There is no dearth of talent to replace him as head of the Reserve Bank. But the question analysts are asking is how much freedom his successor will have.
New Delhi: In some ways, discussions surrounding Raghuram Rajan’s tenure as Reserve Bank of India governor are a product of our time. Never has there been a RBI governor whose ‘sex appeal’ was a topic for discussion, whose reappointment controversy was addressed as an Amul cartoon, and whose public image may have even veered towards becoming that of a ‘people’s’ governor.
But putting that aside, what did Rajan set out to do when he was appointed in 2013 and what does he leave behind? The Wire breaks it down, examining the RBI governor’s stated and unstated achievements, the legitimate criticisms that he faced along the way, and what work remains to be done.
Three key decisions and achievements
In his farewell letter to RBI staffers, the central banker lists three key objectives that he set when he first assumed office: bringing down inflation through a new monetary framework, bolstering foreign exchange reserves and the transparent licensing of new universal and niche banks.
Inflation (Wholesale to Consumer Targeting)
Shortly before Rajan was appointed, the US Federal Reserve had hinted at the prospect of a tighter monetary policy, resulting in an outflow of money from emerging markets such as India. Not only was the rupee falling, causing inflation to rise, but Indians were also importing more gold as a result of rising inflation, putting even greater pressure on the exchange rate.
As Rajan puts it, India was deemed in the eyes of the global investor community as one of the “Fragile Five”. For the RBI governor, the way of achieving monetary stability was through “low and stable expectations of inflation”. The primary way he achieved this was by hiking interest rates, setting a medium inflation-term target, and changing the metric by which inflation should be viewed by the central bank. A committee that he set up early in his tenure recommended that the RBI move away from using the wholesale price index as an indicator of inflation (which was the norm) and instead adopt the consumer price index (CPI) as a metric through which the central bank should tackle inflation.
Unlike the wholesale price index, the CPI measures in the changes in prices of goods and services used by households; a more wholesome indicator. Over the course of Rajan’s inflation-targeting tenure, the CPI dropped from 9.52% in August, 2013 to 5.24% in April, 2016 – helped in no small measure also by a welcome drop in global commodity prices during the same period.
Foreign Exchange Reserves and Rupee
In September 2013, when Rajan assumed charge, he had two related issues. One, the rupee had weakened sharply against the dollar, hitting almost Rs. 69 to the dollar. Secondly, India’s currency reserves had hit a three-year low.
What the central banker essentially did at the time was offer discounted currency swaps to banks in order to spur inflows: specifically, a scheme was announced for FCNR (B) deposits raised by commercial banks that incentivised them to sell those deposits aggressively. These banks ended up raising a total of $34 billion in the three month swap window opened by the RBI in 2013, which helped shore up reserves as well helped protect the-then vulnerable rupee.
While the redemption of most of these deposits will happen in September, which has sparked some amount of concern, Rajan believes that the RBI has enough firepower to manage the deposit outflows.
In his three year tenure, foreign exchange reserves have risen from $249 billion in September 2013 to $359.76 billion as of April 1, 2016.
During Rajan’s tenure, two new banks (Bandhan Bank and IDFC Bank) became licensed. The more important issue, as the RBI governor notes in his departing letter, is not that new licenses were handed out (the process for which had actually started under his predecessor D. Subbaro’s tenure), but that the groundwork for an “on-tap bank licensing” mechanism was laid and licensing of “differentiated banking entities” was also allowed.
On-tap bank licensing, which excludes large conglomerates from applying, is important as India has always had a more ad-hoc, “start-and-stop” means of licensing new banks; as evidenced by the fact that while Rajan handed out 23 new licenses in his tenure, only 12 licenses had been issued in the previous 20 years.
The concept of differentiated banks, while not new, is equally important. While Rajan has referenced “wholesale” and “custodian” banks, the most popular form of differentiated bank for which licenses were handed out were payment banks which potentially could increase financial inclusion. Eleven licenses have been handed out so far, and while a few entities have returned their licenses, at least five of them will launch operations by mid-2017.
What he left unstated: Rich men, poor companies
Curiously enough, Rajan doesn’t highlight in his farewell letter what was perhaps the issue he came out very strongly on during interviews and public discussions: how large, corporate defaulters have been causing damage to the system without paying a price for it.
In interviews shortly after taking charge, he’s stated that “promoters do not have a divine right to stay in charge regardless of how badly they mismanaged their companies” and as many have noted, he strongly believes that there is need to bridge the trust deficit between India’s public sector banks and India Inc.
Over the last six months, the RBI conducted a first-of-its-kind asset quality review (AQR) that forced banks to classify poorly performing and visibly stressed assets as NPAs (non-performing assets). This exercise resulted in a GNPA (gross NPAs) jump of nearly Rs. 2,00,000 crore in just one quarter. At the end of the December 2015, quarter, total GNPAs stood at Rs. 4,00,000 crore and at the end of the AQR, total GNPAs stood just shy of Rs. 6,00,000 crore.
A key part of this AQR was the creation of a new class of “non-cooperative borrowers” besides the existing “wilful defaulters” which has gone a long way in stemming the rise of bad loans and plugging the loopholes exploited by corporates in the loan recovery process.
Much of the clean-up work, which also doesn’t fall solely on the RBI’s shoulders, still remains. Last week the RBI announced provisions that would allow public sector banks to convert at least half of these bad loans into “long-dated equity instruments”; these new “strategic debt restructuring rules” also allow banks to turn over the management of a company should the lenders need to.
Criticisms, and where he fell short
Rajan’s early focus and battle with inflation earned him nicknames ranging from ‘inflation warrior’ to inflation hawk. There are a number of points to consider here when viewing the criticisms against Rajan’s stance on inflation and interest rates. The most important one is that Rajan’s stance is not new; if anything, as a number of analysts have pointed out, he has more aggressively expanded on his predecessor’s attempt at using interest rates to curb inflation.
The arguments in favour of Rajan having erred, when it comes to interest rates and inflation, are three-fold.
First, the central idea that the high inflation in the Indian economy was due to excess domestic demand is flawed. As a handful of commentators have pointed out, this inflation can be more attributed to global excess demand and thus raising interest rates was flawed. If this is true, Rajan’s restrictive monetary policy has been completely off the mark.
Second, even if Rajan’s initial stance of keeping inflation as the RBI’s number one goal was correct, he may have been too late in recognising when this goal was achieved and therefore late in eventually cutting interest rates. In September 2015, Rajan and chief economic adviser Arvind Subramanian (who were both colleagues once at the IMF) issued apparently contradictory public statements. Rajan at the time was still hesitant to cut interest rates even though retail inflation had fallen to 3.8%. Subramanian, on the other, worried that “in terms of the prices measured by national income accounts, we are closer to deflation territory.”
The problem of different perspectives here – whether India was undergoing disinflation or deflation – stemmed from the RBI’s decision to look at retail inflation (CPI) while deciding its monetary policy. So while the the wholesale price index sat at negative 4% at that point of time, CPI was still at 3.8%.
The last argument for Rajan having tripped up was that even after he started his rate cut cycle, he didn’t do enough to help the money markets that were gasping for liquidity; a crucial side-effect of this was that a free transmission of rate cuts did not happen. It was only in his last year, and more specifically in the last five months, that the RBI governor set out to make more cash available in the banking system. Some measures included assuring sufficient liquidity as well as reductions in the daily cash reserve ratio maintenance.
Out of these three arguments, there is greater evidence and support for the last two. In some ways it’s a pity that criticism levied against Rajan comes from parties that had a vested interest in his policies: politicians, India Inc lobby groups, debt-laden promoters and wilful defaulters.
Moving aside from economic and monetary policy issues, one perhaps unfair criticism levied against Rajan is that many of his speeches addressed issues that have traditionally been outside the remit or jurisdiction of what a central bank governor is supposed to speak on publicly. In late 2015, for instance, the RBI governor gave a speech at IIT Delhi on how tolerance and “the tradition of debate and openness” had helped India form a foundation for its current and future success; this was a more than apparent reference to the intolerance debate in the mainstream media at the time.
On other occasions, Rajan also criticised some of the government’s flagship economic programmes such as Make-in-India by stating that an “incentive-driven, export-led growth or import substitution strategy” would not work and that ‘Make-for-India” seemed like a more viable course of action.
More recently, the RBI governor’s “one-eyed man” comment on how India shouldn’t be satisfied with its position in the current, depressed global economic order, seemed directly aimed at the self-congratulatory statements of Modi’s ministers.
India’s bureaucrats and institutional leaders have had a tradition of sticking firmly within their occupational ambits and if one adopts this perspective, Rajan may seem an outlier. But to put this forward as a valid form of criticism, and even suggest that this is why Rajan should have not been granted an extension, is to shun openness, self-criticism and a willingness to look within.
In his farewell letter, Rajan express a tinge of disappointment that he will not be able to see through two important developments: the formation of a monetary policy committee that may eventually reduce the role of the RBI governor, and the asset quality review of public-sector banks.
Apart from these two issues, however, what has received less media attention was Rajan’s aim of overhauling the RBI’s administrative structure, including hiring talented external employees as well as improving the quality of institutional research. Multiple reports have detailed how some of his efforts have met with resistance, including cross-central bank research stints. By February 2016, the RBI governor had succeeding in hiring only one permanent external employee.
The next RBI governor’s job will be to see these tasks through. Who will be a likely candidate? Media speculation has identified a number of names, with potential candidates being everybody from from Subramanian (the current CEA) to State Bank of India head Arundhati Bhattacharya, National Stock Exchange Chairman Ashok Chawla. What can’t be ruled out is the government choosing an internal candidate with Urjit Patel (current deputy governor at the RBI) and Rakesh Mohan, Subir Gokarn and Usha Thorat – all past deputy RBI governors – also currently in the mix. If Thorat or Bhattacharya is chosen, Modi would have given India it’s first woman RBI governor.
In the run up to Rajan’s departure announcement, there had been two camps of thought as to what would happen if Rajan were to leave under less-than-appealing circumstances – ‘REXIT’ as it has been dubbed on Twitter.
The first, in which there were far fewer people, believed that if Rajan were asked to leave, there would be a mass exodus of foreign portfolio investment. The rationale here is that Rajan brought with him a sense of global credibility and a reputation of being a tough and independent RBI governor. Denying him a second term would be a blow to India’s credibility. “If he exits, so will tens of billions of dollars,” writes Swaminathan Aiyar, a popular economic analyst.
The second camp, however, believed that the impact of Rajan’s exit/ouster would likely be much less. An important argument here is that Rajan did his job as any other RBI governor would, much like the way his predecessors handled the post-Lehman crisis (Subbarao), the late 1990s Asian meltdown (Bimal Jalan), and even the domestic Harshad Mehta Scam (S. Venkitaramanan). Furthermore, an important point here is that the RBI is staffed by excellent personnel and will continue to ably assist Rajan’s predecessor and carry on as they have before.
While there is no dearth of talent within and outside the central bank, the key question is how much freedom will the post-Raghuram Rajan RBI enjoy to function independently and take decisions that the government and the ruling Bharatiya Janata party may find unpalatable.
As the markets open on Monday, the next week will tell us which camp is right. Nevertheless, it is perhaps a little unsettling that India’s most publicly discussed RBI governor will be the first in a little over 20 years not to receive an extension.