Shaktikanta Das took charge as the 25th Governor of the Reserve Bank of India (RBI) on December 12, 2018 at a time when the relationship between the government and the central bank had touched a new low.
The relationship had turned sour, particularly with Mr. Das’s predecessor Urjit Patel, over issues such as the bank’s capital framework and governance issues. Finally Mr. Patel quit. The government quickly found a replacement in Mr. Das.
Mr. Das was able to deflect media focus away from the RBI-government tussle. While a committee was appointed to look into the issue of economic capital, the issue regarding RBI’s governance took a back seat at the board meetings.
After taking charge, Mr. Das went for an extensive consultation exercise with all stakeholders, including banks, non-banks and industry houses, in the process giving a signal that he was ready to listen to divergent viewpoints.
This was a departure from the tenure of Dr. Patel who was often accused of not giving a ear to the stakeholders.
Under Mr. Das, the Reserve Bank’s post-monetary policy press conferences became more interactive as he made it a point to give every journalist a chance to ask questions — a clear departure from his predecessor’s tenure when only a few questions were taken.
Setting interest rates, which is the primary policy-making responsibility of the RBI, in the first year of Mr. Das’ tenure was not a complicated process. Inflation remained benign, while growth was coming down rapidly.
In such a scenario, the debate was not whether interest rates should be reduced but on the quantum. Between February (Mr. Das’s first policy) and October, the RBI had reduced the interest rate on all the five occasions when the monetary policy committee met, by a total of 135 basis points (bps).
The first sign that policy-making will not be as straight forward was evident in the December 5 policy. As October’s retail inflation went beyond the central bank’s medium term target of 4%, the RBI decided to pause on rate cuts. The move surprised the market, with yields on the 10-year benchmark government bonds jumping 20 bps in two trading sessions.
The complication in setting interest rates was evident from the RBI’s statement and the Governor’s comment during the interaction with the media.
While keeping the rates unchanged, the RBI maintained an ‘accommodative’ stance, meaning further rate cuts are not off the table.
But the central bank lowered the GDP growth estimate to 5% for FY20, sharply down from the 6.1% estimated during the October policy. Inflation projection for the second half of the current financial was raised to 4.7-5.1% compared with 3.5-3.7% projected in October.
The growth-inflation conundrum had kicked in for the RBI Governor. Mr. Das acknowledged there was a case to look through the spike in inflation, which was primarily due to food prices, but decided to be on a wait-and-watch mode, for more clarity on the inflation front, the outlook for which was also clouded by an increase in telecom tariffs.
He would also wait for the Union Budget to be presented in early February for clarity on government's action to revive growth.
And, there could be complications on the exchange front also. While there were few occasions of volatility, the exchange rate has been relatively stable in the last one year on the back of steady inflows.
FDI flows
Net foreign direct investment increased to $20.9 billion in the first half of 2019-20 from $17 billion a year ago, while net foreign portfolio investment was $8.8 billion in April-November 2019 as against a net outflow of $14.9 billion in the same period last year. This also helped the central bank to shore up the foreign exchange kitty that recently crossed the $450-billion mark for the first time.
India’s foreign exchange reserves stood at$ 451.7 billion on December 3, 2019 — an increase of $38.8 billion over end-March 2019.
Pressure on rupee
But with the economy on a downhill path, how long inflows will sustain needs to be seen. Once the outflows start, it will put pressure on the rupee though the import cover of 11 months acts as a cushion. Depreciation of the rupee could make policy-making further complicated.
Perhaps the biggest challenge for Mr. Das in his second year would be to address the risk-averse nature of the banks. This was evident from the inadequate monetary transmission. In response to the 135 bps policy rate cut by the RBI, the one-year marginal cost of funds-based rates of banks came down only by 49 bps. The gap between the 10-year benchmark bond yields and repo rate is 155 bps. Year-on-year credit growth of banks is in single digits.
Mr. Das, aware of the emerging growth-inflation dynamics, took it head-on, as evident from the pause button the RBI the pressed in the December monetary policy. The RBI cannot mechanically go on cutting interest rates every time, he had said.
True, given the challenges the country faces, a mechanical approach will not help. A consultative approach, for which Mr. Das is known, could help the central bank navigate the current economic environment.
