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Labours of Urjit: Economists outline the challenges he must face

As Raghuram Rajan is set to leave office, Urjit Patel, his successor, now has to carry on the fight against inflation and monetary policy reforms that have been carried out in the past few years.


The primary and most important agenda for Patel on monetary policy is to complete the institutional process, which is the monetary policy committee, says Arvind Virmani, Former CEA, Finance Ministry.


Virmani feels that when a new institution is created, traditions and ways of doing business have to be initiated, so, how the governor handles the monetary policy committee will set the stage for a long time.


In a panel discussion on CNBC-TV18, KC Chakrabarty, Former Deputy Governor of RBI, Neeraj Gambhir, Head of Credit Business at Nomura, Shyam Srinivasan, MD & CEO of Federal Bank and Arvind Virmani list the challenges that the new governor has to face and shared their views on how the monetary policy reforms should be carried out going forward.


Shyam Srinivasan said that the crucial job for the new governor is to bring in financial discipline, increase risk weights and ensure that banks are not over-lending to the same client.


Below is the verbatim transcript of KC Chakrabarty, Neeraj Gambhir, Shyam Srinivasan and Arvind Virmani’s interview to Latha Venkatesh on CNBC-TV18.

Q: What will be the agenda for the next governor on monetary policy? Will it be to bring inflation now down towards the 4 percent mark?

Virmani: I think the primary and most important is to complete the institutional process, which is the monetary policy committee, because when a new institution is created traditions and ways of doing business have to be initiated, so how the governor handles the monetary policy committee will set the stage for a long time.

In my view, that is the most important thing as far as monetary policy is concerned. More specifically on your question about the inflation itself, clearly the monetary policy committee will have a much greater role than earlier governors and therefore that issue remains.

I don’t think it’s anymore urgent than it was. In fact, several people including myself feel that the target which was set for the end year of less than 5 percent will be attained. I think a lot of people have been misled by the short term rise in food prices, but yes people can have different views of course.

Q: The other parts of monetary policy which probably will not be directly with the monetary policy committee (MPC) like yourself has been liquidity. Do you think transmission is something that would be the next point on the new governor’s agenda?

Virmani: As I wrote in the March of this year, I think the monetary aspects, I have argued for more than 10 years, in fact, when the Rajan committee report came out, that in a fragmented and incomplete market like that of India, you can’t make the same assumption that you do for than New York market or the London market, where you just focussed on the short term Repo rate and everything else goes smoothly through the system and yes I think the less has been learnt, so there will be much greater focus and what in the good old days or the bad old days used to be called money supply and you can put another name to it liquidity or whatever and you are right in some sense how much emphasis to give to the Repo rate versus this liquidity or whatever we want to call it will be an issue, yes. You are quite right that balance has to be stuck.

Q: What would you say is the agenda for new governor in liquidity and in other aspects of the bond market?

Gambhir: I think MPC its constitution and its communication with the market, its style of operation. Its overall area of purview, does it only limit itself to rate setting or does it also involve itself with how the liquidity and how the monetary policy operation is going to function. I think that is going to be something that market is going to watch with a very, very keen interest. It is also going to set the stage for the next round of market rate movements. That’s clearly something which is the top of the agenda for the market to understand.

The second thing, I think which is slightly longer term structural reform is to my mind creating capacity for in the bond market, especially in the corporate bond market for the last issuer, that are slated to come once the new rule set in. How do you sort of absorb that capacity, where is the institutional capacity for that.

In that context, I think Reserve Bank stepping into the market and looking to buy corporate bonds for its own portfolio as a part of its open market operations is going to be a very, very important step. I think it is going to create some more liquidity into the market, is going to bring some depth into the market. I think that’s from a bond market perspective is the second most important agenda I would feel.

Q: Bunch of announcements have come on the corporate bond market, but all that will fall on the next governor you think, will it be very important that he has to negotiate with the government, get the RBI Act amended and ensure that those Repos start accepting corporate bonds. Will that be clearly one of the biggest points for the next governor?

Chakrabarty: That is definitely a point if you have to make the corporate bonds liquid, you need to amend the law, but how important it will be I don’t know, because I have my different take on the corporate bond market, because we have to find who will purchase these bonds.

If this is only dependent on the banks then I don’t it is going to serve the longer term perspective, but definitely if we say that this need to be reformed, definitely it has to be on the agenda of the governor.

Q: I guess the governor here will have to play a very important role probably in the Financial Stability and Development Council (FSDC) or as the head liaise with other regulators and ensure whether the Pension Fund Regulatory and Development Authority (PFRDA) and Insurance Regulatory and Development Authority (IRDA) are able to cajole more of those institutions to buy bond. Even getting this large exposure theme implemented could be very important do you think. Here the 23rd governor has only indicated the intent of the Reserve Bank, that starting from FY18, banks should lend to already indebted companies with loans over Rs 25,000 crore only with higher provisioning and higher risk weight. Is this going to be a very key agenda and not very easy to implement?

Chakrabarty: Look what happen that, these types of reform through the direction is very difficult to bring, what I feel that look if what is the purpose of this reform, is it we are trying to de-risk the bank. We are trying to reduce the exposure of the bank or you were trying to bring the corporate to go to the bond market. I am not very clear about that. I don’t think that it will be an easy task to accomplish this thing, especially if we say that we have a financial system which is a bank led financial system. In any case banks have to take that risk so long as the financial system will be a bank led.

Now if the banks have to take the risk, now whether they take it through loan or through the bond what difference it makes, at least I am not able to fully appreciate the things. But, yes if we have to bring corporate bonds more active, I think what we look into that our assumption is that we don’t have a bond market I don’t agree.

Second thing is that who wants a bond market we need to debate these issues, so this is not the part of this issue, it remains an agenda that matter I would say. I have a different take on the same thing.

Q: I think the effort was to ensure that banks are de-risked from these over indebted companies to some extent, over indebted group and that’s why even exposure to single companies is getting brought down from 25 percent of capital funds to 20 percent of tier 1 capital and likewise for groups from 40 percent of capital funds to 25 percent of tier 1. What’s your sense, is this a big part of the agenda. Is it unimplementable or very, very difficult to implement as Dr Chakrabarty says?

Srinivasan: Like Dr Chakrabarty said, the crucial part is bringing in financial discipline. Now putting a number and a date is only a direction to that. I am of the firm view that in passage of time over the next 12-18 months this will get discussed many times over, because there are some real issues and if the intent is to bringing financial discipline and make sure that banks are not overexposed to a particular customer, that’s most welcome. But on the clients’ side you cannot limit the whole thing, because the second part of the market is not very developed. The ultimate risk is still with the bank.

In my view the new governor or the new processes that will be viewed over the next 12-18 months will be informed by what happens in the market over the remaining period. Right now, the credit demand is low. The pickup in the market has yet not sort of very visible. So some of these maybe more academic, but if indeed there is going to be great momentum, there is going to be a large demand for bank loans and credit is going to be pick up in substantive manner. This will get discussed quite profoundly, but having said that bringing in discipline, increasing risk weights, ensuring that banks are not over lending to the same client.

I think that all makes eminent sense, so my guess is the new governor is a person who has the done infra business in his earlier life. He probably understands that and probably will make the necessary tweaks. I am of the view that this will sort of evolve over the period of time.

Q: The digital peace, banking licensing is on tap, a unified payment interface (UPI) is here and about to evolve and then there are this welter of payment and small banks that will come into their own. What does all these mean in terms of responsibility for RBI both in terms of supervision and regulations?

Srinivasan: I think the supervision part will increase, regulation there is not much that needs to be done. Supervision will be in the area of principal security and how this whole development of payments is going to happen because what the infrastructure is quite significant now, the ease of payments is increasing.

Right now it is heavily person to person, how does it become more person to business to increase the utility of it, so over the next, between now and March of 2017 the big agenda will be once the UPI gets to full flow how does that translate into possible risks to the system if there are any, what vulnerabilities that there are coming through.

RBI is already talking about cyber security in a big way. They are talking of setting up an IT wing, looking at security in a massive manner. So, it will be more intensive in terms of supervision. That is on one side.

The other is the infrastructure that is formed in terms of the various payment banks and these surround around that will make this space, a lot of new discovery will keep happening because in the process existing banks are not going to sit quite. So, you will see a fair amount of development or innovative stuff.

That is where I keep saying the supervision aspect will become more intense. However, this is a fascinating space that is opening up.

Q: What is you sense bandwidth of the Reserve Bank to regulate ever many microfinance institutions which are becoming small banks and more banks coming in, will that be a very important chapter of the next three years?

Chakrabarty: All this will be important, but you see when we were discussing the role of the governor what I think that if we want to make the regulation, supervision effective so that the banking system meets the needs of the economy and the society, I think we have to make revolutionary changes. First our regulations have certain basic limitations.

It is not ownership neutral; it is not neutral on time and space. We need to bring neutrality in the regulation.

Globally, the regulation is either rural based or principal based. In our case regulation is discretion based which is very dangerous. We need to change that type of regulation.

Once we change the regulation, we have distinguish what is regulation, what is supervision. If we say more intensive supervision it is just not possible. Globally, the regulators are moving towards the risk based supervision.

So, we have to bring the risk based supervision, then we have to improve the information system. I think this is one topic of discussion separately.

We need to make revolutionary changes in this area and then comes all what types of institution.

Can Reserve bank do all these jobs together; I think a separate committee is necessary to find that what should be the mandate of the Reserve Bank. What should Reserve Bank do, what Reserve Bank should not do? It is much wider region.

Q: There are these welter of institutions and as Shyam Srinivasan says as the payment interface starts getting more financial inclusion and more consumer loans get given probably based on big data and analytics does financial stability will it fall as a big item on the next governor’s agenda?

Virmani: I have long argued that at least for 10 years that if we really want to get inclusion of the public let me start with that, you need to facilitate telephone payments and banking. Now for long the RBI resisted because they said it is too risky. So, the UPI kind of a response to this objections that direct payments will increase the risk to the whole system.

So, in that sense I think it is a good innovation; it is a good compromise. We know that you cannot eliminate all risks so, you have to manage it. The whole point which also relates actually to your earlier question on bonds something we have learned from the global financial crisis is that it is a complexity which hides the risk which is most dangerous to the system.

We talk about too big to fail but underlying that was a complexity where people just didn’t know what the risk was. Whether it is a single institution or it’s a cross institution, so yes in a broad sense this monitoring and managing of risk making it more transparent and I kind of agree with what KC Chakrabarty said and making the provisioning and so on linked to objective measurements of this risk is really quite important.

It is impossible for any Central Banks to kind of monitor personally everything. Having said that I would just add one more thing, is that when you get more digitise you also have digital means of checking. So, in that sense the RBI as a regulator can also develop the digital means of monitoring and therefore that to some extent takes the human element out which is quite difficult to manage the larger the system.

Q: One important piece that might fall on the next governor’s agenda which is perennially there for all governors the external risk. We are at a time when yields are at historic lows indicating probably depression economics and yet equity risk valuations are at the near all time highs. What might be the agenda of the next governor in that sphere?

Gambhir: A constant vigil around what globally markets are doing we are seeing a very unprecedented time in the human history as far as the monetary policy is concerned.

A substantial part of a bond market is yielding negative returns globally and that is quite interesting to see as to how it will evolve. Also we could have a lot more volatility in the markets as and when a major central bank like US decides to substantially increase its rate.

All of these things are still evolving; I don’t think anybody has a very clear idea as to how these variables will evolve over a period of time. They could be in lurking risks as and when some of these things changes, so a constant vigil and fortification of our own financial systems against this risk is going to be an important agenda.

In that context what kind of reserves do we carry, and what kind of monetary policy, how synced up we are with monetary policy with rest of the world and these are the issues that need to be continuously debated and they have to be in a way on top of the agenda.

In the same context, given the fact that the world is printing so much money and we are seeing so much of liquidity its is fairly easy for us to get substantial amount of these capital flows that could end up overwhelming our markets. So, a guard against that is also extremely important in the current context.

These issues have been around in form or other for the last few years, but in the current context it becomes even more meaningful.