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My focus was always under-promise and over-achieve: Raghuram Rajan

Mandating Aadhaar for deposit accounts is an important step forward, said Raghuram Rajan

Anup Roy 

Raghuram Rajan
Raghuram Rajan

Banks were fooling themselves by not acknowledging their bad debt mess, says former Reserve Bank of India (RBI) governor Raghuram Rajan. Speaking to Anup Roy on the sidelines of the release of his book “I do what I do” in Chennai, Rajan says through his speeches he had tried to warn about the impending dangers, which have largely come true now. He also reveals his plan for setting up a liberal arts university in south India as part of his continued engagement with the country. Edited excerpts:

How does an event like demonetisation impact efforts to internationalise the rupee?

I haven’t thought about that as much, because most international investors are invested in financial assets. Demonetisation was not really about financial assets.

Do you think something more is left to the demonetisation saga?

Very hard to tell. First, we have a concatenation of factors. We have had the twin balance sheet problem, the anticipation of GST (goods and services tax), and then demonetisation. These three things probably had adversely affected growth. On the positive side, the world economy is doing better. So there should be a positive effect of growth there. Net effect is, whether we have seen the end is hard to say. Certainly, I understand there’s enough currency available and nobody would be prevented from doing transactions. The two sources of lingering effects of the adverse side are: one, sentiments are depressed, and two, some small and medium enterprises that were working on thin buffers may have shut shop when they found that sales were plummeting for cash-based transactions. Those could be bringing down the growth potential for a little while, until we see new businesses starting up.

You have a research paper that shows that small firms should grow rapidly for the economy to strengthen. That momentum is hurt, right?

Yes. Any firm that goes out of business, you have to recreate its economic capital, its social capital. All that will take some time. That’s why recessions have serious effects because businesses go out. Now some businesses that shut shop may deservedly have had to shut shop because they weren’t particularly profitable. But to the extent the lack of liquidity, lack of loans they were experiencing, is a problem.

We are transitioning to a middle income economy. Are we prepared for that?

We are working on our institutions. This recent move to bring in the bankruptcy code is very useful. It is one of the institutions we need for a stronger financial sector. I think if we keep doing that, we have the precondition for take-off. One of the most important institutions that we have, and this should strengthen, is the Competition Commission. I think we need to continuously beef up the capacity of our central bank and our regulatory bodies.

What about the autonomy of the RBI and its governor?

I think we have some autonomy and it’s important to preserve it.

But you said the bureaucrarcy tries to whittle down the powers of the RBI governor.

I think it is not so much (about) the autonomy, it’s the turf. Every person likes to build more of an empire. And in an environment where the government feels constrained by the RBI, it may on certain occasions allow the bureaucracy more reign. I think it’s important to have a balance. Interestingly, when a job has to be done, because the RBI has built a certain amount of capabilities, that job is often entrusted to the RBI. It’s back and forth.

What were the other alternatives to demonetisation that the RBI suggested to the government?

I can’t talk about the specifics of the alternatives. But I can say that narrowing the scope for evading black money is something the government has been working on, like mandating Aadhaar for the deposit accounts. That is an important step forward because that would slow down the flow of black money.

After the Supreme Court judgment on privacy, the use of Aadhaar has come into question.

I think it is important for the RBI and the government to satisfy the Supreme Court that privacy issues are being respected by the whole Aadhaar process. I think the Supreme Court has a valid concern that it should not be open for everybody and on any basis whatsoever. It shouldn’t be possible for people to fishing for private data, even for government officials to have free access to that private data. So, those kinds of privacy inputs have to be built in and the onus is on the government for those kind of regulatory institutions to prove to the Supreme Court that that has been done.

This time farmer distress was largely because of demonetisation. What’s your view on the moral hazard of such farm debt waivers?

I don’t want to comment on specific sources of farmer distress because I am not sure where it has come from. I do agree with a number of statements that have been made, which I also made when I was the governor, that loan waivers tend to be problematic for the farmers themselves because access to credit tends to get weaker over time because bankers fear the weakened credit culture. Also, these loan waivers don’t touch the farmers who borrowed from the informal sector such as from moneylenders. These farmers may be in difficulty the most. Those with access to public sector loans may be better off. So we have to be a little careful in these situations. Not to vitiate the credit culture and not to be disproportionate beneficial to the farmers who can stand on their own but not to those who can’t. The broader point is that we have to ask what are the sources of agricultural stress and address those at the root.

Should RBI be looking into individual accounts?

I think if you ask the question that way, the answer could be that the RBI should not be both the regulator as well as (someone) making commercial decisions. If you are in a special situation where you have to nudging the process forward, lighter the nudge the better. As I understand, the RBI has so far pushed a number of banks to invoke the bankruptcy code but not specified what kinds of haircut have to be taken. It seem to me that it is a slight nudge. You can argue that even that push should be given by the banks themselves, not the RBI. Fundamentally, the issue has to be how do we make the environment such that banks would take commercial decisions.

Banks don’t have capital, while the RBI’s provisioning norm is very steep. In just six months, as liquidation begins and banks have to set aside more provisions, some banks may become bankrupt.

The bankruptcy structure discovers what is the true value of the loan and creates a capital structure for that. If the value of the loan is really so low that you have to take such haircut, who are you fooling by saying that let us not write this down. The mistake a lot of people do is by saying that the provisioning is causing the bad loan. No, bad loans exist. What the provisioning is doing is acknowledging that the bad loans are worthless. That said, I would be very careful in using the word bankrupt. It’s not clear to me that is indeed the case, but certainly, some banks have been put on prompt corrective action. For bankers to say for bear, don’t force us to do provisions, who are they fooling?

Globally, many powerful, nationalist leaders are coming up. At the same time, central banks seem to be creating a bubble by their easy liquidity stance. Where are we headed?

I don’t claim to have the foresight to say what may happen. It is true that we have a lot more geopolitical tension, especially with North Korea happening. We also just had a border tension with China. Some of it is because we also have voters who have elected stronger leaders and some leaders are moving to a certain authority, for example China. When you have a lot of such people, there may be less room to maneuver. And what is tension quickly turns into a conflict. It is heartening that both China and India have managed to find a solution in this particular situation, but we still have the very important tension between the North Korea and the United States, and at this point we can only speculate how this will be resolved. I will put those geopolitical tensions as an important source of concern. The other concern is that in the financial sector, policies have been very accommodative for a longer time and that it could turn around when interest rates go up. So, at one point you will see there are some fragilities in the system. When everything comes together, we have to be really worried.

The RBI has been criticised for not cutting rates when inflation is falling rapidly and growth is questionable. Is it because the monetary policy committee is just following a single mandate of inflation?

I don’t want to comment on the current policy, but the medium-term inflation forecast targeting is basically achieving the inflation core in the medium term. If the economy is very weak, that gives you room to allow the economy to grow faster. What the RBI has to do, if it departs from the inflation core, is really write a letter to the government as to how to get back to that inflation within a reasonable period. Most people would say a reasonable period is a couple of years. That gives you enough freedom. It gives you the freedom to say that if growth is plummeting, inflation would too. So I don’t need to tighten policy today and I can be a little more accommodative. Those kind of judgments can be made in an inflation-targeting framework.

What kind of role we can expect from you to remain connected with India?

There is nothing on the table. I am doing other things. I am working with some very good people on creating a liberal arts university in the South (India). In fact, tomorrow we are going to have discussions on that. There are engagements that I will have. Not with the private sector, but generally the not-for profit and the public sector.

Will you be the dean of that university?

I am not interested in any position. Just trying to make sure that we create the right structure. I was involved in setting up the Indian School of Business (ISB). So this one I thought was a very worthwhile venture, giving good education to young people.

What led to your departure (from the RBI)?

I had a three-year term that ended. And there was no offer on the table for a new term. That was it.

Is it because of your outspoken nature?

I don’t think I am the right person to answer that question.

We are argumentative Indians, but, as a country, we really don’t have a culture of dissent. Did you try to change that?

I don’t think you can use the RBI governorship to push that agenda. But I thought I said what the position needed to say. I was careful to see that I was not carrying out a private agenda. If you look at every one of my speeches, you will find that what it was warning about and what it was saying has largely come true. When I said “make for India”, I was saying the global environment was weak and our exports were continuously plummeting. It is not that people were saying that Oh! we will have an export-led growth. What has happened since then? That was a saying in order to be able to make for India, at least in the short run. We needed to ensure macro stability. I was saying just be careful about blowing out India, we can’t be complacent right now. Ever since I said that “one eyed King …” growth has been falling. We have to be careful that we don’t over-promise. My focus always was under-promise and over-achieve. We need to worry about some of those things; my point was never to raise the issue of dissent. It was to say what needed to be said.

Our exports are not growing, and there are some who believe a strong rupee is a sign of strong country. Your thoughts.

Because it hinges a little bit on monetary policy. I don’t want to comment directly on this, but broadly I would say that at the RBI, at least in my term, we never focused on a particular level of the exchange rate and never focused on keeping the rupee at some level to indicate strength or to try and keep it undervalued so that we get export growth. Broadly let it move to where the market is pushing it, but make sure we don’t have excess volatility. I don’t know that that policy has changed, but I don’t want to comment on that.

First Published: Wed, September 06 2017. 00:31 IST
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