Raghuram Govind Rajan, economist and 23rd governor of the Reserve Bank of India (RBI), is one of the few economists who predicated central bankers about the 2008 financial crisis. Rajan, 55, was the chief economist and director of research at the International Monetary Fund, is also a distinguished service professor of finance at the University of Chicago's Booth School.
He said the government and the RBI deserved credit for keeping the inflation low and added that country should protect central bank it as a national institution. Rajan further said the aim of the RBI board is to play like Rahul Dravid and not like Navjot Sidhu.
Edited excerpts:
Q: Let me start with things global before I come to things Indian. We seem to have a dichotomous growth, the US is chugging along with excellent job creation while we are seeing the International Monetary Fund (IMF) marking down growth in Europe and more importantly in emerging markets (EMs) like China. Do you think we are going to have this divergent growth for some time now?
A: Initially, we will have that because the US has the benefit of a substantial fiscal stimulus, which is going to take it growing into next year. However, the world is so tightly integrated that if one part slows, the other part eventually does also slow. So, my guess is by the end of next year, when the stimulus has fully worn off, I think you will see the US coming back to earth.
Q: What about interest rates though? We have got such good wage numbers and job creation numbers coming out of the US. Amazon is raising wages, that is telling you something about global inflation. What is your sense about interest rates and about global liquidity, will it continue to get tighter for emerging markets?
A: The latest job numbers as well as wage growth - 3.1 percent year-on-year will suggest to the Fed that they should continue on their path of rate hikes. So, my guess is that they at this point are set on one more this year and may be three more next year. What this means is monetary policy is going to get tighter the world around. The European Central Bank (ECB) is also going to stop its quantitative easing (QE) by the end of this year. So, except for the Bank of Japan (BoJ), which is still pretty much set on its very accommodative policies, the rest of the world is starting to tighten.
So, both in terms of interest rates as well as liquidity, things are going to get more difficult as we look ahead.Q: Is this bad news for emerging markets? Last time around from 2003 to 2008 as the Fed started tightening, also meant good US growth and therefore, EMs prospered. Will it work that way or will this not work that way positively for EMs?
A: There is a difference this time, which is that part of that spectacular US growth is driven by a near end of cycle fiscal stimulus. So, one of the worries that people have as the Fed tightens is, its tightening given the very strong growth in the US but that growth may not last because some of it is fueled by stimulus.
That said, it is premature to say that this tightening process will necessarily create enormous problems for the emerging markets. It typically does, but markets do tend to differentiate between well managed emerging markets and poorly managed emerging markets. So, it is extremely important especially for India at this time to have really spectacular numbers on the macro stability front so that emerging markets look at that and say this is a well-managed economy and we are treated with respect in the difficult times to come.
Q: How would you assess the Indian macros at this point in time? After hitting trade deficit of $18 billion for couple of months, we have come down in September to $14 billion. The fiscal deficit at least efforts are being made to stick to the number. Do you think we get a tick mark, do you think the instability on the currency is behind us?
A: There are some places where we have done a good job.
Certainly on the inflation front, we are in a much better situation than in the past. Both the government and the Reserve Bank of India (RBI) deserve credit for keeping inflation low.
The other aspect that is generally good is, we do seem to be growing faster than most other countries. Of course from the perspective of the level of our gross domestic product (GDP) as well as what we need to create the jobs to keep our youth employed, we probably need somewhat more than where we are today.
Where there is more worry is on the fiscal deficit front and here I am not talking just about the central government fiscal deficit, which has been coming down but the aggregate fiscal deficit: even as the central government is bringing it down, the states are taking it up. When you look at the total, you find that over the last 3 or 4 years, the aggregate fiscal deficit has actually gotten slightly worse and not better.
The second big problem which we are facing today is the current account deficit (CAD) is blowing out partly because of relatively weak exports and partly because of the price of oil has gone up. It has come down recently, but it is a risk that we cannot ignore at this point.
Q: What about the debt problems that we are facing? There is a lack of trust in several non-banking finance companies (NBFC) especially housing finance companies (HFCs). Do you think this can become a very big issue and stymie growth itself?
A: There is concern in the corporate debt markets about the caliber of the rating agencies as well as who has good balance sheets and who has not. This is a good time for those entities that have relatively weak balance sheets, especially if the debt they have taken on is not yet due, for them to shore up their balance sheets. Typically, this means issuing equity so that they actually can put some backing behind any possible weak assets that they have.
I think the markets are somewhat nervous, but I don't think given that NBFCs account for 17 to 18 percent of assets, that this is an unmanageable problem. I think we can manage it, we have to look carefully at it, see what is really a solvency issue, what is a liquidity issue.
Certainly on the solvency front, it is up to these privately managed entities to raise equity at this point when they still have the capacity and shore up their balance sheets.
There is a tendency sometimes to run to the government and say please bail me out. I think first they have to exhibit everything they can do on their own before the government even contemplates anything on that sort.
Q: I do not know how much you are updated on the showdown that this has created between RBI and government. One of the demands of the NBFC sector and those who see that problem as possibly contagious is that the RBI should provide not just general government security liquidity through open market operations (OMOs) but must specifically provide a line of credit or some kind of comfort to NBFCs. Is that possible at all for the RBI?
A: Let me talk about central banks in general, because the specific issue I may not be the best informed on, but in general central banks avoid lending to direct entities because often that requires a level of credit evaluation, which simply central banks do not have and should not presume to have because they are not in the fiscal function of bailing out entities directly.
Of course in a generalised crisis they sometimes enter in a big way, the Fed did, the RBI has done in the past but before that you have to ensure that this is really a liquidity problem. If it is a liquidity problem, the central bank can flood the market with liquidity or give liquidity to specific private entities that are healthy and that are willing to lend to these other entities that are in trouble. If they are willing to lend at a particular price, that suggests that it is a liquidity problem and they are willing to fund these entities.
If nobody is willing to lend to these entities that means it is a solvency problem. If it is a solvency problem, then there is a fiscal function involved and typically the government should get involved in that rather than the central bank. In other words, when you bail out private entities, it requires a serious thinking on what exactly it is.
Q: What do you think the RBI should do in a situation that it is now in? It is a cycle, there are company treasuries that are not putting their money into mutual funds which have commercial paper of NBFCs. It is a trust deficit, how do you break this trust deficit?
A: Generally, when there is a liquidity problem, the central banks try and solve that by putting liquidity into the market. That means lending against high quality paper, that means lending to high quality institutions so that they have the capacity to on lend if there is necessity. If that is done, the central bank has primarily carried out its function.
If there is further money needed because entities are severely undercapitalised or because they have losses on their balance sheet or because markets distrust them and refuse to lend to them, then we have something which is different from a liquidity problem, we really have something which looks much more like a solvency problem. In that case, much closer examination is needed of the particular issue. Certainly, some of this can be remedied as I said by companies going out and issuing equity to bolster their balance sheets. If their market value is still significantly positive, it is possible. If even the equity markets are closed to them, then at that point which is very far from where we are, a bail out could be contemplated. However that bail out has to be carried out by the government because ultimately tax payer funds will be involved.
Q: There is a severe disagreement between the government and the RBI on the liquidity issue for the following reason that 11 banks have been put under prompt corrective action with 3 filters either because their capital is not up to the RBI’s requirements or because they have higher net non-performing assets (NPAs) or three because they have negative return on assets (ROA). Now the government’s position has been globally, prompt corrective action is resorted to only with a capital filter and not with net NPAs and RoA filters. What would you say is the correct position?
A: I do not want to enter into the specifics of that. Let me tell you broadly that there is a bit of a misunderstanding in this debate about what the RBI is supposed to do. I think Dr. Viral Acharya gave the analogy of T20 versus test match, but let me give you another analogy; the RBI is something like a seat belt, as a driver the driver being the government, it has the possibility of not putting on a seat belt but of course if you do not put on your seat belt you get into an accident and the accident can be quite severe. So most drivers listen to that annoying noise which comes when you do not put on your seat belt and actually put on the seat belt because they know it’s for their own good. And historically the relationship between the RBI and the government has been precisely this – the government wants to focus on improving growth and it does all it can within the limits set by the RBI which are set based on financial stability. So the government will push, will try and get the RBI to be more lenient and there are innumerable letters both from industry as well as government which across my desk saying please relax this, please relax that and that understanding was we would examine that in close details, see what the risk to financial stability were and then say yes or no. When we said no the government understood, this crossed the lakshmana rekha in some sense of stability and that we would be held responsible.
We have responsibility for financial stability and therefore we have an authority to say no.
They would respect that come back the next day with another letter saying what about this and what about that and we keep examining all these possibilities. This has always been the relationship between the RBI and the government.
If you recall, there was an anecdote by Duvvuri Subbarao (former RBI Governor) when he talked about a phone call between YV Reddy (former RBI Governor) and P. Chidambaram and he was listening to Reddy’s side and Reddy’s said no, no, no, no and finally said yes. He said what you were saying. Reddy said Chidambaram was asking for this and that and something else and I kept saying no. He asked me at the end if I could hear and I said yes. So that is the notion of the relationship between the RBI and the government. Of course the RBI doesn’t say no out of petulance. It says it because it has examined the situation and believes that this take implies too much financial instability. I think that relationship has gone on for a long and the fact that the RBI says no is not new. The government can keep asking and say please consider this, please consider that but at some point it says okay I respect your decision, you are the financial stability regulator and I back off.
Q: Let me come to the Basel rules: one general rule which the RBI has applied is 9 percent capital adequacy although Basel requires 8 percent. Deputy governor Vishwanathan just the other day explained in detail that Indian risk weights calculations are looser than that of Basel and global requirements. Be that as it may, the government’s contention has been why you are trying to be stricter than Basel requires. Why you don’t lower it to 8. Even in your time it was 9 percent. So what is the RBI’s stand there?
A: The RBI takes a view based on how it sees the Indian economy. If the RBI follows blindly Western practices, the RBI is accused of being thrall of the West. There are people who have made those accusations. If on the other hand we tailor it to Indian conditions we are asked why you don’t tailor it to Western conditions.
I think you cannot pick and choose which regulation you like and which regulation you don’t.
There are many places where the RBI is actually more lenient than Western regulations. I think we repeatedly had Indian banks getting into trouble, for example in Singapore because Singapore said they weren’t meeting Singapore standards while in fact they met Indian standards and we had a lot of back and forth about this. We are not necessarily the strictest regulator and I think that is a problem that we are not as effective as we should be and we are making progress in this path, but I do not think there is much to be gained by pointing to one regulation and saying this is looser or that is looser. Again make the case to the RBI. The RBI will decide but ultimately the responsibility for financial stability lies with the RBI. Once you have appointed these deputy governors and governor, you have to listen to them because that is what you have appointment them for, they are your safety belt.
Q: There is a third point of contention which is perhaps even more irritable for both sides and that is the government want the RBI to part with its capital. It believes that it is overcapitalised and there have been several studies on this even during your time. Do you think that that is a legitimate contention, should the RBI given part of the way, part of the capital. What is the way to find meeting ground because there doesn’t seem to be any?
A: This is a contentious issue and sometimes poorly understood issue. So let me try and explain a bit. One, the RBI’s equity is wholly owned asset of government of India. It doesn’t belong to the RBI, it’s the government’s equity and it ultimately is an asset of the government. Beyond that there is a question of how well capitalised the central bank should be. Like any entity a corporation which does a deal abroad, the reason for adequate capitalisation is for counter parties to believe in the strength of the RBI and to think that the RBI will honour promises it has made, for example when we did the swap deal in 2013, it was a commitment by the RBI that it would honour those swaps and without the kind of equity that would be backing us, it would be difficult. So the board in my time essentially decided that a viable level for the RBI would be to have AAA credit. Why AAA because India itself has a country rating BAA and so relying on the country rating would give us very high cost financing if we ever went out to get those financing instead we should have a balance sheet which in itself cast iron and capable of raising money in dire need from outside with a AAA rating. So that was the decision of the board and since then we have tried to put out an analysis of what it would take to get that AAA ratings. So that’s one; the credit worthiness of the RBI. Second, what can it pay out as dividends? The accountants especially a really respected one like Malegam who used to be on the board told us that you cannot pay more than the realised profits. So that is number two. You have to realise the profit, you cannot just pay out what is not realised profit. For example, the gains on the assets, the unrealised capital gains which is a big part of the RBI’s equity which comes from the foreign exchange assets we hold, we just cannot pay it out like that. The third, which is the least understood but perhaps the most important constraining the RBI is that every year it can only create so much money. Now beyond that essentially additional monetary creation would be inflationary. So every year we set ourselves a target and that is the money that is used to buy OMOs in the market and essentially provide indirect secondhand financing to the government by clearing space in market’s balance sheet for them to buy government bonds. The reality is that amount is limited.
If today, let us say the government wants three lakh crore dividend and that can be realised based on the first criteria that there is enough in the balance sheet and second, that we have profits which allow that payment, it still will hit the third criterion that we cannot create three lakh crore of additional money without selling government bonds in the market to take it back because otherwise it would be inflationary. The bottomline is there is no free lunch here, there is no additional money that government can get because whatever we pay, will have to be taken back beyond that profit that we pay to them as dividends. So by all means there could be a debate about whether the entire profit is paid or some is held back. My guess is that with the recent depreciation of the rupee the balance sheet is healthy enough; remember we hold dollar assets. So the balance sheet is healthy enough that possibly entire profit could be paid but whether there is an additional windfall, I am afraid that these constraints actually prevent that. I have tried explaining this many times in speeches and so on. Unfortunately because it involves monetary economics, it is little harder to understand.
Q: In your case the board said that the RBI should have AAA status. There is a board meeting coming up on November 19th. If it told the RBI governor to handover a part of the capital?
A: Let us address the issue of what the role of the board is. The role of the board in the RBI has historically been not to take operational decisions but to focus on broader strategy as well as ensure good governance. So they are there to ensure that the government’s money is well spent in the RBI, for example the RBI doesn’t pay itself inordinate salaries and so on but also to serve as sounding board which is why we have people from different walks of society, very eminent people have been on the board including Dr. Kakodkar, a Padma Vibhushan, Ela Bhatt whose work is known all over India – these were people on my board and when they spoke you listen because they had useful advice to give. They rarely tried to put themselves in the position of the professional RBI and you must do this or thou shall do that instead we put proposals before them and they weighed in saying we would advise this, we would advise that. We go back, think and come back. And eventually, they would be fine with it.
So my sense is the objective of the board is to protect the institution, not to serve others’ interest; it is to protect the health of the institution but also to provide wide, sensible advice. The aim of the board is to be Rahul Dravid; sensible, thoughtful and not, with due respect, Navjot Sidhu.
Q: The government started consultations with the governor under Section 7 of the RBI Act, which has never been used hither to. So it clearly looks like the government wants to have its way. Does that upset you itself per se the usage of Section 7?
A: I do not think the government has used it so far and I do not know how many times the usage has been threatened in the past. So I do not think we should read too much into this right now. I think certainly it would be best if each side respected each other’s motivation and thoughts and ultimately the RBI after listening to the government and hearing what the government’s issues were, provided the best professional answer it could and historically it has done that. I have no doubt it is doing that today. It has a responsibility to fulfill to the nation. It has to listen of course but at the end of it, after listening it has to make a decision because ultimately it has that responsibility.
Q: Things apparently are much hotter than that. This is an information that we have got that the government and the RBI, and the board and the RBI also perhaps are not seeing eye-to-eye on several issues. If on November 19th or earlier or later the RBI Governor finds that he is asked by the board to do something which he doesn’t want to do. If there is a resignation. How bad can that be if the governor were to resign?
A: I do not want to address a hypothetical and I hope that these issues are resolved. Ultimately it can only be resolved if both sides respect each other’s intent as well as autonomy and I worry that in the recent past a lot of unnecessary noise has been inserted into the board deliberations and I wonder if this is something that can be unwound or rolled back perhaps by taking away some of the people responsible for the additional noise. I think there is a healthy relationship and in these uncertain times and I think Dr. Acharya should be commended for sounding a warning. I have seen a lot of press saying he is comparing India to Argentina and so on. I do not think that was his intent in any way. I think he was just saying let us be careful in these uncertain times. That is a warning that is important for us to heed and heed it in the way it was given respectfully. Recognizing the fact that the RBI is not above the government, it is an arm, if you will, of the government and saying as a responsible part of the government it is my duty to warn that there are certain issues if we go further. I think that we should take that into account. These are not good times to be labelled a country which doesn’t respect the autonomy of the central bank.
One of the things that on the macro front we are doing well on is inflation. If in fact, there is the worry that the government could run roughshod over a central bank as Dr. Acharya pointed out in some countries, it hasn’t been a good thing for that macro economy and so respecting that warning and understanding India is very different from many of these countries, we should not walk down that path and it’s important for both sides to back off and for some, hopefully, elder persons in government as well as former RBI people to create a better understanding between the two and it may require, looking at what has prompted this recent angst in trying to deal with that problem.
Q: Trump has criticised Powell (Chairman, Fed), Theresa May has criticised the Bank of England (BoE) governor. If things came to a pass where the governor didn’t want to continue. Will it be taken in that stride that in all countries even in developed countries these differences are happening or can it be very damaging?
A: You have to look at the extent to which institutions are protected in different countries.
I think in the United States for example, Trump does not have the ability to fire the chairman of the Federal Reserve. The chairman has been approved by the Senate and to that extent there is much more elaborate and different process.
I think in India there has been an unwritten understanding that in fact there will be a viable relationship between the government and the RBI Governor and that these things will not get to a pass where the relationship breaks down.
I think it would be very unhealthy to ever get near the position where things go further. So as far as possible it is in the interest of the country that we stay away from that that we respect the institutional autonomy of the RBI as well as the traditions. Ultimately, this is about traditions on both sides and that we respect the traditions that have got us the kind of institution which the Prime Minister on the 80th anniversary was very appreciative of the quality of the RBI and we should protect it as a national institution.
Q: Finally, I believe You gave a list of wilful defaulters to the PMO and asked them to put all agencies to work together and give some of these guys exemplary punishment.What became of that letter. Did PMO do anything? The CIC has questioned the PMO on this.
A: The list to Prime Minister's Office (PMO) was of frauds (different from willful defaulters). I am not aware of what progress has been made on that.
Thank you Dr Rajan. Hope the relations between RBI and government don’t get as frosty as that between China and the US
First Published: Nov 18, 2018 2:22 PM IST
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