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How practical are Raghuram Rajan's radical ideas? : Business Today

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How practical are Raghuram Rajan's radical

ideas?
Anand Adhikari

March 4, 2014

If we are to achieve results never accomplished before, we must expect to employ methods
never before attempted," said the 16th century author and statesman Sir Francis Bacon.
Raghuram Rajan, the 23rd Governor of the Reserve Bank of India (RBI), may well have
been inspired by Bacon. RBI under Rajan is talking of a radically new approach to achieving
financial inclusion and creating a financial infrastructure for the new millennium.
In his five months at the RBI's Mumbai headquarters, the central bank has come up with
ideas that were never considered before. Consider, for example, the move to have bank
accounts for all citizens by 2016. Or the initiative to raise over $5 billion in September,
without having a sovereign bond issue, to combat the rupee depreciation. This was achieved
through a swap facility to attract NRI funds. The masterstroke was Rajans decision to go
after black money and fake currency by simply withdrawing currency issued before 2005.
Many of the existing banking practices and regulations were given shape several decades
ago. The RBI Act itself was drafted in the pre-Independence era, Winds of change have been
blowing globally for some time and the RBI needs to respond to them. The emergence of
electronic payments is transforming a poverty-stricken continent like Africa. "The
technological revolution bodes well for India. It can leverage payment technologies to bring
about financial inclusion," says Raj Jain, Chairman and Managing Director at RS Software
(India) Ltd, a technology company.

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Financial Inclusion
Today, 60 per cent of Indias population does not have a bank account. In addition, about 90
per cent of small businesses have no links with formal lending institutions. Efforts to achieve
financial inclusion have failed to deliver adequate results. Rajan sounded out his Indian
Institute of Management (IIM) Ahmedabad classmate Nachiket Mor, now a member of the
RBIs central board within days of taking over, for ways to cover small businesses and low
income households. By January, the Mor committee had come up with the concept of
"payment banks" with initial capital of Rs 50 crore, one-tenth of what a full-service bank
requires. These banks could be set up by existing banks as subsidiaries or by consumer
goods dealers and mobile phone companies, non-banking finance companies (NBFCs) and
the post office system. Payment banks will only accept deposits and not do any lending.
But some question the need to create another structure in addition to the existing banking
network. "The infrastructure of mobile phone outlets and kirana stores already exists," says
Mor. This obviates the need to set up more new branches and payment banks can begin
offering basic banking services on getting a licence, he adds. Mor has also recommended
allowing NBFCs to set up wholesale banks which will accept wholesale deposits (not retail)
and engage in lending activity too. Mor reasons that the best incentive for financial inclusion
is to create competitive pressure in the system.
The second important
recommendation of the Mor
committee is to have bank accounts
for all by 2016 by linking them to the
Aadhaar numbers of citizens. But
not many are convinced. They say
the larger issue is of simultaneously
strengthening the banking
infrastructure and raising standards
of living. "Financial inclusion
definitely cannot mean just the
...Not everybody needs credit and not everyone who asks for
opening of a bank account. It also
credit should get it: Nachiket Mor, Central Board Member, RBI
cannot be done only by the banks.
Photo: Rachit Goswami
You have to have financial viability,
telecommunications, power, water, roads and then banks can follow," said Aditya Puri,
Managing Director of HDFC Bank at a recent Indian Bank Association function.
Two of the Mor committee members - Shikha Sharma, Managing Director and CEO, Axis
Bank, and S.S. Mundra, Chairman, Bank of Baroda - have stressed the need for providing
the complete bouquet of financial services which wont be achieved through payment banks.
"But not everybody needs credit and not everyone who asks for credit should get it. Credit
has to be given much more carefully," says Mor.
Rajan is yet to take a call on the Mor committee report.
Monetary Policy Reforms
On his very first day, Rajan also talked about a new approach to formulating monetary policy.
Rajan picked Deputy Governor Urjit Patel to take a look at what more needed to be done to
strengthen the monetary policy framework. The Patel committees report talks of inflation
targeting as the sole objective of the monetary policy and has insisted on using the
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consumer price index (CPI) instead of the wholesale price index (WPI) for determining
interest rates. The CPI itself is a very new series with no long history. The share of food
component is very high in the CPI, almost half, which limits the impact of the monetary policy
on the index, say analysts.
"There is nothing wrong, theoretically or
conceptually, in using CPI as a nominal
anchor, but I dont think it will work as
monetary policy cannot influence any
significant component of the CPI," says
Madan Sabnavis, Chief Economist at Care
Ltd. In the third quarter review of the
monetary policy in January, Rajan has
made a reference to CPI, which shows he
obviously sees merit in using it as an
inflation anchor. Patel committee has also
suggested forming a five-member monetary
policy committee (MPC) to decide policy
action.
These two radical ideas are in direct conflict
with the recommendations of the
government-appointed Srikrishna panel on
Financial Sector Legislative Reforms.
Srikrishna report, submitted a year ago, has
clearly spelt out the governments role in
Financial inclusion definitely cannot mean just the
giving quantitative monitorable objectives to
opening of a bank account: Aditya Puri, MD, HDFC
RBI for monetary policy formulation. The
Bank Photo: Nishikant Gamre
mandate of the RBI spelt out in the Act is to
support growth, financial stability (of the banking system) and price (inflation) stability. "The
objective that the RBI must pursue would be defined by a central government and could
potentially change over the years," added the Srikrishna report.

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The composition of the MPC suggested by the Patel committee - with RBI Governor as
Chairman, a deputy governor, executive director and two external members - is also in
contrast to the Srikrishna committee recommendations. Srikrishna has suggested a sevenmember MPC, which includes the RBI Governor, one executive director from the RBI and
five external members. Out of the five external members, two will be appointed by the
Governor and three will be by the government. Clearly, the government wants to have a say
in the monetary policy decision-making whereas Rajan appointed committee is tilted in
favour of the RBIs independence.
Internationalisation of the Rupee
Many were surprised when on the very first day of assuming office in September last year,
Rajan talked about internationalisation of rupee. "This might be a strange time to talk about it,
but we have to think beyond the next few months," said Rajan. It actually means acceptability
of the Indian rupee for settlement of cross border transactions globally like the dollar. Rajan
spoke about internationalisation when he was actually expected to do some fire fighting to
save the rupee from depreciating against the US dollar. The rupee breached the 68 mark last
August against the dollar. "That may be his long term plan," says Rohit Wahi, CEO and
Country Head, FirstRand Bank India. Internationalisation is a sensitive issue as it first
involves capital account convertibility. This might make the rupee volatile and it might
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eventually depreciate because of a large current account deficit. A report authored by two
RBI executives in May 2010 said: "It depends on market forces, i.e., how much faith the
market has in that currency, which in turn depends on various factors, such as size of the
economy, level of financial development, stability, etc."
Distressed Assets
Rajan is quick to spot the growing non performing asset (NPA) menace in the banking
sector. While his measures for early detection of bad debt are laudable, the second leg of
NPA resolution, which depends on the courts, requires an overhaul of the legal system. The
RBI plans to take up with the government concrete suggestions on reining in NPAs. These
include creation of additional debt recovery tribunals, creating special cadre of officers and a
separate bench for speedy disposal of NPA-related cases. Recommendations may also be
made to the government to expedite setting up of special benches in every high court for
corporate cases. "But these things will take years," says an official of an asset
reconstruction company.
The governor wants to reduce the SLR
(statutory liquidity ratio), which requires
banks to invest 23 per cent of the deposits
in government securities. "This (reduction)
cannot be done overnight, of course. As
government finances improve, the scope of
such reduction will increase," said Rajan in
his very first media interaction. The banks
today hold 28 per cent SLR, more than the
stipulated amount, because of shrinking
lending opportunities in an economic
slowdown. "Commercially speaking, banks
are finding it more comfortable to hold risk
free G-Sec," says Sabnavis.
Separately, Rajans idea of allowing fund
transfers by way of an SMS system also
looks ambitious. "It actually requires
installation of encrypted software in every
handset," says Uttam Nayak, Country Head
at Visa India. And thats a challenging task to
have such an encryption with handset
manufactures spread over different
geographies.
Clearly, Rajan is not looking at band-aid
India can leverage payment technologies to bring
solutions to fix the larger structural issues
about financial inclusion: Raj Jain, CMD, RS Software
(India) Ltd
and has set an ambitious agenda for the
central bank. Can he pull if off? For the moment, Rajan exudes confidence that he can ring in
far reaching reforms.
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