Dear Dr Patel,
Being an insider, you don’t need time to settle down into your new role. Also, there probably couldn’t have been a better time to be at the helm of India’s central bank, with inflation coming down (data for August, to be released on Monday, will testify to that), a stable and appreciating currency with healthy foreign fund flows and close to $367 billion in foreign exchange reserves.
Your immediate predecessor Raghuram Rajan took over in the thick of the taper tantrum when the rupee was depreciating every day and inflation was in double digits; D. Subbarao, who Rajan had replaced, witnessed the collapse of iconic US investment bank Lehman Brothers Holding Inc. a few days after he had taken over. To use a cliché, for both of them, it was baptism by fire. In contrast, you have moved to the corner room at a time when both the macroeconomic scenario in India and the external environment are relatively benign. In cricket parlance, it’s a dream pitch to bat on.
Many in the financial sector feel that Rajan had taken quite a few initiatives rather aggressively, and your job will be to take them to their logical end. I will not be surprised if you review a few of them and, of course, there are many challenges.
Retail inflation, which has been rising since April and was 6.07% in July, is expected to be around 5% in August and by January it could come down to below 5% because of the fall in the prices of fruits, vegetables and pulses as well as the so-called base effect. March 2017 inflation could be around 5%, in sync with the Reserve Bank of India’s (RBI) projection.
This means there will be pressure on you to cut the policy rate. Rajan cut the policy rate by 1.5 percentage points since the start of 2015 but could not cut further as inflation started rising. You will have to prove how serious you are about the long-term inflation target of 4%.
You can avoid paring the rate in your October policy as the likely volatility in the currency market on account of the outflow of FCNR (B) redemptions will keep you busy from mid-September till early December when you will present your next policy. If there is no disruption in the market, we will probably see you announcing the first rate cut in December. But one cut will not whet the market’s appetite. If you don’t go for a deeper half a percentage point rate cut in December, there will be expectation of another cut before the fiscal year-end as growth still remains a concern. It will be interesting to watch how you manage market expectations.
Another area of worry is the health of public sector banks and slow transmission of monetary policy. Both are intertwined. Because of the pile of bad assets, the public sector banks, which have little under 70% market share, have not been able to cut their loan rates. Indeed, some of them are buying bonds at a lower rate, but we have a predominantly bank-led financial system. And unless banks pare their loan rates, a large segment of borrowers will not get the benefit of an accommodative monetary policy.
Most banks are unable to cut their loan rates as they need to set aside dollops of money to take care of their bad loans. In fact, because of this, many of them are seeing erosion in their net worth; they need capital. But the government seems to be in denial.
RBI’s insistence on “deep surgery" is fine, but you would need to take a call whether after the surgery you will nurse the banks back to health or keep them alive by offering them a life-support system in the form of release of small doses of capital periodically. I think it’s time to play the end game as far as the public sector banks are concerned. You would need to force the government, the majority owner of these banks, to take decisive action.
Your immediate task, however, is the formation of the monetary policy committee (MPC), which will guide RBI on its rate actions. I doubt whether this will be in place before the October policy. The government is yet to choose three members of the MPC while you would need to choose one more who will also be your deputy. This position is critical as you, being the governor, can only exercise your veto power in case of a tie or a stalemate with three members each in favour and against a rate cut (or increase, as the case may be). Two members of RBI are executive director Michael Patra and you, by virtue of being the governor. The third member is the deputy governor in-charge of monetary policy, a post currently vacant following your elevation. If an insider gets the deputy governor’s job—the last time an RBI executive was chosen for this post was the late S.S. Tarapore, two decades ago—it will be relatively easy for you, but if an outsider, who is not in sync with your approach to monetary policy, comes in, you will face a tough time.
Even otherwise, it is important to get a competent deputy in charge of monetary policy. Bimal Jalan had Y.V. Reddy to do this job; Reddy had Rakesh Mohan; and Rajan had you. Do I need to tell you more?
Finally, a word on your communication policy. Many believe that your reticence and unwillingness to talk have fetched you this job. I don’t necessarily agree with them. You’re probably one of those who believe that only the boss should talk and I respect that. But when you are the boss, the market expects you to talk. When the going is good (like now), the market doesn’t mind a silent central banker but in times of crises you would need to talk—talk the market up.
Wishing you all the very best.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank For The Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.
His Twitter handle is @tamalbandyo
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