Inflation to bad loans: Raghuram Rajan has many battles to fight

When Raghuram Govinda Rajan took over as the 23rd governor of the Reserve Bank of India (RBI) on 4 September, 2013, the former IMF chief economist was seen as a long-awaited saviour to rescue a faltering economy, than just a mere, routine change of guard at the Mint Road.

There was a mountain of expectations built around Rajan. Almost everyone praised former finance minister P Chidambaram and (for a change) the UPA government for choosing Rajan as the government’s money manager.

The economy was facing severe stress on multiple fronts.

The rupee hadn’t recovered yet from its lifetime lows and was still trading at 67-levels per dollar, retail inflation numbers were soaring close to double digits giving nightmares to the policymakers, growth was anaemic and foreign investors were dumping local stocks.

But Rajan was hardly caught nervous in his appearances at pressers.

There was a certain degree of confidence and conviction in his words, from the very first day in office. Rajan said he didn’t have an magic wand to solve the ills of the economy, but everyone believed otherwise.

There were only few critics for Rajan’s decisions on multiple fronts, which ranged from some form of capital controls to save falling rupee, his uncompromising stance on inflation fight even at the cost of sacrificing growth, his efforts to usher in fundamental changes in the monetary policy framework, central bank machinery and in the conventional model of banking in India.

One year down the line, it looks like Rajan indeed had a magic wand that has worked to resolve the cracks in the economy, through direct and indirect, step by step measures.

The rupee, which plunged to its all-time low of 68.85 per dollar in August 2013, has recovered since then and has gained stability.

Capital flows have resumed, inflation has responded to the monetary policy treatments, current account deficit numbers have narrowed, the very structure of the banking industry is being changed, promising efficiency to the banking system. Share markets too have bounced back.

Some of these factors cannot be fully attributed to the RBI (for instance, declining deficit was more due to gold import curbs by the government), but to a large extend Rajan is credited for bringing back stability to the financial system.

But the man who famously predicted the 2008 global economic crisis, may have to fight many more good fights in the year ahead. Some of those could be the following:

Against populism

This wouldn’t be a fight familiar to the economist-turned-central banker but Rajan is getting familiar with it.

The fight involves dealing with the populist measures taken by state and central governments that are often politically motivated, but difficult for the RBI to ignore, since some such measures can have serious implications on the country’s banking system.

Two such immediate cases Rajan will have to face are the Rs 1.2 lakh crore farm/gold loan waivers announced by the Andhra Pradesh and Telangana governments and the massive financial inclusion programme, Jan Dhan Yojana, which envisages opening crores of zero-balance accounts with embedded benefits, within a short time.

Even though Rajan has made it clear that he isn’t keen to give any special regulatory dispensation for the waivers, the state governments are determined to go ahead with the plan, since that was one of their key poll promises. Following the waiver talks, borrowers have already stopped paying loans to state-run banks, resulting in a spike of bad loans.

In a state, where about 1 crore borrowers are defaulters to microfinance companies in the aftermath of 2010 microfinance crisis, a loan waiver can have disastrous implications on the banks operating in the geography. This can also set a precedent for other states as well.

One has to wait and watch how Rajan can tackle this challenge.

Second, Narendra Modi’s flagship financial inclusion programme, Jan Dhan Yojana, which was launched on 28 August, could prove to be yet another acid test for the banking regulator. The programme requires banks, mostly state-run, to open 7.5 crore bank accounts in a period of five months. Banks have already been pushed to open over 2 crore bank accounts in the first two days of the programme.

Though the programme is well-intentioned, these accounts, which come with the benefits of Rs 1 lakh insurance, Rs 30,000 life insurance and Rs 5,000 overdraft, have been opened with minimum KYC virtually posing a threat to the banks given the chances of duplication of accounts and lead to possible defaults.

Even during the UPA’s regime, state-run banks have been used to roll out the populist agenda of the incumbents - sometime in the form of directed credit to certain segment or restructuring of loans.

As the guardian of banks, will Rajan have the courage to fight against the government’s micromanagement in state-run banks?

Against inflation

Rajan has embarked upon a fight against the high inflation in the economy ever since he took charge from D Subbarao. The governor has consistently refused the demand from politicians and industrialists for a rate cut to support growth saying it is too early to lower the guard against the high inflation, which is taking away the fruits of economic growth from the poor in the far-flung areas of the country. He tries to convince them that sustainability of low-level of inflation is a must for strong economic growth in the long term.

Inflation has indeed fallen in the recent months. Retail inflation, the key price indicator for Rajan to determine the policy direction, has remained at sub-8 levels in June and July, but, according to economists, isn’t fully under control yet. Rajan has set a target of 6 percent for himself by January, 2016. While on one side when the call for rate cuts is getting louder, can Rajan finish his inflation battle?

Against bad loans

Under Rajan, early this year, the RBI has begun efforts to resolve the bad loan issue in the banking system that threatens the very stability of the economy and multiply the capital requirements of banks.

Rajan has begun addressing the issue through a detailed approach of early recognition of bad assets. The plan envisages a closer look at the stressed asset cases and incentivising banks, which act early on future bad loan accounts and impose penalties on those who ignore early signals. But the approach doesn’t deal with the existing stock of bad loans.

About Rs 2.5 lakh crores of gross non-performing assets are piled up in the banking system, while yet another Rs 5-6 lakh crore loans are being recast under various channels.

Besides the usual reasons of economic slowdown and slow decision making process, criminal nexus of bankers and middle men to facilitate corporate loans are emerging as a major reason for bad loans - an area that will need Rajan’s close attention.

For changes within the RBI

One of the critical changes RBI has attempted during Rajan’s tenure is revamping the monetary policy framework and the very way the central bank operates. Part of these plans are appointing a chief operating officer (COO) and a fifth deputy governor at the RBI and regrouping the departments of the RBI to five clusters for better efficiency.

There are reasons to believe that the changes are the partly, the brain child of Rajan. On the other hand, the government doesn’t seem to be too keen to implement these proposed changes and has ruled out the appointment of the COO .

Proceeding with the planned HR restructuring process within RBI, may not be an easy task for Rajan.