The Big Picture – Urjit Patel- Challenges before the New RBI Governor?

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Urjit Patel- Challenges before the new RBI Governor?

Urjit Patel is going to be India’s 24^th RBI Governor and the 8^th Deputy Governor to be promoted as RBI Governor. This decision has shown that the government is committed for previous policy continuity.

The new RBI Governor is called as a ‘fiscal conservative’ having a ‘hardline stance’ on inflation. With overtaking Raghuram Rajan as the RBI Governor in September 2016, Urjit Patel has numerous challenges decorated in front of him. Some of crucial challenges are expected to be:

Monetary Policy Committee

• A six member panel is expected to start deciding interest rates from the next monetary policy review date (4^th October 2016)
• Urjit Patel will be the first RBI Governor to oversee the interest rate decisions by MPC.
• The RBI Governor has no veto power but will cast vote in case of tie.
• The decision of the committee — three each nominated by the government and the central bank – will be binding on the central bank.

Inflation targeting

• The targeted retail inflation rate is 4% (+/- 2%) till March 2021
• The CPI inflation is on the rise (crossed 6% in July 2016).
• Raghuram Rajan’s tenure had experienced declining inflation rate. The CPI was going down and WPI had contraction.
• This time monsoon in 2016 has been better than before and oil prices remain at low level which might ease pressure on economy
• Yet, with the indicator being CPI which has 48% weight in food commodities and since lot of inflation is food prices induced, it is going to be a tough road ahead for inflation and growth balanced monetary policy due to improved rural demand due to good monsoon.

Both these changes have come on basis of recommendation of a committee headed by Urjit Patel as Deputy Governor. In some sense, he is the architect of both these issues. It remains to be seen how these mechanisms will perform.

FCNR-B Funds

• It is the Foreign Currency Non-Resident Bank account where the account can be opened in the name of NRI individuals (single/ joint) or with resident Indians on ‘former or survivor’ basis.
• The FCNR-B funds are maturing from September 2016. It means that more than 20 billion dollars is going to go out of country.
• Though the stage is set with liquidity being surplus in the banking sector but it has to be seen that there are no knee-jerk reactions in the market.
• As the forward purchases and the FCNR-B swaps are not exactly synchronous in terms of maturity bands, RBI has cautioned that foreign exchange reserve could see some dip in the interim. (Demand for dollars can depreciate the rupee’s value.)
• Background: 34 billion dollars was raised in September and November 2013 for three years. Out of it 25 billion dollars was through FCNR-B.
• Reason: in August 2013, rupee slumped to record low of 68.80 which forced the banks to raise funds

Banking challenge

• Banks are still in a big mess.
• The banking sector has been beset with bad loans that have risen due to slow growth, delays in project implementation and high wilful default rates.
• In the last 12 months, for 39 listed banks, gross NPAs rose 96% between — to Rs. 6.3 lakh crore in June 2016 from Rs. 3.2 lakh crore in June 2015
• Rajan has set a deadline of March 2017 for banks to clean up their balance sheets. Urjit Patel will have to ensure that this is met.
• Unless the banking NPAs and the banks’ ability to lend is directly linked to investment revival, a more sustainable path of economic growth is challenging.
• Rajan’s initiatives will start showing the results and has to be seen if they help in reviving the investments in India.
• The Asset Quality Review done across the board without making any distinction between problems arising out of real sector and problems arising out of the banking sector per se, has made the banks very risk averse.
• The challenge will be to instil more confidence and risk taking capacity among the bankers, especially the public sector banks.
• There has to be a fine balance established between cleaning the system so that banks can start lending again and maintaining the stability of the banking system.
• Critical leadership role in PSBs as they will be looking towards the RBI Governor not only as a regulator but as a leader to help them in crisis situation by interacting with government and managing the public perception about their work.

Debt Management

• Need for institutionalising the process of creating a separate debt office which is neither an appendage of finance ministry nor that of RBI.
• So, there has to be an independent debt office which must conduct the operations of government’s borrowing requirements

Regulatory control over bond trading

• The bond trading is controlled and regulated by RBI.
• It should ideally be under SEBI.
• The turf war between two institutions is visible. The new Governor has to bring out a solution to it.

Trickling down of interest rate cuts

• Rajan was criticised that he ignored growth and focused on inflation management. There was expectation that interest rates will be lowered so that more industries, particularly small and medium industries are able to borrow.
• Low interest rates were expected to help real estate too where consumers’ and developers’ borrowing from banks for housing loans would lead to growth which will lead to employment.
• With lower repo rates from RBI, the commercial banks were expected to follow RBI’s footsteps. However, that never became the case.
• The banks were aiming to recover their profits and stability with stable interest rates.
• Thus, the benefit of low rates was not actually transmitted to borrowers.
• RBI Governor will have to endure that it can make the banks work in tandem with RBI as well as the market needs.
• However, if the banks are forced to pass on the cuts, it reduces the profitability of bank when it is faced with large NPAs
• Also, RBI Governor has to make sure that it does not cut rates when inflation is on the rise. The depositors earn a negative return with high consumer inflation and this may repel them from finance sector, away from bank deposits to gold and real estate.

Management of NPA

• Public sector banks are grappling with NPAs amounting to about Rs 4.76 lakh crore at the end of March 2016.
• Large no. of corporates have misused the banking lending facilities by misusing loan taken for a particular purpose or taking loan in a very risky manner for the projects which are not viable.
• However, the banks are not to be solely blamed for NPAs. NPA or bad performances of banks have been result of bad economy in general and also some of the external considerations like large infrastructure projects not taking off because of delay in land acquisition or delay in environmental clearances making the entire project unviable.
• In this context, many economists feel that if the banks pursue bad loans very aggressively or NPAs in punitive sense then there is a likelihood that banks become more conservative in lending and the new industries would also become over-cautious in taking up new projects. This will ultimately effect the economy.

New digital banks

• Many digital payments and small finance banks are expected to start their operations in coming months
• RBI gave in-principle licences to 11 applicants of Payment banks in August 2015. Within 18 months, three have given up their licences.
• It also gave in-principle approval to 10 applicants to set up small finance banks. (Small banks can perform all activities similar to commercial lenders, though on a restricted scale)
• Only half of the work is done. Now, the use of technology to allow the poor to transfer money, at a low cost is more important task.
• The new RBI governor will have to regulate the new age banks

On traditional front, it will be his challenge to live up the reputation of fiercely protecting RBI’s autonomy and show the ability to withstand mounting political pressure that could arise during the course of the central bank chief’s tenure. However, having served as the deputy governor in the past three years, Patel is well positioned to further institutionalise these policy changes in the period ahead.

Key Words:

Forward: In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today, making it a type of derivative instrument.

Derivative Instrument: A derivative is a security with a price that is dependent upon or derived from one or more underlying assets which include stocks, bonds, commodities, currencies, interest rates etc.

CPI: Consumer Price Indices (CPI) measure changes over time in general level of prices of goods and services that households acquire for the purpose of consumption. It is used as a macroeconomic indicator of inflation, a tool for inflation targeting by government and central banks

Payment Banks: A payment bank is a differentiated bank that is allowed to carry out restricted banking functions. Payments banks can collect deposits, but cannot lend. These institutions are primarily aimed at giving access to formal banking services to those at the lower end of the income scale and also in remote areas.

Connecting the dots:

1. The new RBI Governor has taken over recently. What are the challenges encountered by him on macro-economic and banking front. (GS-3 Mains 2016)

Refer:

The Big Picture – Raghuram Rajan’s Last Policy: What’s his Legacy?