Raghuram Rajan's last report is of hope and caution

Outgoing Reserve Bank of India Governor Raghuram Rajan wrote his last report card of RBI on Tuesday, August 30, 2016. He observed that though economic growth showed signs of picking up, it was not matching yet the expectation of the people and as well as the capability of the country.

On inflation, however, the soon-to-be-former governor commented that the projections were still above the high normal level of RBI's inflation objective, constraining the leg room for any interest rate reduction.

Subdued interest in private investment due to low capacity utilisation and delayed rolling out of public investment in certain sectors are key reasons for slow growth.

Also read: Raghuram Rajan's inglorious exit shows Modi's weakness

As everybody's hopeful, even the RBI governor expressed his hopes of a good monsoon and a good kharif harvest resulting in greater food production. Coinciding with the 7th Pay Commission payouts must see some spurt in consumption demand on the one hand and greater spending on the other. It must help ease out inflation and reduction in headline CPI.

Demand side improvements must surely aid the industry to make full utilisation of installed capacity and investments to brighten, to set in motion virtuous cycle of growth. There is also this anticipation of benefits coming from Pay Commission and the major tax reform GST getting rolled out for trade, industry and as well as the consumers.

In the annual report for 2015-16, the central bank said the near term domestic outlook appears bright enough to keep the investment, growth and consumption functions of the economy ticking all right to a good beginning of an early and new financial year in January 2017.

The report underscored the fact that consumption demand will be the mainstay of aggregate demand having a favorable impact on prices.

Rajan however, sounded circumspect on inflation levels being satisfactory to induce any immediate rate cut considerations by the RBI. If inflation slowed, a rate cut would emerge as a natural corollary of that, he said.

Also read: By getting Raghuram Rajan out, Modi may have won, but India has lost

He added that RBI needs to balance saver's desire for positive real interest rates with corporate investors and retail borrowers' nominal borrowing rates. But, creation of room for a cut in policy rates can come about only through inflation easing out. Rajan predicts the upside risks of inflation target touching 5 per cent by march, 2017.

He reiterated that the short term macro-economic priorities of RBI will continue to be a focus on bringing down inflations towards government set target of 4 per cent. It would need the willingness of public sector banks to cut lending rates and overcome its reluctance to lend to industry and SMBs at lower interest rates compared to the private sector banks that are on their way to doing it.

Also read: Why Modi chose Urjit Patel as RBI governor

The report ends with a positive note that RBI's continued vigil over distressed assets will bring some good to the book debts of banks. Banks have, of course, suffered heavy losses in recent times after the banking regulator forced them to classify many accounts as non-performing. But, RBI has suggested to banks to incorporate claw back clauses in agreements they sign with their lenders for sustainable structuring of stressed assets.

Under a new SA4 Scheme, banks can convert a portion of the unsustainable debt into equity which will lower the overall debts though not the loan amounts or the loan term. By this arrangement, banks are given a hint to restructure their distressed assets in a way that will enable them to accelerate repayment if the corporates make unexpected gains.