RBI governor, Raghuram Rajan, admits there is sluggishness in investment. The rate cut should help improve investment sentiment. In formulating his credit po0licy, Dr Rajan has argued like a pragmatic economist and not a central banker alone. In his media interaction, he observed that it was no good checking inflation by killing the economy. So what do you do?

You encourage the economy to grow to its full potential while not letting your guards down on inflation. He explained, at 7.5% annual growth, most other major economies would have raised interest rates to check overheating. However, it is a different story in India. The Indian economy has the potential to grow faster without overheating. Industrial sector, for example, is showing tepid performance. Corporate sector results are also not buoyant. Thus, there is need for encouraging growth further.

RBI governor said that it would have been too cautious not to cut rate at this point of time. There are of course inflation risks, he stressed.

There are three main risks to inflation.

First, monsoon looks uncertain with El Nino factor being strong, according to some predictions. Hence, the critical factor would be food management. Government will have to fine tune releases from buffer stock and stabilise prices of sensitive items like pulses. RBI indicates possible imports in case of price spurts.

In the longer term, raising farm production was the best bet for price stability in India. Minimum support price could be instrumental. But, Dr Rajan criticises its implementation as limited. Governor felt that minimum support pricing policy needed restructuring. It is currently confined to only a few commodities and to a few states. To be effective, MSP should be extended to many other commodities and to all states.

Secondly, crude prices are again rising. Crude prices have recovered from just around $40 for a barrel to around $70 a barrel now. The recovery has been stretched over the last six weeks. At the same time, there are upside checks on crude prices. US shale production kicks off at $70 per barrel which sets an upper limit. Thus, it is reasonable to expect that oil prices will not exactly catch fire in the global markets as seen sometime before.

Thirdly, volatilities in the global markets could throw a spanner. These can create some disruptions and send ripple effects. The global volatilities could touch Indian financial sector and even exchange rate. While refusing to get pinned down on any specific exchange rate for the rupee, the RBI action programme was to intervene when there were “significant movements either way”. Incidentally, Dr Rajan felt that there was “plenty” of exchange reserves available for market interventions in such times.

RBI governor termed Tuesday’s announcements as “Goldilocks Policy”.

But then, what is the point of cutting policy rates if these are not transmitted. What has been witnessed earlier is that the banks refused to cut their lending rates even when RBI reduced its policy rates. The governor hoped that banks should now cut their rates. Past rate cuts have not been fully reflected.

Credit policy is a routine business of a central bank. There are some long term development goals for the financial sector with the development of the real economy. RBI policy statement and subsequent interaction of governor Rajan give insight into what is playing in his mind.

Three things stand out:

First, governor Rajan is bent on letting more competition on the ground. Indian banking should not be a closed club affair or one reserved for crony players. Governor announced that a new set of bank licences should be announced by August. More banks should bring in a whiff of fresh air. There should be differentiated classes of banks meeting differentiated needs. We have heard about payments banks, specialised rural banks, and maybe more such niche players in the future.

Secondly, Dr Rajan has done some plain speaking which is really welcome. He asserted, fairly robustly, “RBI is no cheerleader. Let cheering be done by those who want to do that”. RBI stands for credibility and its task is to provide stability and soundness. Hence, there was no question of RBI either acting at the behest of the government or it is set against it. Governor insisted RBI and government were acting in sync: “We both play together”. He made the observations in the context of a question if RBI and government had serious differences. He felt government was taking steps to remove bottlenecks and clear stalled projects.

Thirdly, the governor was not too happy about the state of the public sector banks. Governor was concerned over bad assets portfolios of Indian banks. He however insisted banks should recognise bad debts and provide for these rather than putting off recognition of bad debts. It is the banks themselves who have to deal with this problem and come out with clean balance sheets. But this should be achieved quickly and not postponed. Does the bad debts portfolio make it imperative to shore up the PSU banks’ capital base immediately? This still remains a vital issue.

As for banks’ capital structure, governor said that even if immediate capital infusion was not needed generally, more capital would be essential for future. He emphasised on banks generating funds internally and also raising funds from market. The second option might broach the further issue of government’s shareholding in PSU banks and government conceding controlling stake. (IPA Service)