By: Asma Chandani
India’s Reserve Bank Governor has hit some strong notes in the past few days, in a manner befitting the Economist-in-Chief of a burgeoning nation at a critical inflection point in its history of democracy and world influence.
Rajan has held his own against pressures to cut interest rates to stimulate growth, on the heels of a regression in GDP growth to 5.3% from the prior quarter’s recorded growth of 5.7%. Taking a long view, Rajan shot back at critics for being too “short-sighted” and presented his vision for a more sustainable growth framework that avoids “flip-flops “on rates and instead targets “gliding into” a consumer price index post January 2016 of 4% with a 2 percentage point buffer in either direction. In his policy statement yesterday, Rajan reflected, “headline inflation has been receding steadily” and “is expected to show a further softening.”
The global drop in commodity prices, and, in particular, the 37% slump in Brent crude prices, has eased inflation in India, tempering Rajan’s historically hawkish stance on interest rates. However, while asserting that a “change in the monetary policy stance at the current juncture is premature,” Rajan put Dalal Street on notice that “if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.” Rajan has also clarified that the cuts, once introduced, should be expected to have a large signaling effect and lead to further cuts. Rajan stressed, however, the need to wait and see how current conditions continue to manifest prior to any change in monetary policy.
The central bank’s new dovish tone signaling the impending certainty of rate cuts has sent yields on Indian bonds to a 16 month low, as bond markets price in a cut in the key repo rate.
In addition to his core objectives of ensuring monetary stability and stimulating inclusive growth, Rajan has initiated a bold dialogue on factors other than the benchmark interest rate that increase the cost of credit – by tackling head on the entrenched giants of wealth and power behind India Inc.: India’s omnipotent “promoters” of industry.
In a culling dissertation on the state of India’s credit markets delivered last week at the Institute of Rural Management Anand, Gujarat, Rajan assailed “large borrowers” for eroding the sanctity of the debt contract by holding lending institutions “hostage in a game of chicken” and unevenly exposing creditors to downside risk without any upside potential. In a country where promoters are treated as “divine” by the masses, Rajan attributes a higher cost of borrowing to the self-serving, entitled bad eggs amongst the ranks of India’s promoters. “Unscrupulous promoters” ratchet up the credit risk premium, lead to more draconian legislation and enforcement and generally cause an imbalance in the system. Rajan expounds upon these Goliaths of industry, highlighting the fact that promoters have deep pockets and can retain “the finest legal brains to work” towards postponing the recovery of debt. The confluence of these asymmetries of power, Rajan says, leads to a class of “super equity” for promoters, bestowing upon promoters riskless capitalism and emasculating hapless bankers to write off debt on the order of 1.27% of the nation’s GDP.
Rajan also took a strong position against the argument for “regulatory forbearance”, warning banks against “ostrich-like behaviour” and urging them to act promptly to recognize bad loans, with the assurance of additional flexibilities to enable restructuring of problem loans. In contrast, Rajan applauded the role of institutional investors, private equity funds and other professional turn-around agents who can infuse both capital and better management capabilities into stressed and sick companies.
© 2014 DaWall Street. All Rights Reserved.
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