Can he pull it off?

Plain speak and decisive action have become Raghuram Rajan's trademark. But in coming to grips with issues like inflation-growth dynamics and distressed banks, he has his work cut out

Central bank Governors seldom indulge in plain speak. You have to always read between the lines to understand what they are really wanting to say. In that context, election results are the last thing on earth that they would comment on in public forums. But Raghuram Rajan is clearly no prisoner to any tradition - evident from his observation during a speech in Delhi in the second week of December that nobody could take it for granted that India would have a stable government after the Lok Sabha polls.

The Governor then went on to advise the current government not to splurge money on populist measures but be active in passing all pending Bills, as he thought it would be "overly complacent and dangerous" for the government to postpone necessary legislations in the belief that they would be passed post-election.

Rajan has gone off the beaten track in many other ways, too. According to central bank insiders, he is most probably the first governor of the Reserve Bank who holds one-on-one discussions with general manager-level officers. He has also said he is even ready to interact with assistant general managers, provided they know their subject. Rajan is also keen to alter the demographic structure of the central bank, by inducting younger officers. This is indeed a big deal in the central bank - typically characterised by bureaucracy and lack of decision-making ability (only North Block can perhaps beat them on these parameters).

These are just two examples of the freshness that the former International Monetary Fund chief economist has brought in from the day he moved into the corner office on the 18th floor of the RBI headquarters in south Mumbai. He obviously knew that he had to do things differently from day one itself.

That explains his maiden media briefing on the first day itself, where he issued a seven-page statement, the content of which is no less than a full-fledged monetary policy, minus the interest rate stance.

Amidst the hype on his first day in office, Rajan made it clear that he would not hesitate to take tough decisions - "Some of the actions I take will not be popular. The Governorship of the Central Bank is not meant to win votes or Facebook 'likes'," he said. What followed was a policy rate hike later in the month, which changed the policy rate trajectory, and took the market off guard.

Observers say he has succeeded in changing the idiom. During his predecessor's time, markets would go into a sulk even if the RBI prescribed a status quo on rates. Consider this change: When Rajan raised the interest rate a second time in two months in October, and maintained a hawkish tone, the stock markets actually closed the day in the black and the finance ministry would actually say that the central bank was on the right track. Compare this with what happened a few months back. When D Subbarao announced a status quo on rates, Finance Minister P Chidambaram responded by saying he would walk alone on the growth path.

So Rajan has indeed been able to manage expectations quite brilliantly. He has also had initial success. Exchange rate volatility was arrested, and he managed to stay ahead of the curve (his predecessor D Subbrao had faced constant criticism for being behind the curve) in managing inflation. To act quickly and decisively is becoming Rajan's trademark.

The governor took charge at the central bank at a time when the currency was hitting new lows every other day, there was stubborn double- digit inflation, and non-performing assets of Indian banks were mounting. In addition, he also has the responsibility of issuing fresh bank licences - a process recurring after a decade or so. Further, he has emphasised the idea of differentiated bank licences - lenders offering specialised services or operating in a small area, which can change the entire landscape of banking in India.

INFLATION
Rajan was quick to move ahead of the curve in his fight against inflation. Inflation is still high - at both the wholesale and the retail level - mainly due to high food prices, though non-food manufacturing inflation has softened significantly, indicating the diminishing pricing power of the industrial sector.

Most importantly, supply-side issues are dominating inflation numbers, where monetary policy has a limited role to play.

"With the government not doing its bit and leaving the RBI to fight a lone battle, monetary conditions are tight, as inflation rages on and inflationary expectations remain stubbornly high," Kunal Kundu of Societe Generale wrote in a report.

THE FIVE PILLARS OF RAJAN'S AGENDA

Apart from short-term objectives, Rajan has indicated five focus areas

• Strengthening the monetary policy framework: A committee under the chairmanship of Urjit Patel, deputy governor, RBI, has been set up to review the process
• Strengthening the banking structure through new entries, branch expansion, encouraging new varieties of banks, and moving foreign banks into better regulated organisational forms
• Broadening and deepening financial markets and increasing their liquidity and resilience, so that they can help absorb the risks entailed in financing India's growth
• Expanding the access to finance of small and medium enterprises, the unorganised sector, the poor, and remote and underserved areas of the country
• Improving the system's ability to deal with corporate distress and financial institution distress by strengthening real and financial restructuring as well as debt recovery.

So, the consensus is that despite his best efforts, Rajan's fight against inflation may turn out to be futile, if the government fails to remove the supply-side bottlenecks.

EXCHANGE RATE
Coupled with Rajan's hawkish tone, the measures to boost foreign inflows stabilised the currency and recouped half of the rupee's losses during April-August in the following two months. Inflows of $34 billion through the twin swap facilities boosted foreign currency reserves and calmed the nerves of foreign exchange market players.

The former chief economic advisor in the finance ministry is also lucky, some may say. In tandem with the steps Rajan took, the US Fed signalled that the tapering of its asset purchase programme is not imminent, and this took the pressure off emerging market currencies.

But Rajan was not complacent. "Let us remember that the postponement of tapering is only that, a postponement. We must use this time to create a bullet-proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike," he said in his first monetary policy review on September 20.

Building up foreign exchange reserves is seen as one of the important ingredients of a stable currency. India's import cover has halved to seven months - last seen in 1998 - in the past five years.

The country's present foreign exchange reserves - a little above $290 billion - can cover imports for about seven months, while experts see 8-10 months' cover as essential for the stability of the currency.

NEW BANKS, NEW TYPES OF BANKS
Rajan also has the mandate to complete the unfinished task of his predecessor D Subbarao, under whom the process of granting fresh bank licences was started back in 2010. The central bank is set to grant fresh licences after almost a decade. While Subbarao did all the hard work on this highly debated subject - from framing guidelines to modifying laws to give the central bank more power - the decision is now left to the PhD from the Massachusetts Institute of Technology (MIT). It is a tough call, as for the first time the RBI will consider the applications of industrial houses for entering banking. From business conglomerates like the Birlas and Bajaj to micro lenders and non-banking finance companies, all have queued up for this coveted licence.

Under Rajan's aegis, the country will also see a departure from the single type of licence to differentiated licences. At present, only a universal banking licence is available in the country; unlike in the developed nations, differentiated licences are not granted. Now, a discussion has been initiated by the RBI on whether differentiated licences are a viable option, with a lender only serving retail or high net worth clients, or investment banking clients, or offering all services but in restricted areas.

ASSET QUALITY
With the asset quality of lenders, particularly public sector banks, deteriorating every quarter, the governor has made it clear that one of his priorities will be to "deal better with distress".

According to a CARE Ratings study of 39 banks (26 public sector and 13 private sector), the overall gross NPA ratio for these banks will be around 4.5 per cent by March 31, 2014, with public sector banks (PSBs) having a higher gross NPA ratio estimated at 5 per cent. Further, banks will have to provide more for restructured assets, as per the RBI's guidelines. These factors would exert downward pressure on margins and are likely to squeeze profits for 2013-14 by around 30 per cent.

"Deterioration in asset quality continues to be the major factor impacting profitability of banks in the near future," the rating agency said.

Coming down heavily on banks, Rajan had said the worst way for a bank management with limited tenure to deal with distress was to "extend and pretend" to evergreen the loan, hoping that it recovered by a miracle or that one's successor had to deal with it. As a remedy, Rajan advised banks to detect stress early and promised incentives for such vigil.

"Here again, you bankers have a critical role to play, by fighting the natural incentives that are built in to the system. You have to help those with genuine difficulty while being firm with those who are trying to milk the system. The RBI will help you with every means at our disposal," he had said.

These are quotable quotes. But with the honeymoon over, can the new RBI Governor pull it off?