RBI shouldn't play the role of govt's debt manager: Rajan

Raghuram Rajan, author of the latest report on financial sector reforms, today said that the Reserve Bank of India (RBI) should distance itself further from the government to preserve its credibility at a time when the Centre was rapidly borrowing to fund deficit.

Rajan, a professor at the University of Chicago, said if the money raised by the government was not spent, it could result in inflationary pressures, pushing up real interest rates. The problem could get aggravated if foreign capital flows rose, said Rajan, who was in Mumbai to deliver a lecture.

He suggested that RBI should be relieved from the role of being the government’s debt manager and have a clear focus on inflation.

“The rationale for guiding the government to manage its own debt as opposed to having it lie with RBI is that in that situation RBI is not pressured into buying debt because it is the debt manager. To my mind, this is one of the reasons why it makes sense to separate these two offices,” he said.

Maintaining that there was not too much room for further monetary and fiscal policy accommodation, Rajan elaborated on the rationale for RBI to focus on inflation.

He said it would not in any way result in diluting the central bank’s mandate of managing interest rates. It would only mean that the focus would automatically ensure low interest rates, which in turn was a necessary ingredient for growth, he said.

“A more formal monetary policy committee structure should be set up with technical experts and former governors of RBI to broadbase the process of determining interest rates,” he said. The former International Monetary Fund Chief Economist also said that banks should float convertible debentures for managing the crisis instead of maintaining buffer capital. While delivering a lecture on ‘Financial Sector Regulation in Light of the Crisis, Rajan said buffer capital was often a burden on equity and was also expensive.

“Raising capital in good times and reducing it when times are bad is not easy. Therefore, banks can float contingent capital in the form of convertible debentures which could be converted into equity only when they need capital. Managing debt is cheaper than equity,” he said.

In a report on the financial sector, G 8 had recommended that banks maintain higher capital in good times to be used during the bad times.

He also said that new markets and instruments should be developed to reduce over-dependence on the banking system. These would also act as shock absorbers for diversifying risks.

Greater foreign and domestic institutional participation in the corporate bond market and securitisation facilities of the receivables of finance companies could go a long way in this regard, Rajan said. “The lesson from the (credit) crisis is not that we should stop having markets. Conservatism is good but at some point in time one should trade off between risks and conservatism for growth or otherwise the policies will be questionable,” Rajan said.

Insurance and pension funds were not at all used for the corporate bond market, he said. At the same time, funds were a constraint for infrastructure development, he added.

Rajan pointed out that India Infrastructure finance company borrowed from banks and on-lends to banks. Instead, he said, markets should be developed for infrastructure companies to source finance from households. He reiterated his earlier recommendation that India should create a statutory body called the Financial Sector Oversight Agency comprising chiefs of regulatory bodies that would be answerable to a council headed by the finance minister.

Commenting on a single currency for better returns vis-à-vis dollar, he said renminbi (Chinese currency) could emerge as a substitute currency when made convertible, followed by the Indian rupee, given their stability.

He said India was poised delicately for growth; but the big question was whether or not we regain the same level of growth and consumption.