Raghuram Rajan Takes On Critics, Again, And Shows Chart By Chart Why They're Wrong

Governments should protect the independence of central banks and look beyond uninformed criticism, he says

27/07/2016 8:37 AM IST | Updated 28/07/2016 12:59 PM IST
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Reserve Bank of India Governor Raghuram Rajan

Outgoing Reserve Bank of India Governor Raghuram Rajan took on critics again Tuesday and defended the key policies undertaken by the central bank during his tenure, going into extraordinary detail explaining the context of many of the bank's decisions.

Specifically, he addressed concerns about interest rates, which many of his critics say have been too high, hurting credit growth and spending, and the RBI-mandated clean-up of bad loans and balance sheets at banks, which some critics allege has compounded the credit growth slowdown.

"The RBI, of course, stands by its policies," Rajan said addressing the 10th Statistics Day conference at the RBI headquarters. "Nevertheless, this debate is very important because it could shape policy directions in India over the medium term."

Here are the highlights of his arguments. Read the full speech and see the charts here.

On inflation:

Rajan warned against the dangers of high inflation that mostly affect the weaker sections of society, noting that weaknesses from rising prices usually add up and eventually lead to a crisis. He also expressed worry that there was little anxiety in the public commentary when inflation was moderately high.

He also countered criticism that India's success at curbing inflation during his tenure was just "good luck" and the result of the global low energy prices, noting that the process of disinflation, in fact, started in late 2013, long before oil prices collapsed. He also pointed out that "a significant part of the fall in oil prices globally has not been passed on" by the Indian government, which has hiked excise on petrol and diesel.

"Critics offer two contradictory arguments on inflation. On the one hand, they argue that we have killed demand and growth through high rates – though this itself seems at odds with the received wisdom that we are the fastest growing large economy in the world," Rajan said. "On the other, they argue that our policy has had little effect on curbing inflation, that disinflation has been a result of the fall in oil and other commodity prices."

He outlined that "the best way central banks can support growth over the medium-term is by keeping inflation low and stable."

"Without any political push back as inflation rises, it is necessary to build institutions to ensure macroeconomic stability... Perhaps this is why successive governments, in their wisdom, have given the RBI a measure of independence," he said, noting the current government's decision to set a formal inflation target and the creation of a monetary policy committee were steps in that direction.

On slowdown in lending:

Rajan argued that RBI's "monetary policy has not been too tight" and that the slowdown in credit growth has been largely because of stress in the public sector banks, stemming from past mistakes in lending.

"This will not be fixed just by a cut in [interest] rates. Instead, what is required is a clean-up of the balance sheets of public sector banks, which is underway and needs to be taken to its logical conclusion," Rajan said.

He also deftly noted that the lending growth from private sector banks has, in fact, been "extremely high" in real terms, in stark contrast to the lending at public sector banks. The healthy lending at private banks suggests strong demand for loans at prevailing interest rates, he added.

"The obvious conclusion one should draw, therefore, is that the slowdown is because something is affecting credit supply from the public sector banks specifically," Rajan said, adding the slowdown in the growth of non-food credit by public sector banks was probably not because of lack of demand or capital; nor was it because of high interest rates but largely because of stress in public sector banks.

On bad loans clean-up

According to Rajan, as with inflation, it was "easy to ignore" the problem of loan losses and hope it somehow goes away. But loan losses have a tendency to increase, get too big to ignore, too late to manage, pushing the system into crisis.

"As with inflation, it was the duty of the central bank to press for bank clean-up earlier," he said, noting that lenders were initially reluctant to implement the clean-up exercise, which began in December 2015 with RBI identifying 150 largest accounts that were facing problems with bad loans.

Following the clean-up mandate from RBI, banks have reported close to 14 per cent or over Rs 8 trillion (Rs 8 lakh crore) have declared stressed assets as of March 2016, while non performing assets have alone crossed 7.6 per cent. "Fortunately, after an initial reluctance, banks have entered the spirit of the clean-up and some have gone beyond what was demanded of them," he said.

"It t is obvious remedy to anyone with an open mind would be to tackle the source of the problem – to clean the balance sheets of public sector banks, a remedy that has worked well in other countries where it has been implemented. Clean up is part of the solution, not the problem, and that is what we are doing," he said.

On criticism itself, and the need for independence

He welcomed criticism of RBI and said criticism "comes with the territory" and that central banks should make a case for their policies.

However, at the same time, "it is important that governments look beyond uninformed and motivated public criticism and protect the independence of their central bank to act, he said. "That is essential for stable sustainable growth."

He also noted that criticism of the central bank using arguments unsupported by evidence is widespread around the world.

"The Bank of England was criticised for laying out the economic costs of Brexit, the ECB has been criticized for doing too much to restore health to troubled peripheral economy financial sectors, and the Fed is under fire for departing from the Taylor Rule," he noted.

According to him, what's happening in India is "the classic behavior by a banking system with balance sheet problems."

"We are able to identify the effects because parts of our banking system do not suffer from such problems," he said.

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