Why Rajan matters to India? It’s not for the Chidambarams or Swamys to decide

Congress-leader and former Finance Minister P Chidamabaram is wondering whether the National Democratic Alliance (NDA) government under Prime Minister Narendra Modi deserves Raghuram Rajan at the helm of the Reserve Bank of India (RBI).

“I’m beginning to think whether this government deserves Dr Rajan,’ Chidambaram said while replying to a query at a Congress presser on the occasion of the Modi government’s two-year completion.

Raghuram Rajan. Reuters

Raghuram Rajan. Reuters

Surely, Chidambaram’s words will be taken with a pinch of salt by everyone for two reasons: One, Rajan is an appointee of the Congress-led United Progressive Alliance (UPA) government and hence the party will tend to argue that their choice is the best.

Second, Chidambaram’s son Karti, is now being chased by various investigative agencies under the NDA rule. Logically, one can’t expect anything except criticism from an aggrieved father since he himself is indirectly targeted by the Modi government.

High media scrutiny

Never before has the appointment or reappointment of a RBI governor gone through such media scrutiny. Again, there are two reasons why it is happening now in the case of Rajan.

One, Rajan came to India with the high profile image of a world-renowned celebrity economist. For long  he has been a well-known name among international economists and academia and is credited with predicting the approach of the 2008 global financial meltdown that followed the collapse of Lehman Brothers Inc.

In India he made a mark with his financial sector reforms report he submitted way back in 2008. The report that recommended a hundred small steps to reform the country's financial sector has acted as a guide ever since. With this, Rajan was seen more as a visionary than as a bureaucrat.

Secondly, the Subramanian Swamy factor. Swamy, a senior BJP leader and Parliament member, has unleashed a tirade against Rajan saying his ‘wrong’ monetary policies have failed to support the economy and generate employment. Swamy even went on to personally attack Rajan alleging he is possibly leaking sensitive RBI information. He has also said that Rajan is ‘not fully mentally Indian’ since he is a US green card holder.

What Rajan did

Whatever the politicians argue, the way to arrive at a consensus on whether Rajan merits another term at the RBI is by answering the following questions: Did the former chief economist at International Monetary Fund (IMF) do anything exceptional at the RBI that his predecessors didn’t? Will Rajan’s discontinuation at the RBI be a loss to the country at this juncture? Or is it that the whole issue is being made a subject of unwarranted hype by Rajan fan-clubs? (Read R Jagannathan's view on Rajan here.)

Every RBI governor has had challenges in their respective time periods. It was the Asian currency crisis for Bimal Jalan, for instance. As former RBI deputy governor, Usha Thorat put it later, it was an “extremely volatile situation with foreign funds pulling out, bringing the currency under pressure. Even though the rupee was quite appreciated at that time (in real effective terms), his first priority was to ensure that the markets did not see the movements in the rupee as evidence that we were part of the Asian crisis. His first task was to stabilize the exchange rate and he used all measures — market, monetary and administrative — to ensure this.”

For Y V Reddy, it was the resurgence on inflation and for Subbarao, the challenge was to save the economy from the perils of the 2008 global financial crisis. Subbarao took over as the RBI governor on 5 September 2008, barely 10 days before the global financial markets faced one of the biggest meltdowns in their history after the collapse of investment bank Lehman Brothers in the US. As the RBI governor, Subbarao had to safeguard the financial system and provide the impetus to the economy through a series of rate cuts to ensure liquidity in the financial system.

Looking at a broader reforms perspective, Rajan’s work has been exceptional. It was under Rajan that the central bank initiated structural reforms in the banking industry and in the way monetary policy was conducted until then. On his first day in office, Rajan announced his reforms intent by setting up a few expert panels to revamp the monetary policy (under Urjit Patel) and financial inclusion (under Nachiket Mor).

The monetary policy framework was reworked to focus on consumer price index (CPI) inflation and the policy reviews were made bi-monthly to sense the rapid changes in the domestic and global economic factors. This strategy worked to bring down the double-digit consumer inflation to the current levels of around 5 percent.

It’s not fair to blame the central bank entirely for food inflation since this is more due to lack of supplies of produce, whereas the monetary policy can act effectively only when there is a demand-driven inflation. Similarly, blaming the RBI for slow economic growth and unemployment is bunkum as the primary responsibility of the central bank is not growth, but financial stability in an economy. Interest rate is only one part of the problem.

Rajan also managed to bind the government to a joint monetary policy committee mechanism, under which the committee will set the inflation target for the RBI. Structural reforms in the banking sector were initiated by giving shape to the idea of several small banks (payments and small finance) and changing the bank licencing system to on-tap (continuous) mode. Until then, issuing bank licences was a once-in-a-decade affair.

Rajan brought back the confidence of investors to the Indian economy by arresting the rupee’s free fall. The rupee was near its all-time lows of 68.85 which it hit in August 2013. The economy was struggling to show any signs of recovery, forex reserves had depleted below the $300 billion and high inflation was hurting the common man, snatching away the fruits of economic growth from his life. Through a series of measures, Rajan limited the capital outflows and encouraged inward flows.

The NPA issue

Rajan’s biggest contribution to the Indian economy is that he dared to address the problem of hidden non-performing assets (NPAs) in the banking system. This is something that, if left unaddressed, possessed the potential to drive the Indian economy to a bottomless chasm at some point. No central bank governor or finance minister before had ever addressed the problem of hidden, rotten, bad loans in the banking system.

What banks showed in their balance sheets was not the actual chunk of bad loans present on their balance sheets. Everyone — both the banker and the borrower firm — were happy with continuous evergreening and technical adjustments since it showed both parties in good light. But, the rot was running deeper and it could have turned fatal to the entire body at some stage — sooner or later.

Banks merrily pushed loans to the restructured loan basket at the first sign of trouble and retained them as standard assets. Cronies thrived with these technical adjustments since they were still eligible to borrow even more from the same banks or other bank unless he is tagged as a defaulter.

It was Rajan who insisted that banks shouldn’t postpone today’s problem to tomorrow and worsen it. The RBI withdrew the regulatory forbearance on restructured loans, requiring banks to make provisions on restructured loans at par with bad loans, forcing banks to set aside 15 percent of the loan amount as provisions if they choose to go for a fresh restructuring. Earlier, banks used to conveniently push many stressed loans, especially in the infrastructure segment, to the restructured loan category to prevent them from slipping into the NPA category.

Rajan also insisted banks recognise stress in their portfolio early and classify them into special mention accounts (SMAs) depending on the period of repayment delay. Banks were asked to form Joint Lenders’ Forum and address the problem as a group. In effect, the RBI forced banks to have a clear roadmap to clean up their balance sheets. He set a deadline of March 2017 for banks to clean up their books.

The evidence of hidden bad loans on bank balance sheets lies in the last two quarterly numbers of state-run banks. How did all these NPAs accumulate and why didn’t banks report them earlier? Rajan made it clear that there is no free lunch for wily promoters who wouldn't put in money if the asset becomes stressed. Rajan spoke against their 'divine right to stay in control despite their unwillingness to put in new money'. He asked banks to deal with wilful promoters with an iron hand.

The world attaches more credibility to the central bank of a country than its political leadership when it comes to matters of financial stability. That is critical for any aspiring economy to receive foreign investments. True, India’s economy will certainly not collapse if Rajan is not given another term. But, it can certainly impact the ongoing structural reforms in the banking sector (especially clean-up of NPAs).

Rajan’s continuity or discontinuity at the RBI should be evaluated based on his work at the central bank, not on the arguments and judgments passed by the Swamys and Chidambarams in India.


Published Date: May 30, 2016 01:36 pm | Updated Date: May 30, 2016 03:11 pm