The latest financial review by RBI Governor Raghuram Rajan contained few surprises. Knowing his mind and style of functioning over the last four years, it would have been naive to expect he would switch course in the last bi-monthly monetary review to make others feel comfortable. In a post-review interview, Rajan said: “If I go along just for being comfortable, I think we will be building risk for the future which will really hurt the country.”
The markets had more or less factored in this eventuality. So did the India Inc. There is a marked acceptance and this is a good indicator. Rajan has come across as a man who does not want to score a last minute goal and become a darling of the markets. He has shown a lot of character and vigour.
Nevertheless, the rationale for status quo was obvious — the rise in food prices has pushed up inflation which has gone beyond RBI’s projected inflation trajectory. Secondly, liquidity is currently plenty in the banking system, thus not necessitating an urgent dose of rate cut. The market was hoping that if all goes well, a rate cut may come by October.
Yet, given the persisting upside inflation and the central bank’s March 2017 target of 5 per cent, one needs to wait and watch if it goes for a rate cut then or wait further. The 7th Pay Commission payout could be adding to inflationary climate. A possible rollout of Goods and Services Tax (GST) in the later part of next year will also be inflationary even though it is too early to worry about that. But this is a call for Rajan’s successor to take.
Coming back to the latest financial review by the RBI, the central bank did not change the policy repo rate and the cash reserve ratio which stand at 6.5 per cent and 4 per cent respectively. There was adequate liquidity in the system and there is no change in the situation.
Interest rates and liquidity were never the crux of the problem that ailed the system. Last year, the central bank cut interest rate by up to 125 basis points and urged banks to pass on the interest easing to customers. The banks did it half-way through. Despite rate cuts, banks have passed on the rates only modestly.
The banks first said it was lack of liquidity that held their hands. When that was addressed, they cited Foreign Currency Non-Resident Redemptions that came in their way of passing on the benefits of the lowered interest rates. These are excuses that Indian banks are not short of. Therefore, there was no guarantee that even if interest rate was cut this time, banks would have brought lending rates down.
The outgoing governor put much emphasis on clearing balance sheets of banks. The move has already started yielding results. Major public sector banks have been allocating substantial amounts of funds for provisioning.
A concerted effort has been made to clean the messy non-performing assets book. Pressure has been built on banks to name and shame big corporate defaulters which did not happen before.
Rajan has left for his successor a disinflationary glide path, an inflation-targeting monetary policy framework and more importantly, a philosophy of central bank independence. There are silver linings on the domestic front. They include gathering of the Southwest Monsoon and signs of improvements in industrial production and service sector. The RBI has retained the growth rate at 7.6 per cent. Going forward, the job of the new governor may not be that tough. Unless he succumbs to North Block pressure, he may pursue the Rajan’s track for some more time and then let the economy go into automatic mode.
