Raghuram Rajan’s first press statement after his appointment as governor of Reserve Bank was a model of prudence. He delivered eight sentences in five minutes, liberally distributing gratitude and admiration. It was a proper and unsurprising speech; not even the prime minister could have bettered it.
His second statement came on the evening of September 4, when he reached Bombay to take charge. It had substance; he signaled his intention to depart from past policies. That could imply criticism of them, which a new governor is not supposed to indulge in. So he harked back to monetary stability, the foundation mandate of the Reserve Bank in the 1934 Act. He took it to mean absence of inflation. If I may put it starkly, that is heresy, for inflation has been the bedrock of the policy of the UPA government. The rulers would not put it that way; they would say that they had to choose between price stability and showering billions on the poor, and they chose a downpour. Rajan showed awareness of this devotion to inclusive growth, and said he too would worship at its altar, but with different flowers: he would require banks to provide a certain proportion of their services in villages, but to make it profitable, he would let them open branches in cities without any restrictions. Instead of, or in addition to MGNREGA, the world’s largest programme of corruption creation, he proposes to make banks lend more and create employment in villages.
In his report of 2008 on financial sector reforms, Rajan had favoured a large number of small private banks. That is entirely contrary to Reserve Bank’s policy till now. It procrastinated for years on giving new bank licences. When it could no longer do so, it put out a discussion paper, and asked for comments. It protected its favourite daughters, the inefficient and indolent government banks, from competition for a decade. Now Rajan, who believes in more competition, has become governor. He finds that the Reserve Bank has entertained less than three dozen applications, mostly from big businesses. How does he reconcile his convictions with those of his predecessor? He appointed a committee under Bimal Jalan, an old-style ex-governor, to look at those applications; that will lead eventually to very few licences. For the rest, Rajan says that this is not the last time; there can be more exercises in the future to give more licences. Will there be, or will he succumb to the establishment? Let us watch.
The Reserve Bank has been extremely fearful of “speculation”, and has severely restricted forward trading. As a result, forward trades on the rupee have migrated abroad; Singapore does far more trade on the rupee than all Indian markets combined. Rajan was cautious on this — not surprising, since he is the man who warned against irrational exuberance, which played its part in the global crisis of 2008. He promised importers and exporters greater leeway in booking forward foreign exchange contracts, and proposed to create a forward market in interest rates. He was right on this; forward trading can destabilize markets, but it is basically an instrument to buy risk insurance.
Rajan said that Aadhar identities would be used as a foundation to build credit histories. But Aadhar applies only to humans, whereas most of the credit flows to firms; there is no Aadhar for firms. However, most firms in India are partnerships or private limited companies whose shares are not traded on the stock exchanges; they can, therefore, be linked to their individual owners. Such an ownership data bank would be enormously useful to lenders, including banks; but the data are scattered just now in credit bureaus and rating agencies. At the risk of destroying their business, the Reserve Bank needs to create a single data bank. It would not be easy; there are 1,200,000,000 Indians, and too few names; I, for instance, share my name with a great lawyer, a retired judge, and many less distinguished Ashok Desais. Aadhar seeks to give each of us a distinctive number; but it has faced competition from the Registrar General, who holds censuses. And in theory, there is a single data bank for limited companies in the Registrar of Companies, but it is an extremely underfunded and inefficient department of the government. Rajan seems unaware of the mess; he should offer to take over the registry from the government.
He wants to create electronic factoring exchanges where there would be bulk trading of small firms’ bills raised against big firms; but why distinguish between small and big firms? There is no reason not to trade bills of small firms against small firms or of big firms against big firms. The point is that these bills of exchange are trade debt, and a substitute for bank loans. Banks could actually reduce their risks greatly if a market in bills of exchange — let us call them hundis to give them an Indian flavour — were traded; a market would make them more liquid, and reveal information about the bill issuers’ soundness. But banks have been extremely hostile to the emergence of such a competitor. The Reserve Bank should actively encourage banks to lend by buying hundis, and set up local exchanges where they can be traded. Rajan wants to have a look at bad debts, which the Reserve Bank prefers to call non-performing assets, and the asset reconstruction companies and debt recovery tribunals that the government set up in the 1990s to tackle them. It would be a wasted exercise; like our judicial system, this entire infrastructure requires activity from very lazy parts of the government. Better information on financial soundness of firms, generated by markets, is a better option.
Rajan’s idea of bringing the millennia-old European giro to India is excellent. It works like this. If I want to pay someone, I go to my bank, buy a giro in his name and give it to him. He goes and deposits it in his bank. It is like a banker’s draft, but European banks issue giros much more readily and with less red tape than Indian banks issue drafts. European post offices are even more active in the issue of giros than banks. The problem lies with Indian banks, which Rajan will have to tackle before we see giros. And he should give a banking licence to the Indian post office, whose reach across the country is unmatched by banks.
Rajan wants to encourage mobile-based payments; he may not know that they were developing rapidly in India and the Reserve Bank killed them because non-bank finance companies were running the show. This is where Rajan will face the greatest challenge. There are thousands of NBFCs in India; their costs are much lower and reach much greater than those of banks. Reserve Bank — not to mention Andhra politicians — has been extremely jealous of, and hostile to, them. Rajan, who believes in competition, should encourage them, regulate them, and develop them as a supplement to banks.
As this column shows, Raghuram Rajan made me think more with a 15-minute speech than his three distinguished predecessors did with their 15,000-minute perorations. He should keep his mind ticking.