Rajan's tough messages: will the government buy in?

RBI Governor Raghuram Rajan used the CD Deshmukh memorial lecture end of last month to send out some tough messages on the economy and the banking sector. Some of it is familiar enough but those wanting to know where he stands in relation to major policy questions today would do well to go through the speech.

Growth and inflation: Rajan thinks we need to put stability ahead of growth at this point. Trying to grow at more than 7% through resort to fiscal or monetary stimuli could endanger stability. Higher fiscal deficit and higher borrowings could raise the debt to gdp ratio. Monetary stimulus could lead a to resurgence of inflation.

He thinks neither savers nor businessmen should complain about interest rates. In real terms, savers are better off. And businessmen are seeing profits rise even while revenues fall because input costs are falling even more. This may be true for some businesses but not all (as the governor concedes). The fact, remains, however, that the real interest rate for investors (which would be nominal interest rate adjusted for WPI) is rising because WPI is in negative territory. This does cripple investment, which is the area where we have maximum pain at the moment.

Yes, the international situation is grim. But I doubt that the government can settle for 7% growth for long. Job creation is crucial to the PM's agenda. And 7% growth won't give us the jobs we need. The government may accept a low growth rate in the third year of its tenure. But, in the last two years, it will want to press the accelerator. Then, the stability argument won't wash. What if the international environment remains adverse next year? Will the government forsake monetary and fiscal stimuli? I doubt very much.

Banks and stressed assets: Rajan reiterated the need to clean up banks' balance sheets. This means recognising NPAs in full and providing for them. But this means an erosion in banks' capital. On this, the Governor has an interesting take. He thinks the government may not have to chip in a great deal on top of what it has committed. Other sources (the capital markets?), he thinks, can provide some. Plus, he thinks there are several assets the banks have that the RBI would be willing to count towards regulatory capital provided the banks have met the common equity norms. I am not very sure about this. First, I think the infusion by government will have to greater than the Rs70,000 crore the government has committee to under Indradhanush. Secondly, I don't know how the market will view the other sources of capital that the RBI proposes to include towards regulatory capital. Thirdly, these may suffice to keep the banks afloat but lending will be sluggish unless there is significant infusion from government- remember, you need a buffer of about 5 percentage points over the regulatory minimum if you want banks to take risks with loans.

Bank governance: On this sensitive subject, the Governor has been content with posing several questions. 

....should boards not determine strategy as well as the appointment or renewal of their chief executive? What about their executive directors? Can bank boards have more freedom in choosing these? Can boards be given the freedom to set compensation structures and performance measures for their senior executives, including long term stock options?

He wants PSB board members to be paid better, an incontrovertible proposition. Why they continue to be paid Rs 5000 as sitting fee must rank among the mysteries of government in India.

On a lighter note, the RBI governor refers to a recent scam that involves ripping off gullible individuals. I couldn't help chuckling although it's no laughing matter:

Many of you must have received an email from me saying that the RBI had concluded a pact with the IMF or the British Government to take over the gold found on pirate ships in the sixteenth century, sell it, and give the proceeds to deserving citizens like you. In return for a small transaction fee of ₹ 20,000, the email goes on, I would be happy to transfer the sum of 50 lakh rupees into your bank account. Without pausing to think why I need ₹ 20,000 when I supposedly have ₹ 50 lakhs of your money with me, some of you send ₹ 20,000 as requested into an untraceable account. My office then gets repeated phone calls from you asking what happened when the ₹ 50 lakhs does not show up. The truth is that we are all gullible – no amount of warnings that the Reserve Bank does not ask you for your money helps. The central theorem of financial literacy is “There is no such thing as a free lunch”. In the context of financial investments, it can be restated as “There is no return without risk”. We need to imprint these two statements in everyone’s head and we intend to roll out campaigns to do so.