Need to step up reforms steadily, says RBI governor Raghuram Rajan

MUMBAI: Reserve Bank of India Governor Raghuram Rajan stressed the importance of reforms, making the point that incremental policy change was essential for strengthening the economy and putting it back on a high-growth trajectory. This comes as the Narendra Modi government struggles to get moving on its liberalisation agenda in the face of a recalcitrant Opposition.

"For a country as big and populous as India, reforms cannot be shots in the dark, subjecting the economy to great uncertainty and risk," Rajan said in the RBI’s annual report that was released on Thursday.

"Wherever possible, we have to move steadily but firmly, ever expanding the scope of reforms while always limiting the uncertainty they create. The Chinese term this 'crossing the river by feeling the stones'. It is an appropriate metaphor to guide our own reforms," said Rajan.

The report didn't give too much away with regard to interest rates, with the next monetary policy announcement scheduled for September 29. Uncertainty over the monsoon is balanced by the drop in crude oil prices, he said. There have been calls for a rate cut before September end amid slowing inflation and some doubts about a recovery.



"The risks to this trajectory (CPI 6% in 2016, 5% in 2017) are balanced as the weather-related uncertainties are offset by falling crude prices," Rajan said. "Inflation developments will warrant close and continuous monitoring as part of the overall disinflation strategy that requires inflation to be brought down to 5% by January 2017." CPI is the consumer price index, the price measure that the RBI monitors. It has set a target of 6% consumer price inflation next year and 5% in the year after.

Rajan said the primacy of price stability is now cast in stone with the agreement between the government and the central bank that provides for a 4% consumer inflation reading with a band of 2% on either side.

"The government's commitment to the agreement also enhances the credibility of the framework, bringing confidence about the process of fiscal consolidation and supply management, both of which are highly relevant for maintaining price stability," Rajan said.

The bad loans burdening banks, one of the key systemic afflictions of the Indian financial system, looms larger than ever. Stress in the sector is high with distressed assets – gross bad loans plus restructured ones – at 11% of the total. That's putting the squeeze on funding of economic activity. The need for reform, therefore, is urgent.

"The current stress in the banking system suggests that the real economy will not wait for the banking system, and a slow pace of reform could lead to greater, rather than lower risk residing in the banking system," the report said. "Financial sector reforms need to move on many fronts.''

The government and RBI are working on a bankruptcy code and a resolution corporation-like mechanism to make recoveries easier and ensure financial stability. The central bank is poised to throw open the financial markets with new instruments such as options and cross-currency swaps in pursuit of higher investments by foreign investors in debt securities in the year ahead. Getting the banks in shape is a key element of this.

"RBI, while cautious about evolving risks to the external sector and inflation, has highlighted the need for institutional and structural reforms to alleviate supply constraints for a sustained increase in investment," said Saugata Bhattacharya, Chief India Economist, Axis Bank. "Broadening participation in financial markets to increase size, depth and liquidity is a crucial part of these reforms."

The governor again said the belief that transferring government debt management to an independent agency would bring down the cost of funds is misplaced. Rather, the objective is fiscal prudence.

"While the public discourse has sometimes suggested large reductions in government bond yields from setting up an independent PDMA (public debt management office) with no conflicts of interest, these stem primarily from such an agency being unable to sell debt to captive government-owned or regulated institutions, thus forcing the government to reduce fiscal deficits," Rajan said. "Given the government has embarked on a fiscal consolidation path, the benefit from such discipline may be small. At any rate, RBI is working closely with the government in setting up PDMA."