Forget Subramanian Swamy's barbs, Modi has reasons to extend Rajan's term
Modi should ensure that Rajan continues at the central bank in the larger interest of the economy
Finance Minister Arun Jaitley was bang on when he cited two critical factors that can change the fortunes of the Indian economy with a 7.75-8% growth this fiscal year — a good monsoon and better bank health.
The first one — a good monsoon — is something only the weather gods can decide, but the second — keeping the banking sector healthy — is something humans have a say.
In the current context, the best thing the Modi government could do is to ensure continuity at the top deck of the central bank, which is halfway in cleaning up the mess in the banking system and tackling large wilful defaulters such as Vijay Mallya.
Also, it is surprising why the BJP government is silent on the likes of Subramanian Swamy in the party who is levelling allegations against Reserve Bank of India (RBI) governor Raghuram Rajan, which are neither substantiated with facts nor makes any logical sense, such as this.
True, everyone is entitled to his or her opinions. But, when a person of Swamy’s stature — a professor and an economist — speaks of Rajan ‘wilfully and deliberately wrecking the Indian economy’, he also needs to substantiate his statement with evidence. If the argument is that Rajan’s interest rate policy has acted as a hurdle to economic growth, it should be debated. But blind accusations such as Rajan not being ‘mentally not fully Indian’ are nonsense. Here, clearly, Modi needs to put an end to the Swamy show.
As noted in an earlier article, Swamy’s blind allegations are major embarrassment to Modi and the BJP since the government and Modi personally have acknowledged Rajan’s good work.
Coming back to Jaitley’s remark on bank clean-up, the central bank deserves full credit for kicking off the exercise. Under Rajan, the RBI has set a target of March 2017 for Indian banks to clean up their balance sheets by recognizing all non performing assets (NPAs). Following this, banks have begun to aggressively classify NPAs on their balance sheets since the December quarter.
Even in the March quarter, the process has continued causing huge losses to several public sector banks (PSBs). Going by banking analysts, the pain of digging out the dirt from bank balance sheets will continue throughout this fiscal. But the entire process will help the banking system to emerge cleaner and stronger.
But it is critical for the Modi government to ensure the central bank has a freehand in the process. After Rajan took over as the RBI governor in September 2013, the central bank has acted decisively to contain bad loans. As the first step, it laid out rules for early recognition of stressed assets on banks' balance sheets and then later following it up with withdrawal of special dispensation provided to restructured loans. This requires banks to make provisions for restructured loans at par with bad loans. Of course, banks can still recast loans but with tighter scrutiny.
To cut down corporate bad debt in future, the RBI has also laid out rules to limit corporate borrowings. Of course, there isn’t an easy cure for the bad loan trouble that has gripped the country’s banking sector, in particular state-run banks. At least 11% of India’s loans (Rs 4 lakh crore NPAs and substantial chunk of restructured loans) are in the stressed category.
There are a few more good reasons for Modi to ensure Rajan continues in the central bank in the larger interest of the economy:
For one, the transition of the Indian banking sector is currently underway under the leadership of Rajan. India is arguably witnessing the biggest revolution in its banking sector since the nationalisation with the entry of new set of small finance banks, payments banks and plans to make universal banking on on-tap mode. In other words, at a time when the banking infrastructure overhaul is underway, it is important to ensure continuity at RBI top brass.
Two, under Rajan, the RBI has managed to control inflation at manageable levels from near double-digit levels when he took over in late 2013. A slew of reforms in the monetary policy process (focusing on retail inflation as key policy indicator, bi-monthly policy reviews and efforts to guide the banking system to a more efficient monetary transmission mechanism) have so far worked well but still a work in progress.
Three, change to inflation targeting monetary policy mechanism. Rajan managed to bind the government to sign a pact with the RBI on joint monetary policy mechanism that will predominantly target inflation and empowers the central bank to adjust the policy rates to achieve that target.
Four, there isn’t an iota of doubt that Rajan taking over as the RBI governor has helped the Indian economy to a great extent regain confidence of international investors and rating agencies especially after questions were raised about the credibility of the GDP numbers and the ability of the government to take ahead the reforms process. In uncertain times, it is critical to ensure Rajan stays for now.
As Firstpost noted before, high interest rates have been only one of the reasons that has hurt growth. The real reasons are structural and to a large extent due to global factors. Blaming the central bank is of little help.
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