Wednesday, September 20, 2017

Raghuram Rajan back in the news

Raghuram Rajan was in India recently and he hold forth on a wide range of subjects in numerous interviews. Many interviewers tried hard to to get him to say that his differences with the government on demonetisation caused his exit from RBI. Rajan didn't quite oblige.

He was also asked if he would have resigned if demonetisation had been pushed in his time as Governor. He said he could have answered the question only if he had been confronted with the proposition when he was Governor. All he could say now was that if a civil servant did not want to go along with any government measure, the only option was resignation.

I thought his views on the banking sector deserved more coverage than those on demonetisation- he didn't really have much to add to the latter.

My column on this subject in BS is reproduced below:

Rajan in the limelight again
T T Ram Mohan
Former Reserve Bank of India (RBI) governor Raghuram Rajan came, he saw, he conquered the media. For a year following his exit as RBI governor, Dr Rajan had chosen to maintain silence on the Indian economy. During his recent visit to India, it was hard to open a newspaper or switch on a channel without seeing an interview with him.

The interviews covered pretty much the same ground, with the focus always on demonetisation. Dr Rajan said many things that would have gladdened the hearts of those critical of the initiative. Yes, he had expressed his reservations when the proposal was put to him. And, yes, he thought the short-term costs were steep  he mentioned estimates in the range of 1-2 per cent of the gross domestic product (GDP). And, yes again, he wasn’t sure the long-term benefits justified the costs. It’s fair to say that Dr Rajan hasn’t added anything to the debate on the subject. We do not have a handle yet on either the costs or the benefits of demonetisation.

The focus on demonetisation was a bit unfortunate as it overshadowed some pretty strong remarks Dr Rajan made about the banking system. Dr Rajan expressed reservations about mergers of public sector banks (PSBs). He warned that it would be unwise to attempt mergers at a time when PSBs were weak and wrestling with the problem of high levels of non-performing assets. One hopes the finance ministry is listening.

Dr Rajan was equally forthright on the need to do what it takes to recapitalise PSBs. He went so far as to say that the government should provide the necessary capital to PSBs even if it meant cutting allocations on other heads. The government and the top brass at the RBI have been telling us that some PSBs are so hopelessly deficient in managerial capabilities that putting more capital into them is money down the drain. Rajan clearly doesn’t think so.

We have thus far got banks to clean up their balance sheets without providing them the necessary capital. By many estimates, PSBs would require another ~1 lakh crore in order to meet the regulatory capital requirement. The Budget for this year has provided for just ~20,000 crore. Dr Rajan believes this is a sure recipe for holding up growth in credit and private investment.

Dr Rajan’s views on reform of governance at PSBs are rather more debatable. He wants the Banks Board Bureau (BBB) to have greater autonomy from the government. He would like the Department of Financial Services (DFS), whose job is to monitor PSBs, to be closed down. He wants PSBs to be monitored entirely by independent boards, presumably appointed by a truly independent BBB.

These views have wide currency today. However, the notion that PSBs should be freed from the supposed tyranny of the DFS is conceptually flawed. It overlooks a crucial fact about the governance model that obtains in India: Ownership of enterprises, whether in the public sector or the private sector, is not widely dispersed, as it is in the Anglo-Saxon model. We have instead a dominant owner in either the government or in industrial houses.

Where there is a dominant owner, the role of the board is rather more limited than in cases where ownership is widely dispersed. It is natural for the dominant owner to call the shots. The government cannot be expected to adopt a hands-off policy towards PSBs any more than Tata, Birla or Ambani can in their enterprises.

Moreover, it is possible to overstate the effectiveness of “independent” boards. Boards the world over are notoriously ineffective, which is why corporate governance is still work in progress more than two decades after the movement began. Those familiar with the working of PSBs would know that it is the government director and the RBI director who often make the most meaningful interventions.

Leaving matters at PSBs entirely to independent directors could, therefore, create a dangerous governance vacuum. There remains a case for the DFS to play a monitoring role. What is undesirable is that the DFS should issue directives to the CEOs of PSBs. Instead, the DFS should communicate its views through its nominee directors on boards, thereby strengthening the effectiveness of boards.

What Dr Rajan did not say is also significant. Dr Rajan is no foe of the private sector. Yet he made no mention of privatising any of the PSBs. Dr Rajan’s silence on privatisation at a time when “strategic sale” is the buzzword should make the finance ministry sit up and take note.