Handling the fall-out of the tapering process is going to be Dr. Rajan’s first challenge
fter the rapturous, rock star welcome that he got from the markets, media and the public alike last week, Raghuram Rajan must be a wary man indeed. He’s surely seen enough of life to know that such adulation can quickly swing to the other end which will only be adding to the tremendous pressure he already is under. The job of RBI Governor is not easy in the best of times, and these are anything but that.
It’s been a good start alright but the test just begins for Dr. Rajan. Amongst the many that he will encounter in the days ahead, there are five trip wires, in particular, that he needs to watch out for.
Managing the rupee
That’s obviously the most immediate challenge. In his speech on Wednesday, Dr. Rajan hinted that he was willing to go out and bat on the front foot when he spoke of creating depth in the local currency markets to take on the overseas non-deliverable forward market for the rupee. The promise to examine the possibility of introducing interest rate futures on overnight rates and cash settled 10-year interest rate futures as also the internationalisation of the rupee show his willingness to play ball with the markets and speculators. He has to watch out for speculative bouncers though.
Much as he may want to be proactive, the fact is that in the near-term at least, his strategies for the rupee will largely be reactive to the policies of the Fed. His decision to postpone the mid-quarter review by a couple of days to September 20 ostensibly to give himself more time to “consider all major developments in the required detail” demonstrates how the Fed’s policies will drive the RBI’s own; the Fed will have a crucial meeting on September 18 where a decision on commencement of tapering is expected.
Handling the fall-out of the tapering process is going to be Dr. Rajan’s first challenge. The dilemma will be choosing between retaining the existing measures imposed to support the rupee, which are having an adverse impact on sentiment, and loosening up and risking a run on the rupee. The markets will be closely watching the RBI’s moves in the run-up to the mid-quarter policy statement.
New bank licences
D. Subbarao has bequeathed the hot potato of new bank licences which he inherited from his predecessor to Dr. Rajan. Though new banks are desirable if only for the competition that they will bring, opinion is divided on the basic question of number of licences to be issued and how many of them should be given to corporate groups.
Given the divergent views and the fact that some well-known corporate houses are among the 26 who have applied for licences, the RBI is unlikely to be able to please everyone. Dr. Rajan has a tough one on his hands. His speech hints at a liberal approach to granting new licences but how many will he grant now? The “on-tap” licensing he spoke of can also be interpreted to mean that only a few, maybe less than five licences, will be given now with the losers free to apply later. But by appointing someone with the credentials of Bimal Jalan as head of the committee to examine and recommend applications, Dr. Rajan has started well.
The problem of bad loans is not something that has suddenly reared its head. The overweening ambition of promoters and companies to expand during the heady period of 2009-11 without giving a thought to basic fundamentals of demand and supply has resulted in bad loans, and numerous instances of corporate debt restructuring. Gross NPAs and restructured loans are estimated to be as high as 10 per cent of total loans outstanding — non-performing loans rose by about 14 per cent in just the first quarter of this fiscal to Rs.1,76,000 crore. SBI alone saw its gross NPA ratio shoot up to 5.56 per cent in the April-June quarter, its highest in the last nine quarters.
With the economy slowing down considerably and GDP growth in the second quarter likely to be as bad, if not worse, than the first, corporate profits are likely to suffer with adverse consequences for loan repayments. This will indeed be a major problem for Dr. Rajan to tackle in the short-term; in the long-term, he has to take steps to blacklist defaulters from returning to the credit system. If individual borrowers can be monitored by CIBIL and blacklisted for defaulting over relatively small amounts, then there is no reason why large corporate borrowers and businessmen should not be given similar treatment. More so because their borrowings are large enough to threaten the stability of the banking system. Dr. Rajan’s remarks in this connection are encouraging, as they signal a zero-tolerance approach to defaulting-promoters and businesses. But then again, as with his other promises, he will be watched closely for action here as well.
One of the main reasons driving domestic investors to gold has been the absence of attractive investment options that take care of inflation. The stock markets have been indifferent in the last couple of years while inflation has been raging at over 10 per cent at the consumer level.
In this backdrop, bank deposits have become unattractive as the returns, post-inflation, are piffling, and, sometimes, even negative, depending on the term.
It is not surprising then that household savings in financial assets fell by half to 8 per cent in 2011-12 compared to 2009-10. The loss of the financial system has been the gain of gold and real estate, investment in which rose to 14.3 per cent of GDP from 13.2 per cent over the same period. Household savings as a whole has dropped from 25.2 per cent to 22.3 per cent with adverse consequences for gross domestic capital formation in the economy. Though it is not the RBI’s responsibility alone, the central bank has to do whatever is within its powers to get domestic savings going again. Dr. Rajan has acknowledged this by proposing inflation-indexed bonds linked to the consumer price index, which reflects consumer impact better, rather than the wholesale price index, which was used hitherto. More such steps are necessary to wean retail investors back from gold and real estate.
Protecting the turf
This will be a continuous battle for Dr. Rajan in the face of constant efforts from North Block to encroach on the RBI’s territory. He’s not the first Governor who will face this problem, and he will not be the last. What is different though is that the pressures are now bigger given the slowdown in the economy. The report of the Financial Stability and Legislative Reforms Commission has put the central bank on the back foot, and Dr. Rajan will find it difficult fending off the government’s yorkers from this position. But yet, he will have no option but to keep defending as his predecessors have done. He will be watched closest on this count.