to look at.

Do you have any idea now how much corporate foreign exchange borrowing is unhedged?

The banks themselves don’t fully know that the clients they have lent to are hedged fully or not. We have put the norms (in place), we have told them etc. etc. and they come back to us telling us, well how do we monitor exactly how much they have done? We said you have to do the best job you can, because ultimately there’s a risk if they are unhedged. We have to continue to improve our data on this, and understand the extend of hedging. Any number you put out also has to take into account a few things like the number of these entities who have borrowed in dollars (who) have natural hedges. Second, if you borrow longer term, as opposed to short term, typically there’s a certain amount of natural cycle that plays out. And if your borrowings are spread over time rather than focused on a block repayment, then that also acts as a little bit of hedge. If you look at the rupee, any depreciation is driven not by something strange, but by inflation differential and productivity differential over time. Put those together and it explains where the rupee is.

The reason you hear often for people borrowing in foreign currency—I want to borrow foreign currency because it’s cheaper—that’s a nonsense reason. Because whatever gain you make in paying a lower dollar interest rate, you will lose in the relative movement of the currencies—at least that’s been the story so far.

Is RBI worried about the systemic risk posed by some of the large borrowers?

We have to look at systemic exposures. Individual bank exposures to particular clients, but also systemic exposure to clients. And we certainly are discussing what we have to do on that. But examining systemic exposures to clients has to be a part. This is something that a number of multilateral agencies have also spoken to us about. This is something that we are very concerned about and we will look at finding ways to gently reduce the systemic exposures to certain entities.

Are you expecting volatility as quantitative easing in the West winds down and interest rates go up?

There will be volatility. Every time the US sneezes, emerging markets round the world catch cold. Your hope is that you don’t catch pneumonia. I think what we have done in the last year-and-a-half in stabilizing the macro-economy should help us sustain that initial bout of volatility. Remember that in the taper tantrum that started in May last year, the initial bout was non-discriminatory, stronger emerging markets sometimes experienced more selling. Because there you could get out without so much of a liquidity impact, but over time, investors reassessed what’s a good market and what’s not a good market and went back. Relative to a number of countries, the perception of India is somewhat stronger.

Is there now a comfort on the kind of portfolio investors investing in Indian debt ? Also is the question of increasing the FII (foreign institutional investor) limit in debt now off the table?

When we looked at the data of what happened in June, July and August last year, we saw that a lot of the movement out was at the short end of the curve. And so over time as the money has started coming back, we have been trying to nudge it to the long end of the curve. I feel relatively comfortable when it’s three-year money than when it’s one-month money...As and when the need to increase limits arises, we will take a view. I foresee a steady expansion in limits over time, but that expansion in space for FIIs has to be driven by both our sense of comfort with the pace of expansion as well as nature of the investor coming in and so on. We certainly don’t want to get into the situation where the bulk of the bond market is being driven by foreign institutional investors rather than domestic investors. So we also want to expand demand from domestic investors. As banks over time will play less of a role in the bond market, we have to increase the demand from domestic institutions and possibly also retail investors for the government securities. We haven’t frozen those limits, as and when those limits get filled up, we will re-examine how much and when we will expand them. The general movement will be towards expanding the nominal limit; what fraction of the bond market we feel comfortable to be occupied by foreign investors we will make a judgement as we go along.

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Published: 07 Aug 2014, 12:01 AM IST
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