Raghuram Rajan’s opening speech has been fairly open and bold where he has laid down the path to be followed in the next few weeks or months. More importantly, he has spoken of the need for us to adapt to change as there will always be risks involved with change. He has kept the monetary policy options open by not revealing his preference, and the fact that he has deferred the policy to September 20 makes it evident that Ben Bernanke’s call will have a bearing on his decision. He has stuck to financial sector reforms which are partly under his domain and worked on the assumption that there would be a buy-in from other regulators where required. He has consciously not given any hints on any possible action on the exchange rate front—leaving it open-ended for the time being.
But what are the risks that he is talking about? A lot of what has been said finds mention in his now famous 100 small steps report of 2008. It looks like that he is also aware of the fact that these steps may also not work but should be implemented anyway.First, he talks of getting away from lazy banking, which indicates that SLR would be reduced. There are two issues here. One, banks are willingly holding on to excess SLR, which makes lazy banking voluntary (the investment deposit ratio is over 30%). Two, lowering it creates an ideological battle with the government, which will necessarily have to control its deficit and ensure that the borrowing programme is under control. It will take a lot of character to drastically reduce this component. In fact, it will be revolutionary if RBI mandates an upper limit for SLR securities, which has not been spoken of.Second, he talks of inclusive banking and free opening of branches. The question is whether this is an issue? Banks are withdrawing from non-viable branches and while RBI may like to have more rural branches, banks’ P&L may come in the way. Also, it has been observed that typically NPAs tend to be higher in the priority sector lending. If this were so, then allowing banks to open more branches may not quite deliver the result. In fact, RBI could think of ensuring that the priority sector norms are adhered to and that non-compliance should not have access to the RIFD window.Third, deepening the financial markets is a good idea and should be done. However, given the experiences of the West, we would have to tread carefully here and not open up the trading limits for institutions especially those which are dealing with other people’s money. RBI will still have to put in enough safeguards so that the overall risk involved while widening the market does not grow proportionately. Counter-intuitively speaking, if there were no issues involved, it should have been done. Clearly, Dr Rajan is going to reverse this line of thinking.Fourth, RBI will once again be working on getting in the 10-year interest rate futures contract. This has been experimented with earlier and has not worked out. It would be necessary to study as to why this has not worked before reintroducing the product. The present state of limited liquidity across the maturity spectrum has come in the way of the development of the yield curve and hence an interest rate futures market. This will have to be examined in detail so that the final product is successful.Fifth, internationalisation of the rupee is an interesting concept, and the entire design has to be drawn up neatly to make it work. Today the demand is for hard currencies, which are the dollar and the euro. To say that ‘as our trade expands, we will push for more settlement in rupees’ is bold because it means that we do expect other nations to accept these terms of trade. He also admits that this will mean opening up our financial markets for those who receive rupees to invest it back in. There has to be a buy-in from other financial regulators which will have its own challenges considering that we do have limits to foreign participation in most market segments.Last, he has touched upon the tricky issue of NPAs and has rightly said that the promoters should not be allowed to get away with bad debts. This will be a hard nut to crack given the long processes that exist today where a defaulter tends to have an upper hand when dealing with the banking system. There is no indication of what can be done, as this has been a nagging issue which has often forced banks to shy away from lending and prefer lazy banking as it was safer.Most of what Dr Rajan has stated are, as he has already said, points that have had acquiescence from within RBI, and what he would be doing is really putting them into action as soon as possible. This really shows that we can expect continuous action to begin with, which should enthuse the market, though admittedly the latter still keeps looking for guidance on the exchange rate and the interest rate and his preference between currency, growth and inflation. More so now that he has raised expectations that he is going to be different. To know more on this, we will have to wait till September 20. Till then the markets will continue to be choppy.
But what are the risks that he is talking about? A lot of what has been said finds mention in his now famous 100 small steps report of 2008. It looks like that he is also aware of the fact that these steps may also not work but should be implemented anyway.First, he talks of getting away from lazy banking, which indicates that SLR would be reduced. There are two issues here. One, banks are willingly holding on to excess SLR, which makes lazy banking voluntary (the investment deposit ratio is over 30%). Two, lowering it creates an ideological battle with the government, which will necessarily have to control its deficit and ensure that the borrowing programme is under control. It will take a lot of character to drastically reduce this component. In fact, it will be revolutionary if RBI mandates an upper limit for SLR securities, which has not been spoken of.Second, he talks of inclusive banking and free opening of branches. The question is whether this is an issue? Banks are withdrawing from non-viable branches and while RBI may like to have more rural branches, banks’ P&L may come in the way. Also, it has been observed that typically NPAs tend to be higher in the priority sector lending. If this were so, then allowing banks to open more branches may not quite deliver the result. In fact, RBI could think of ensuring that the priority sector norms are adhered to and that non-compliance should not have access to the RIFD window.Third, deepening the financial markets is a good idea and should be done. However, given the experiences of the West, we would have to tread carefully here and not open up the trading limits for institutions especially those which are dealing with other people’s money. RBI will still have to put in enough safeguards so that the overall risk involved while widening the market does not grow proportionately. Counter-intuitively speaking, if there were no issues involved, it should have been done. Clearly, Dr Rajan is going to reverse this line of thinking.Fourth, RBI will once again be working on getting in the 10-year interest rate futures contract. This has been experimented with earlier and has not worked out. It would be necessary to study as to why this has not worked before reintroducing the product. The present state of limited liquidity across the maturity spectrum has come in the way of the development of the yield curve and hence an interest rate futures market. This will have to be examined in detail so that the final product is successful.Fifth, internationalisation of the rupee is an interesting concept, and the entire design has to be drawn up neatly to make it work. Today the demand is for hard currencies, which are the dollar and the euro. To say that ‘as our trade expands, we will push for more settlement in rupees’ is bold because it means that we do expect other nations to accept these terms of trade. He also admits that this will mean opening up our financial markets for those who receive rupees to invest it back in. There has to be a buy-in from other financial regulators which will have its own challenges considering that we do have limits to foreign participation in most market segments.Last, he has touched upon the tricky issue of NPAs and has rightly said that the promoters should not be allowed to get away with bad debts. This will be a hard nut to crack given the long processes that exist today where a defaulter tends to have an upper hand when dealing with the banking system. There is no indication of what can be done, as this has been a nagging issue which has often forced banks to shy away from lending and prefer lazy banking as it was safer.Most of what Dr Rajan has stated are, as he has already said, points that have had acquiescence from within RBI, and what he would be doing is really putting them into action as soon as possible. This really shows that we can expect continuous action to begin with, which should enthuse the market, though admittedly the latter still keeps looking for guidance on the exchange rate and the interest rate and his preference between currency, growth and inflation. More so now that he has raised expectations that he is going to be different. To know more on this, we will have to wait till September 20. Till then the markets will continue to be choppy.
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