Saturday, August 27, 2016

RBI's Next Thousand Days

What Urjit Patel can do to help improve India's investment climate
Urjit Patel will take over as Governor of RBI on September 4. Close to 53, he is among the youngest to be appointed to this position. One ho pes this is part of a larger move by Prime Minister Narendra Modi and the NDA government towards placing younger persons in high policy positions, in line with India's demographic profile.A lot of ink has been spilled on Patel being an inflation hawk. This is an irrelevant discussion now that an inflation target has been hardwired and maintaining a pre-determined inflation rate is the law of the land.
Patel is duty bound to implement the law, in consultation with the monetary policy committee (MPC). With these statutory changes, it does not matter one tiny bit if the Governor is a hawk, an eagle or a dove. The days when the Governor was the monarch or James Bond of Mint Road are definitely behind us.
Patel can, however, help the investment climate by focussing on improving the monetary policy transmission mechanism and ensuring sufficient liquidity in the system, both of which will help bring down lending rates even when repo rates are left unchanged by the MPC.
It is amply clear that reining in food inflation, responsible for sustained high inflation during UPA's two terms as also at present, is key to controlling headline CPI inflation rate. Food prices that constitute 46% of the consumer price index are not readily amenable to monetary policy measures. Therefore, food inflation requires addressing supply side constraints.
Patel will have to persuade and cajole his government counterparts to bring down barriers that currently prevent private traders, with their ears to the ground, to move food supplies in and out of the country , and across state borders, thereby improving the supply response for emerging shortages and surpluses.
Additionally , RBI should set up its own system for food price monitoring so that it does not have to depend on dodgy and delayed government statistics to initiate necessary action. Patel certainly does not want to land in the situation in which some of his predecessors found themselves, where both interest rates and food inflation remain elevated.
Cleaning up of commercial bank balance sheets and ridding them of dubious accounts and non-performing assets will have to be pursued. Having worked together with him on the board of one of India's largest commercial banks, i know of his frustrations in securing honest and correct data on advances and NPAs.
Hopefully, that experience will not make him go for the jugular and force banks to clean up their balance sheets by March 2017. That could have unforeseen deleterious consequences for the corporate sector as also for banks themselves. Taking a longer term approach that allows banks to take advantage of growth over the upswing of the business cycle, to nurse some non-performing assets back to health may be a better approach.
This does not imply that Patel should not expose the cronies and wilful defaulters. But it does imply that banks are allowed some more space to help those honest entrepreneurs who currently find themselves in trouble because of cyclical downswing, delays in clearing their receivables either by the government or corporate clients due to financial constraints. A physician's approach rather than that of a surgeon would perhaps be more apt at this stage.
Patel would also do well to pay far more attention than given by any of his predecessors, to financial technology.While there has been substantial progress over the past 10 years Indian banks, by and large, are way behind the curve in designing their processes and compliances around a core IT and digital system.
Digital India, to be successful, will necessarily have digital finance as one of its principal components. Opening 210 million new Jan Dhan accounts will be of no avail in improving financial inclusion if these are not digitally linked to payments and credit flows.
Can the RBI, under Patel, at least start a sustained attempt at using `fintech' to reduce intermediation and compliance costs and initiate a conversation on India's move towards digital money that would be transformative?
Completing the digital transformation of the financial sector could be Patel's legacy.
There are other challenges as well.Will Patel do away with statutory liquidity ratios (SLR) that encourage lazy banking? Will he bring the tamasha of priority sector lending to its logical end in these days of universal access to credit through digital networks?
Will he agree to the finance minister's budget announcement of opening an independent debt management office in the North Block?
These issues would require Patel to work closely with the government and become an important member of the macroeconomic management team which has the goal of maximising employment generation with macroeconomic stability. Being a team player and minimising the perception of RBI being at odds with the government would bring kudos for Patel during the next thousand days.
The writer is senior fellow at Centre for Policy Research, Delhi

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