An agenda for the new RBI governor
Three things need Patel’s attention: cleaning up bank balance sheets, evaluating robustness of CPI and pushing for digitisation in financial services
The appointment of Urjit Patel as Reserve Bank of India (RBI) governor is an inspired choice. Patel has the strongest monetary economics pedigree, with an MPhil in economics from Oxford and a PhD from Yale. As a PhD student he jointly authored academic papers with his advisor, the respected macroeconomist Prof Willem Buiter, then at Yale. For India, his long stint at IDFC, gives him a deep understanding of the infrastructure sector that is currently causing stress to bank credit portfolios. He has been deputy governor, looking after the crucial monetary policy department for almost four years and so, is well equipped to take over as governor. However, I find all the commentary surrounding his appointment blithely stating that his appointment suggests a choice by the government for a continuity in RBI policies, to be simplistic.
While Patel made fewer speeches in his tenure as deputy governor than others, the ones he made were not reported or as widely read as they should have been. For example, he made an important speech on inflation, where he remarked that inflation in India was contained by three things — fall in oil prices, effective management of agriculture supplies by the government and RBI’s interest rate policy. His speech illustrated his nuanced understanding of inflation in India, recognising the limitations of interest rate in affecting food prices. Similarly, on infrastructure, and the rise of bad loans in bank balance sheets, he asserted: “If one goes behind the NPA (non-performing asset) numbers related to the infrastructure sector, they are not white elephants as such. These assets generate a stream of output that has ready demand.”
He understands the infrastructure sector and its needs in India better than most. Bank lending to infrastructure that has now turned sour was not a simple function of poor credit assessment but equally the result of withdrawal or non-provision of government clearances for infrastructure projects that were bid out. Likewise, when there was a lot of noise about low growth in many parts of the developed world, he was quick to point out that demographics in Japan and Europe were limiting its growth. When the population is shrinking it affects both consumption demand and the investment sentiment. These comments are different from what others in the RBI have been saying, and so, to just repeat that his appointment signals continuity, is naive.
There are many things he will have to do as governor, but I wish to highlight three that are most important and require urgent attention.
The first challenge he will face is to clean up bank balance sheets in India. This will require action at three different levels. The first is in terms of correcting the narrative — going away from loose talk of crony capitalism to an understanding of why so many infrastructure projects got stuck. The new governor has not once spoken about the character of Indian industrialists in broad generalisations and such loose characterisation does not serve Indian banks well — a politically charged atmosphere makes pragmatic deal-making difficult even with non-wilful defaulters.
The second will be finding a way to resolve bad loans, especially with public sector banks. Given that just five sectors contribute 61 per cent of the stressed assets of the banking sector — infrastructure, steel, textiles, power and telecom — it will be worthwhile to consider a sector-based approach. The new RBI circular S4A allowing banks to restructure debt, where 50 per cent of the debt is sustainable, is a step in the right direction; with some refinement it can become more effective.
Finally, he will have to work with the government to provide a long-term solution to make public sector banks more robust and sustainable. There is an urgent need for them to obtain governance and human resource autonomy and be in a position to raise capital. Numerous suggestions are available but a politically workable solution will need to be found.
The second task that he should undertake is to evaluate the robustness of the Consumer Price Index (CPI) in India. The RBI, as is the global convention, has chosen the CPI as the index for its monetary policy. But the index in India is not as robust as elsewhere. There are many who question how truly representative the CPI is for all of India? Does the same basket apply to all regions, types of employment and income segments equally? Are the weights in the CPI appropriate and do they need any adjustment? Over 50 per cent of the index represents just food and beverage as compared to 29 per cent in other emerging economies. If we were to say that 65 per cent of Indian gross domestic product is consumption and 35 per cent investment, should the weight for CPI be 100 per cent in determining inflation? When Wholesale Price Index and CPI diverge for long periods, could we consider a weight of 35 per cent for WPI in calculating the inflation index that RBI targets? If so, the weighted inflation rate in India may be more like four per cent than the six per cent suggested by the CPI. As the index is critical I would wish that he gets it reviewed to judge the appropriateness of its composition and weights.
The third task is to push digitisation and use of data in financial services more broadly. Spurring the use of mobile devices for financial services transactions, reducing the use of cash and the fuller use of data, will not only foster financial inclusion but also dramatically reduce the need for collateral in lending. Data will allow the emergence of robust credit-scoring models that will become much more accurate in predicting default. A sharp reduction in the use of cash not only promotes greater efficiency but also automatically fosters inclusion.
These are the top three opportunities or challenges to address. There are others, of course, but I believe starting with these would be appropriate. Patel’s pedigree and qualifications will serve the RBI well. He comes well equipped to handle his new responsibility. I salute the government for its choice of RBI governor.