Raghuram Rajan, the former Reserve Bank of India (RBI) governor between 2013 and 2016, is traversing the country to promote his latest book, 'I do what I do', which is a collection of commentaries and essays penned by him in that period. In an exclusive interview with Forbes India, Rajan talks about everything from banks’ bad loans to his ‘difficult’ days as the RBI governor; recollecting the days he would eye forex rates every 10 minutes during its volatile phase; the reluctance of bankers to deal with the problem of bad loans and if an RBI governor needs to match the expectations of the ruling government.
Former Reserve Bank of India Governor Raghuram Rajan
Image: Mexy Xavier
Excerpts of the interview:Q I want you to reflect on your stint as the RBI Governor. What was your worst phase, or a time when you felt challenged or unsure of the efficacy of your policy?
I think the most difficult were the early days when we had just emerged from the ‘taper tantrum’ and we had a bunch of policies that we were monitoring each day to see if they were working.India’s currency was marked as being part of the “fragile five” [besides Brazil, Turkey, South Africa and Indonesia], one of those likely to be the most impacted once the US Federal Reserve started to normalise and raise interest rates. Rajan, in his latest book writes: "I thought it was time to go all out, I wanted to send the message that India had strong institutions like the RBI that could push forward reform even when Parliament was stalled and international investors should not write India off."
I used to look at the forex rate every 10 minutes and if I saw something worrisome, I would call the foreign exchange desk and talk to them because stability was the most important indicator that the markets had regained confidence. We had to nurse the rupee back to health. I felt almost like a doctor feeling the temperature of a patient every ten minutes. It was probably not worthwhile an investment of time but I was concerned.
There were a number of areas that had to be constantly monitored. We had taken the oil companies off the market [dollar demand from oil companies was taken off the market because of the free fall of the rupee]; we had to look at the flows coming from the Foreign Currency Non-Resident `B’ [the RBI had in 2013 introduced a concessional window for banks whereby they would woo their Non-Resident Indian clients to deposit surplus dollars at a fixed interest rate for the tenor of the deposit. These could be swapped with the RBI for a period of three years]. All these were not easy steps and we had to take a lot of decisions.Q Who were your go-to men?
We had some very strong people. There was Gurumoorthy Mahalingam, the then executive director [of RBI] and now Sebi (Securities and Exchange Board of India) whole-time member, who was terrific. Also, former deputy governor H R Khan had a very pragmatic attitude and was not ideologically extreme in any direction, so I could always trust his advice. Q You have spoken about how solving the financial stress of banks was a bit of a disappointment for you. Theoretically, do you allow a bank to resolve its bad loans problem and then recapitalise it or do you first do the latter and hope they emerge strong… essentially, is it okay to throw good money at bad?
It is both. Banks have to have the assurance that they will get capital otherwise they become reluctant to deal with the problem of bad loans because they consider that it would be a hit on their capital and therefore, always seek more time to deal with it.
There is also this belief – which I debated with the public sector bankers at that time – that somehow since the market did not realise the real extent of the problem, so [banks felt] that they should not take on these losses. But the market price for some of these (PSU) banks has been completely knocked down and trading as though investors fully understand the extent of the problem.Q ...the market also perceives that there is some short-term resolution to the problem, if higher provisioning is made?
So, you cannot provision too often, for the question asked will be: When will this exercise end? That is why it was important to have a time-bound programme at the end of which the market would feel that the worst is already out there - and then start the recovery process. It would be easier for a bank to issue capital when the markets know that there will be no more unpleasant surprises.
This was part of our constant battle [with banks] – we often told them not to believe that not provisioning fully for bad loans would work. The market already knows that provisioning needs to be done and it is embedded into the bank’s stock price.Q …the coming of the NPA ordinance is still not the end of the exercise.
Well, there is a dynamic and a stock [situation]. Our sense was that by the time we came to the end of the AQR (asset quality review) exercise in March 2017, the stock [of bad loans] would be publicly known. But the economy was also not going gang-busters, so there is likely to be some more deterioration in asset quality. Plus, the older bad loans, although recognised, will continue to deteriorate if you have not fixed them.
Ultimately the only factor that will elevate India will be much stronger economic growth as well as an ending of the clean-up exercise and the recapitalisation of the banks.Q Have ARCs played the role as well as you thought they would?
I have not looked at them closely but my hope was that some of them with their foreign capital and expertise could play a bigger role of managing assets better, rather than just winding down liquidation. This would make them more useful and they would truly be performing the role they were set out for.Q You have indicated recently that India should aspire to grow at 9 to 10 percent in the coming years. What do we need to set right?
We have to set out a template of reforms, which is what the country is moving towards. We have parts of the broader game plan but [the government] has not spelt out what they want to go towards. Historically, India’s way of reform has been opportunistic - when the occasion opens up, the country does it. But it would be useful to know how all reforms fit together.
For example, India has informal [small] organisations, which prefer to stay of this size due to tax, inspection concerns; some of the recent moves make it difficult for them to function. We want them to become more formal. Some of them may be able to function only if they stay under the radar. The question we have to ask ourselves is whether we are willing to let these entities survive because they provide jobs or do we ask them to pay the same as everybody else and in turn, put them out of business.
What we need to have is a transition path by which they can move into formal zones. That gives them the opportunity for growth and reduces the burden on them, so that the transition from informal to formal is not so traumatic. How does one create this transition? A piecemeal reform does not create this path. The government is looking to improve the ease of doing business but are we easing the conditions for the small businesses?Q So we need to do more, rather than talk more?
We need a seat-of-the-pants approach, have a pragmatic vision, do every detail right and constantly ask why did we not get things done. We let things fester too often but do not go back to see if things can be un-bottlenecked. The drive for strong development – a recipe seen in China and South Korea – the belief that it can be done and will not rest until it is done, is what is required.Q Are there any dangers about our growth being services-driven?
I would not be worried about that. What if we were providing educational services to the rest of the world through top universities? India does not need to produce widgets, maybe services is the export-led growth of the 21st century. Can we create broader educational services for Africa? We need to create the environment for the students to come into and they will cherish. India needs to work on these things.Q In India, what would be the banks of the future, considering the problems which PSU and some private banks face, and the challenges from small finance banks?
We will have a mixed economy but I would like to see them ownership neutral. Whether owned by the government or private sector, they should have similar regulations, structures and support, so that the best entity stands to win.
The public sector entity has an edge over private sectors because the government is a stakeholder but it should not be a disadvantage for them in terms of their limitations to hire top talent or subjecting them to more intervention…Q …we see that with State Bank of India which has been very nimble in taking decisions…
Absolutely, so I would strengthen the forces which would allow the government to express its desire as a shareholder but they should run like any other company, protecting the rights of all shareholders. Sebi has been moving in that direction [it has called for listed PSU companies’ need to achieve a minimum 25 percent public shareholding norm]. RBI and Sebi feel that companies need to be treated in an ownership neutral way.
But I would move towards having board-governed companies. When governance lies outside the board, we see problems. The board should be able to appoint management. It would nice to take the suggestions of the gyan sangam and have the Banks Board Bureau appoint directors. Q …but the BBB has not served its role yet…
It has not got the full powers that we thought it would. The idea was it would devolve as we got more experience. We need powers to come from the government into the BBB.Q Does India need larger banks, will bank mergers become a reality?
We need banks that are fit for purpose. There is an argument that India does not have banks to finance large projects that we need. If we need larger banks that are well diversified, but how do we achieve this? I worry about trying to kill two birds with one stone – dealing with the bad loan problem and the need for a larger bank through mergers.
Bad loans take a lot of management time and as do mergers. Putting both together is demanding huge amount of management bandwidth. That is a concern.Q A government’s expectation from the central bank is to create policies to spur growth, while the central bank seeks to control inflation. Can a central bank’s action match with these expectations?
It is not about personalities or one trying to undermine the other’s role. Each one has different objectives. Any government will continue to pressure the RBI to cut interest rates regardless of which government is in power and the RBI is distanced from the government precisely so that it can decide whether to succumb to pressure or not. The pressure is always there and the RBI choses when to succumb and when not. The government never pushes beyond that. That is the nature of the relationship.
The back-and-forth on issues is built into it but this should not be interpreted as conflict. [The only ‘conflict’, which Rajan talks about, in his book, relates to safeguarding the term and turf of a central bank governor by getting protection similar to court judges] Q Looking at your tenure, what would be that one reform – benchmarking CPI, on-tap bank licences or creating the monetary policy committee (MPC) – which has changed the landscape for India’s financial system?
It is too early to say but in the short-term, based on data, controlling inflation was probably it. We were not solely responsible for making this possible. It was achieved because we were so focussed and did not succumb to the temptation to declare the battle won. That became the source for other benefits – the government has lowered interest rates on small savings; we can issue ‘masala’ bonds, a stable currency rate – all this comes from stabilising inflation. Q You say during the public meetings to launch your book that the global economies are faring well with all big engines firing at the same time. Is there more stress in the system compared to the 2008 crisis?
Considering the financial sector, there are two contrasting forces playing out. On the one hand, we have had a fair amount of deleveraging, and increasingly in Europe, because of the banks. At the same time, financial [policy] conditions have been very accommodative and we have also seen some re-leveraging in China and some parts of the United States [even though housing loans have not been back on a tear so far], the quality of auto loans has been deteriorating.
So, re-leveraging because of very accommodative conditions has been one of the recent phenomena but I do not think it is at a point which is as worrisome as the pre-2008. We also have the lessons of 2007-08 which hopefully people have now absorbed.Q Large economies are still coping with problems linked to climate change, sweeping technological advancements and geo-political tensions. What challenges do monetary policy makers face in these countries?
Monetary policy cannot deal with every shock, especially the one-off catastrophic shocks; as long as they are absorbed by the country, it is not something which monetary policy can contribute heavily to. In fact, look at something like Hurricane Harvey, the damage done by the hurricane – tragic as it is – also gives the opportunity to rebuild which creates economic activity – so there will be scope for additional economic activity which does not need the fuel of a more liberal economic monetary policy.
But what happens to countries which are poorer, like Haiti [which braces for Hurricane Irma and is still recovering from the impact of Hurricane Mathew in October 2016], their monetary policies will take these factors into account due to systemic shocks and try, and therefore, maintain more accommodative conditions so as to hope that economic recovery takes place faster. So, in the inflation focus, in those circumstances, both demand and supply has been hit. Businesses have been crushed but demand has also been crushed. So, you have to be careful about monetary policy and use it judiciously, but typically it would mean that you cut interest rates to the bone to revive economic activity.