Supriya Shrinate, Executive Editor ET NOW, Times Group interviewed Raghuram Rajan, former Governor of Reserve Bank of India, on RBI vs. Government showdown. Excerpts from the show that was recently telecast on ET Now
Raghuram: It is a big overhang right now and I do think that we should be worried about the dialogue coming from each country. In US, it’s ‘Make America Great’; in China, it’s ‘Make China Great’. Every country wants itself to `make’ great. But, when it comes to relationship with other countries, I think the trade conflict is one of those worries. The hope is what we will see over a period of time; a better understanding of each other’s position. I think there are some agreements to be had right now. If in fact China can convince USA that it will change its behavior on the acquisition of property and on the flip side, if the US assures China that it is not going to use tariffs as a general means of blocking China’s path to growth for which there is an agreement to be had but it requires significant negotiation; it requires deep understanding of each other’s position and ultimately it requires acceptance that China is going to be one of the big powers and has to have place in global stage eventually on par with US.
I think, it is a process of learning and I think you cannot expect China to do that immediately but at the same time worst way to get at China to become a responsible global player is to essentially tell them we don’t like your rice and we are going to stand in your way. What that means is China will back off from international engagement, focus on building its bar looking both inward and regionally and eventually that will not be good for the world; because it certainly will be start of the cold war if not eventually a hot war So I think there needs to be much more dialogue…
While the world was celebrating United States becoming the global engine growth, all over again are the fault lines that you see, because many people believe President Trump’s policies are indeed very short-term and things may go belly up…
We had ten years of very easy money, and that has resulted in high levels of leverage both in pockets of US and across the world. Enormous amounts of money has been flown into the emerging markets and what that means is the Fed continues to raise interest rates and it will continue to do so because the US economy as you said is chugging along very nicely. The labor market is very tight; the job numbers are very healthy, also the wage growth is picking up so the Fed is worried about inflation. It is going to increase interest rates and entities that have borrowed a lot; especially in dollars, it is going to face the consequences down the line as the rates grow up and the rollover becomes more difficult so this I think is certainly a concern. Today, it is masked by the strong growth of the US economy but remember this is a stimulus which has come late cycle. It is a fiscal stimulus which will wear off into next year at which point, you will have the Fed high rates as well as the high debt but not the stimulus for growth. So my sense is at this point we should be preparing for a more volatile world going forward.
Every country wants itself to make great. But, when it comes with relationship with other countries, I think the trade conflict is one of those worries. The hope is what we will see over a period of time, there is a better understanding of each other’s position
We don’t know what the true level should be. I think by most estimates there has been an adjustment of the Indian Rupee towards a more comparative value. I think where you look from the Indian rupee is probably appropriately valued or overvalued or undervalued. But I think our focus should not be on rupee but doing all the things that will allow the rupee to find its appropriate value which means focus on micro stability and ensure that India presents a very healthy picture to the world when that volatility comes.
Former Governor Y V Reddy said the problem with currency management this time is that so far it was the Central Bank that was doing it; for the first time we are seeing a dual function being performed by the government in New Delhi and the Central Bank.
I don’t know what he has in mind; ultimately it is the trading desk at the Reserve Bank which trades both in futures market as well as in the spot market. So in that sense I am not sure what he means by dual role; if he means that there is more being voiced about the rupee from Delhi, well that varies from administration to administration. The historical sort of norm has been that it is the RBI which talks about the exchange rate and typically in my time we didn’t talk about it either because it was a sensitive issue; there is no way you can speak about it in the right way, just leave it alone. And if you are moving markets with what you are saying, you should not be probably saying it.
The US is not afraid of using its various economic powers in all directions. I think it will have effect and certainly in this administration there is a belief that if Iran is brought to its knees it will effectively agree to all that the administration wants in a new Iran treaty. I think we have got a waiver as I understand it, for six months, but I have no doubt that once the oil market is well supplied and prices are reasonable, the administration will try again to shrink the supply of the Iranian oil. That said, if the oil market is well supplied and prices are reasonable it may not be directly harmful for India and of course there are bigger geopolitical issues at stake but I think if in fact it comes when the market is tight which is possible then we could see ramp up in oil prices, which could be harmful.
I think we have to have a longer-term strategy in mind. I think historically short-term moves to address short term problems have proven sort of problematic. In the longer run if we want to `Make in India’, I think we have to have a far more open economy; we need to be part of global supply chains; we need to attract the business that is leaving China and going to Vietnam rather than coming to India - that typically means much lower tariffs. Of course we have lower tariffs over time but lower tariffs and a presumption the tariffs will stay low and predictable because just haphazardly raising it here and there will make it very hard to produce in the country. I think given how much of the components of products we export are imported, our aim should be to lower tariffs generally to have a more open economy. That being said, the current account deficit is heading towards 3%. I think that is certainly one worry especially if the price of oil is so volatile, it pushes it higher. The other big worry is after five years of fiscal consolidation the general government deficit which is state plus center is still stuck at around 7%. In fact, over the course of this government it has been going up not because the center hasn’t done what it is supposed to do but because the states have been increasing their deficit. I think the one time we had a big jump down was when Chidambaram came and reduced the fiscal deficit by a percentage point but since then we have been stuck at 7% at the aggregate. That is a problem because 7% fiscal deficit doesn’t look good when you have CAD to boot as well as growth which is around 7%.
Both are bad. I think we have had number of committees which have talked about responsible fiscal management, including the NK Singh committee. I think we should take all that. There is a tendency to believe that all the markets’ worry is the bottom line number from the center. And clearly it is much more than that as we have seen with the pricing of government bonds. The yields have moved up, even though the center is bringing down the fiscal deficit-the way you bring down the fiscal deficit also matters, whether you bring it down by actually matching revenues to expenditure or you get one time dividends from PSUs, which then go out and borrow in the market and by that token they don’t actually reduce the borrowing requirement. I am not saying this is particular to the current government but overtime, we have steadily tried to improve our fiscal management and we should continue to do so. Because ultimately markets are not fooled by the numbers if they think they don’t believe in fundamental change.
The historic relationship between RBI and government has been based on the fact that the government naturally and correctly thinks about pushing growth and for that it wants freedom given to all the entities who are responsible for growth
Let’s think a bit of what really the relationship between the Central Bank and the government is. Ultimately a good analogy is, it’s a seat belt for the government which is the driver. The driver can decide whether to put on the seat belt or not which is useful in terms of crash. Now think of the Central Bank as thinking about that crash and saying I want to protect financial stability because I don’t want that to be a terrible event. And the driver is thinking of normal driving and says I want to be relatively free of constraint but when they talk to each other, they realize there is some value to putting on that seatbelt because it prevents the really unfortunate eventuality.
The historic relationship between RBI and government has been based on the fact that the government naturally and correctly thinks about pushing growth and for that it wants freedom given to all the entities who are responsible for growth. While the RBI focuses on financial stability and says here is the amount of growth I can allow without in pinching on the financial stability and they work with each other on that basis and the government always pushes numerous letters on my table, saying relax this, relax that. And they know we would look at the letter carefully, take a view but that view would be saying how can we maximize growth, while protecting financial stability and then we say no, they would go and say okay, they have thought about it and two days later some another letter would come in for some another issue and they would try to keep pressing the boundary. Ultimately, the responsibility was for the RBI about financial stability and if we failed on it, we would be held to task. So given that responsibility, we had the authority to say no and let me remind you of that quote in Dr. Suba Rao’s book, where he talked about the relationship between Dr. Reddy and Chidambaram based on a phone call, where Dr. Reddy said he was hearing and Dr. Reddy said no, no, no, no and yes. When Dr. Suba Rao asked what are you saying no to, he said, he asked me to relax this, relax that and I kept on saying no, ultimately he asked, ‘can you hear me?’ I said ‘yes’. And that’s how the call ended and that anecdote is really about the relationship between the RBI and the government. The government appoints the governor, appoints the deputies, but ultimately goes by the views, knowing these are professionals, they are not doing for political reasons or for their own self-interest, they are doing it because they have taken a view on the ultimate stability of the country.
I think it is possible to disagree but still be respectful of each other’s territory and I think, certainly in my relationships, there were many disagreements but I hope there was an understanding that this was not because of bloody-mindedness but because there was a worry and they knew when the RBI said yes, it meant we were taking responsibility for the financial stability consequences and we always try to maximize the potential for growth while keeping the financial stability concern. RBI is an agency of the government and of course it has to respect overall concerns and objectives of the government. But the government has entrusted it the responsibility for financial stability and therefore it has to be a good responsible entity to carryout the responsibility and sometimes, as I said, seatbelt constraints. That seatbelt constraints because you put it on, knowing that it will prevent you from accident.
Firstly, Section 7 has not been invoked so that is the good news and I do believe that when the relation gets so precarious that if invoked, we have to be worried. I think the dialogue between the Reserve Bank and the government is always ongoing and there are always points of view being expressed; sometimes there are disagreements but ultimately it works on respect. You have to know why the other guy is doing, what he is doing and ultimately at the end of the day, you have to part, maybe not as friends but be respectful of each other’s territory. When you encroach on each other’s territory, it becomes problematic and I would hope that respect gets re-established.
I want to talk about the substantive amount of disagreement and one of them is liquidity infusion in the markets right now. The government is insisting that this must be done to bail out the NBFCs that are facing a cash crunch; the RBI believes that liquidity is enough in the system and that is a judgment for Central Bank to make. Is this a cry for more funds or is more funds required to avert a bail out avert a superstition by the government of many more NBFCs like IL&FS.
But generally in a situation, where there is financial stress, the Central Bank has to figure out whether it is ultimately a liquidity problem that is infusing liquidity into the market. Will it resolve some of those issues or is it a solvency problem that is some of these entities have taken on really bad assets and they are really de-capitalized-the reality is it is the solvency problem. It doesn’t mean that the government and Reserve Bank should not intervene but it really involves fiscal use of funds and therefore the government has to be directing that and putting tax payer money at risk. Now that is a big political issue because you are using tax payer money to bail out a private entity and people will ask these people made money over so many years, why is it that you are bailing them out-that was a big issue in the US when the bailouts took place. If it’s primarily solvency you can address that by infusing liquidity in the market and if the problem is if you need liquidity directed to certain places, perhaps lend to certain entities who can make those loans. I think any kind of intervention should come after the entities that are in difficulty have taken their own steps to bolster their balance sheets. If your view is that your commercial paper is coming in six months from now and if you are worried about roll-over, shouldn’t you be raising equity now? Even if prices are depressed in order to back your balance sheet that would be a good signal. That means you are not directly running to government and Central Bank to bail yourself out; that you are willing to take all your steps and it is when all the markets are frozen that you go and at which point the government has to decide it is a liquidity or a solvency and if it is the solvency, it may require wiping out the equity of these entities and taking them over as for example IL&FS has been done.
On the issue of frauds, the full arm of the course of the law should be employed to bring these frauds to book and to essentially show that Indian law enforcement structure is capable of doing that. That certainly is work in process
Well, we tried it three times when I was governor, to have a comprehensive discussion on this dividend; it always becomes the source of controversy, especially when it gets closer to budget time. And I wanted to make it a much cleaner and a mechanical process and I see we haven’t really solved the issue yet. This is an issue people need to know about; the reality is the RBI is a fully owned subsidiary of the government which means that whatever value is in the RBI is an asset of the government. There is no two questions about it; it belongs to the government. That said, is there a reason to leave some equity on the RBI balance sheet and take it out as an enormous dividend and the reason is we have a country which has a BAA rating. If the country went out to borrow in international capital markets for emergency, it would have to pay rates at that BAA rating rate. Having the RBI as a separately capitalized entity, which has an AAA rating-that was what the board in my time counselled would be what the RBI should focus on and gives you a vehicle which can actually make promises in the international market which are credible.
So for a rainy day, it helps to have one entity in the country which is well capitalized and which can hold its own in international markets. The first aspect of the dividend is will it essentially maintain high quality rating you want for the RBI. Today, I think with the recent depreciation in the rupee the value of RBI’s equity has gone up because remember RBI has $4 Billion or so as assets, when the rupee depreciates because its liabilities are in rupees, essentially, its equity goes up. Now it probably has reasonably amount of equity, so then the second question comes, you have reasonable amount of equity, you can pay, how much can you pay? You cannot pay more than profits. So we can pay profits and we can pay as much as we can make. That is what we were doing during the three years that I was governor, we paid all the profits. Then the third question comes, can you pay more than this of course there is accounting issue, the credit worthiness issue but beyond that there is a third issue, which is the RBI is not like an ordinary PSU it actually prints the money. If I pay extraordinary dividend let’s say it is three lakh crore, it means that three lakh crore of more money is there in the capital markets and that is going to be inflationary.
I think, there are two separate issues which are being confounded-one is the issue of fraud and the other is of wilful defaulter. On the issue of frauds, the full arm of the course of the law should be employed to bring these frauds to book and to essentially show that Indian law enforcement structure is capable of doing that. That certainly is work in process. Separately, there is the issue of number of business people who the banks believe are not paying when they have the ability to pay and eventually through a quasi-judicial process declare them wilful defaulters. I am not well-versed enough in the legal lease to understand why those names cannot be made public, after they have been through a judicial process but this is something that belongs to the legal realm rather than something that I have expertise in.
There is an intent to bring these people to book. But I do think that from a long-term perspective, if frauds go unpunished it simply encourages more fraud. If there is sense that there is no place on earth where you can hide because the long arm of the Indian law will come after you, I think it will send a sound message. If you have gotten away with money, you will not be able to enjoy the money. You cannot prevent fraud but you can create incentives such that it doesn’t pay.
There is room for improvement from all sides on the governance of banks, both, in the private sector as well as in the public sector as well as the role RBI plays. I think we to have recognize level of NPAs in both the public sector as well as the private sector is not by any means a level to be proud of, so we have to examine what went wrong and do what is necessary to put the banking system on a healthy turf because going forward, the amount of lending we need to get to that 9-10% growth, we must have in order to employ all the people that are coming to the labor force. We need a healthy banking sector.
Dr (Col.) A. Balasubramanian
