BackGovernor with veto will undermine monetary policy committee: Raghuram Rajan
On stressed bank assets, the RBI governor said it was tough to say whether bad loans had peaked
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Mumbai: The Reserve Bank of India (RBI) and the government have reached an agreement which incorporates all the “necessary requirements of a good monetary policy committee", governor Raghuram Rajan said in an interaction with financial newspapers after the monetary policy review on Tuesday. Rajan added that giving the RBI governor veto powers over the committee would only undermine the panel.
On stressed bank assets, the RBI governor said it was tough to say whether bad loans had peaked. He said it is “extremely important" to find a solution to the debt build-up at state power distribution companies, or discoms, where the situation has become untenable. Edited excerpts:
You have said that you are not in favour of giving the RBI governor veto power under the monetary policy committee (MPC) framework. Can you explain your view?
The current system is effectively veto. Because you take outside advice but do what you think is appropriate. The difficulty in the current system is that it personalizes the policy too much, which becomes too dependent on one person. For instance, there are many in India today who may say that I am overly conservative and that I should have cut rates long back. Research has shown that committees are less prone to mistakes. Also, committees are less susceptible to pressure, both internal and external. A committee also ensures continuity in monetary policy. This is why we are trying to institutionalize the framework, first with the inflation-targeting framework and next with the monetary policy committee. If you undermine the policy committee by insisting that the governor has a veto, then we are no different from the current system. If you have a veto which is rarely used, that is fine but if it is a veto that is used often, then there is no point.
What is important is that the segue from the current system into the new system be such that it doesn’t create any surprises. I think the committee structure that has been agreed with the government is along those lines.
This issue has become a little overblown in some senses. Couple of ways in which it is overblown—in fact, the government appoints everyone, even the RBI governor. So, in that sense, it has a lot of control already. What is important is that MPC itself coalesces into a body which wants to maintain its reputation for meeting its objective. That will be the ultimate protection. Even at the US Federal Reserve, the government appoints the members, even though they have to be approved by the Senate. But it is the notion that the Fed has a responsibility to meet a certain set of objectives, is what keeps it on the straight and narrow.
As a loose analogy, think of this as the difference between a democracy and a dictatorship. Dictatorships are more volatile while democracies are much less volatile. But in terms of mean growth it’s very hard to find a difference. You can be lucky and get the right dictator or you can be unlucky and get the wrong dictator. But the diversion from the mean is much lesser when you have a democracy. Think of that as the benefit of a committee—you avoid large mistakes.
But does it undermine the governor’s position?
I don’t think so. The governor’s objective is to fulfil the monetary policy mandate and create the basis on which the committee can make a decision. A good governor will convince the committee. Again, what is important, in our context, is a process by which the committee can establish its reputation. That is what we needed; I think we have it.
So you are okay with the suggestions of the new draft Indian Financial Code?
I didn’t say that. I said I am okay with the agreement that we have reached with the government. Yesterday, the finance secretary said we have reached an agreement. I am verifying the fact that we have reached an agreement which has been discussed over time since the budget. There is a good agreement in place between RBI and the government, which represents all the necessary requirements of a good monetary policy committee. I don’t think there is anything for anyone to worry about. This is going in the right direction.
Has there been movement on finding a solution to discom debt? Also, taking these individual stress sectors into account, could bad loans continue to rise?
Our stance has been that we don’t know whether the peak in terms of NPAs (non-performing assets) has been reached yet. I think we will only be able to know in hindsight. As far as discoms go, it’s extremely important to find a solution. We have to make sure that operating losses are cut significantly. I think the department of financial services secretary has said, which we support, that this cannot go on. This is a problem for not just the discoms but also the states and eventually the Centre. Because these kinds of losses ( ₹ 13,000-14,000 crore in each of the big three states) are going to lead to a debt problem. This is certainly true for discoms and eventually the states and then via the discoms for banks. So this has to be dealt with. First thing is to recognize that previous restructuring plans did not work. So we need to move from contingent action to upfront action...But it has to be understood all around that the current situation is untenable.
To what extent will bank recapitalisation help? Is it not a short-term fix?
It’s a chicken-and-egg situation. Clearly what you don’t want to do is pour more capital into a leaking receptacle. So if the money is leaking out as quick as it’s pouring in, there is no point. This is why you should see the recapitalisation in light of the other changes that are being made. From the government side, the appointment of new bank chairmen and managing directors appears to be just around the corner. The revamping of boards with professionals will also lead to better management of the risk processes in the banks. We have also freed up banks to focus on things that matter by clearing up the calendar of reviews. And then the whole set of changes we have made on managing distressed assets. Part of this is asking banks to recognize the problem and do deep restructuring where needed. To do that, you need capital. Some of the banks are not taking the steps, as they don’t have the capital. So recapitalisation was also important to get the NPAs taken care of better.
There is a fear that the real interest rate is too high given the current economic backdrop...
I see the real interest rate today as being about 1.5% and maybe even lower. If you look at the seasonally adjusted momentum of inflation last month, we get a number of 6.6% for inflation last month. If you take the repo rate of 7.25% and subtract that inflation number, you get 0.6%. That is your monetary real interest rate. Even if you take RBI’s 6% inflation target into account, the real risk-free rate works out to 1.25%. People add on to this various risk premia but that is not the real risk-free rate. So we are not responsible for the high rates; the high-risk premium attached to certain borrowers is responsible for the high rates. That is what people keep forgetting.
Ultimately there is a balance between savers and borrowers. For the first time in many years, the real interest rate has become positive and you are seeing financial savings moving up. That is extremely positive. Deposit growth is stronger than credit growth, so banks have more liquidity to spare. Eventually that will result in lower lending rates and more credit to industry.
What, in your view, is holding back the investment cycle?
If you ask any of the industrialists waiting to invest, interest rates would not be the main reason for not investing. If you look at the banks, they are looking to lend to good projects. Besides most of these loans are floating-rate loans. I have no doubt that if we were to cut rates steeply, the markets would rejoice for a few minutes. But then people will start to say, are these guys nuts? Then people will start asking, what about inflation? What about savings? What about the global backdrop? So, like I keep saying, what we are doing is not standing in the way of investment, it is supporting investment. So interest rates are not the primary factor holding back investments. Capacity utilisation is low, rural demand and foreign demand is weak, even though urban demand is strong. So what we have to do is create the conditions for stronger growth. As I said, when we have the room, we will accommodate. But we have already accommodated 75 basis points which will take 3-4 quarters to filter through into the economy. Banks have slowly started cutting rates but money market rates have eased and that is where firms are borrowing. So firms have already seen some cost reduction on interest rates.
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