The current central bank governor of the Bank of England (BoE) and the governor of the Reserve Bank of India (RBI) have a great deal in common. Both were considered ‘outsiders’ as Mark Carney is the first non-British governor of the BoE whilst Rajan’s appointment marked the entry of an established and trained macro-economist into the RBI.
Both assumed their current roles in 2013 when their reputations preceded their actual entry with both governors dubbed as ‘rockstar central bankers’. The commonalities extend to their lives outside of central banking as well with both being active marathoners and both often finding themselves in the midst of controversies for voicing their views on political matters.
However, the commonalities between the two governors end there with BoE governors enjoying stability and continuity in the form of being given an 8 year term (in fact, all BoE governors appointed since 1973 have enjoyed a 10 year term). Furthermore, the BoE's Monetary Policy Committee (MPC) is made up of 9 members comprising the Governor, the 3 Deputy Governors, the Bank's Chief Economist and 4 external members appointed by the Chancellor.
Whilst all RBI governors appointed since 1992 have had a 5 year term, governors are technically granted only a 3-year term. This means that RBI Governors have to undergo a futile and often humiliating debate by the powers that be in New Delhi regarding the merits of a 2-year extension of the initially granted 3-year term. The RBI will also transition into a committee framework of monetary policy making this year but the Indian setup involves a 6 member committee with 3 appointed by the RBI and 3 government appointees.
Even as an announcement regarding the extension of Raghuram Rajan’s term is expected only in August 2016, it is worth objectively analysing what this governor has brought to the table.
The most important change that Rajan administered as the RBI’s governor was to effect a swift transition from being a central bank that ‘loosely targeted both GDP growth and WPI inflation’ to one that is now ‘explicitly focused on targeting CPI inflation’. Shifting to inflation targeting with the CPI inflation (rather than WPI) as the nominal anchor has been one of the most significant reforms in the history of India’s central banking that Rajan implemented. Furthermore, he implemented this reform rather effortlessly and in under 6 months i.e. an unimaginably short timeline in government circles.
Rajan then administered repo rate hikes of 75bps over the first 12 months of his tenure and CPI inflation fell from the 22 month high of 11.5% in November 2013 to 3.3% in November 2014. From January 2015 till date Rajan then cut rates cumulatively by 150bps as inflation began to tend towards 5%. Rajan’s performance on the inflation targeting front can also be judged by the fact that actual inflation was below the RBI’s target in January 2015 and January 2016.
The side-effects of credible inflation targeting were also evident in the stability of the rupee with the coefficient of variation of the INR/USD exchange rate being recorded at 4% under Rajan as opposed to 10% over the previous decade. Rajan lived up to his reputation as a first rate macroeconomist by repositioning the RBI as the guardian of the value of the rupee.
Turning to the banking front, this governor has brought about multiple policy changes to radically increase competition in the financial services sector. Since Rajan took charge, the RBI: (i) has issued 23 new bank licenses versus 12 licenses in the last 20 years; (ii) has pushed for the creation of a new Bankruptcy Code and has taken various measures to develop bond markets in India; and is (iii) trying to close the regulatory arbitrage between different types of lenders to promote healthy competition in the sector. The RBI also issued draft guidelines for “on-tap” universal bank licensing and has highlighted the prospect of introducing new differentiated bank formats, such as wholesale banks.
Whilst a greater degree of foresight being displayed by the RBI nominees on Public Sector Banks’ boards could have meant that the Indian banking system would have been in a better position today, Rajan did systematically work to tighten the screws over the non-performing assets (NPA) recognition once the problem at hand became apparent. In FY16, the RBI carried out a system-wide asset quality review (in place of bank-specific Annual Financial Inspection (AFIs)). Using its centralised database and forensic checks, the RBI forced banks to recognise 2% of their loan book as NPAs.
The RBI also adopted a conservative stance on banks provisioning against standard loans that could be inherently weak. The RBI has asked banks to raise provisioning coverage on certain restructured loans from 5% to 15% over FY17. Furthermore, the RBI has set a deadline for Indian banks to clean-up their balance sheets and make adequate provisioning by end-FY17.
So Rajan’s report card as the RBI governor has been record-breaking on the ‘macroeconomic management’ front, tremendous on the ‘engendering competition’ front and behind-the-curve but highly effective on the ‘banking supervision’ front. The next best alternative that India has is a distant second. So here is hoping New Delhi makes an objective decision regarding Rajan's term renewal - based solely on his report card and not on the views of some loose cannons in Lutyens' Delhi.
Ritika Mankar Mukherjee is senior economist - vice president, and Sumit Shekhar is junior economist, Ambit Capital.