Trinity Trick

While Rajan’s monetary policy review did ensure to handle two of the trinity trilemma i.e. sinking rupee and rising inflation but the last one i.e. meek growth demands Government action.

With US Federal Bank postponing quantitative easing withdrawal and with debutant RBI-Chief Raguram Rajan coming up with pragmatic monetary policy, positivity seems to have enthused in Indian economy. On one hand the breather given by Fed-Chief Ben Bernanke has ensured that Foreign Institutional Investments (FIIs) will remain intact till December, on the other, RBI-Chief’s move to hike repurchase (repo) rate has signaled that notorious inflation will also be guarded. Consequently with external and internal stability, the rupee-volatility will soon be the thing of passé.

RBI has raised repo rate i.e. the rate at which banks borrow from RBI for short-term credit to 7.5% from 7.25%. Simultaneously, it has reduced Marginal Standing Facility rate, a special and expensive borrowing window for banks, to 9.5% from 10.25%. Usually hike in repo rate translates into increased borrowing cost for banks but considering that MSF is the effective policy rate since July which has been lowered, cost of borrowing for banks has actually come down. The idea behind this move is to provide fresh air to banks currently suffocated with cash dearth but at the same time prepare them for the ensuing normalcy when repo rate will regain its position as effective policy rate. In that case, during normal circumstances, even if repo rate is increased from current level of 7.25%, it will be less than the present rate of MSF, thus there will not be any dramatic impact on banks’ cost of borrowing.

Another positive implication of repo-rate hike is that the subsequent arbitrage advantage in interest rates will attract more foreign investors, something which is needed to shore up foreign reserves. Increase in repo-rate also suggests RBI’s hawkish stand on inflation front. Fighting inflation through increased rates is justified as it is undoubtedly notoriously high inflation which fuels the vicious cycle of economic slowdown. Though it will hurt the already languishing growth with expensive loans and all but lower inflationary pressure is required even if it comes at the cost of short-term growth.

The so called impossible trinity trilemma of sinking rupee, rising inflation and meek growth has to be dealt with now. While Rajan’s monetary policy review did ensure to arrest sinking rupee and control rising inflation but meek growth cannot be strengthened solely by RBI. It does need policy-push and legislative reforms something which demands Government action. Effective monetary policy will come to a copper as long as it is not backed by prudent fiscal and legislative policies and expecting fiscal and legislative prudence on the part of Government in an election year is like asking for moon. Therefore, thumbs up to Rajan, a question-mark on Government’s intent!

                          

Raghu Reform Rajan

 Mr. Rajan’s beginning is definitely commendable. He might have travelled across the half way too quickly but covering the other half would not be easier.

“If you can trust yourself when all men doubt you, But make allowance for their doubting too” following lines from the poem ‘If’ by Rudyard Kipling is probably the best message newly appointed RBI-Chief Raghuram Rajan could convey to everyone bewildered with current economic turmoil. Through his maverick maiden speech, he effectively addressed the hopes of each stakeholder but how much walk of his talk will take place is something yet to be seen.

Slew of measures, in order to provide fresh breather to banks, have been proposed by Rajan. For instance, well-run scheduled commercial banks do not have to acquire permission from RBI in order to set-up new branches. Also, no fees will be charged for this purpose. That underserved areas don’t remain neglected, RBI will make sure that banks open up branches in those areas in proportion to their expansion in urban areas. Apart from this, he also emphasized to expedite the process for issuance of new banking licenses. A committee chaired by former RBI-Chief Mr. Bimal Jalan will be looking into the applications after an initial review and compilation by RBI staff. The process is stipulated to be completed by Jan 2014 i.e. the new licenses should be issued by then, if the deadline is not extended any further. In a bid to set up robust banking structure in the country, differentiated licenses will also be issued to small banks and wholesale banks. Large urban cooperative banks will be converted into commercial banks.

Rajan also took into consideration the growing Non Performing Assets of the banks due to loan-defaults and subsequent Corporate Debt Restructuring. He took a hard line on owners of those companies and said they do not have the divine right to stay in charge unmindful of how badly they mismanaged their enterprises. Banks aren’t supposed to bear the brunt of their bleak business scenario. Thus CDR norms are certainly going to get tougher now. To the relief of cash-strapped banks, Rajan intends to reduce their requirement to invest 23% of their deposits in Government securities which is known as Statutory Liquidity Ratio. It reduces the amount of cash available with banks to make loans.

For the benefit of citizens, finally an RBI-Chief will be launching Inflation-indexed savings instruments pegged with Consumer Price Inflation (CPI), not WPI as it is former which reflects the actual inflation being borne by consumers. A national grid-based Indian bill payment system will also be launched, where households will be able to use bank accounts to pay school fees, utilities, medical bills etc. This will make payment anytime anywhere a reality. Also, a pilot will be conducted to enable cash payments using prepaid instruments issued by non-banking entities and Aadhar-based identification. An application for encrypted SMS-based funds transfer that can run on any type of handset will also be examined by a technical committee.

Acknowledging that access to finance for the poor and for rural small and medium industries is hard, Point of sales devices and mini-ATMs will be set up by even non banking entities so that financial inclusion leading to inclusive growth can be feasible.

As monetary policy is the first and foremost responsibility of RBI, a committee under the chairmanship of Urjit Patel, in three months, will be suggesting measures to strengthen the monetary policy framework. Measures such as liberalization in forward market and internationalization of rupee etc. have certainly spurred the confidence of investors that India is not afraid to take bold decisions concerning with financial markets.

They say that ‘well begun is half done’. Mr. Rajan’s beginning is definitely commendable. He might have travelled across the half way too quickly but covering the other half would not be easier. All eyes are now set on 20^th Sep i.e. the day when he will be coming up with his first monetary policy as RBI-Chief. All the best Mr. Raghuram Rajan!! Hope you setting-off to tread on the other half-way is a success.