BJP has made a blunder by attacking Raghuram Rajan

For Reserve Bank of India (RBI) governor Raghuram Rajan, predicting the 2008 global meltdown in a research paper in 2005 would have been far easier than negotiating the maze of political compulsions while framing the monetary policy for a large developing nation as India.

Just as Rajan, an IIT-Delhi and IIM-Ahmedabad gold medallist, seemed to have pulled off much of his three year term relatively easy, making light of pressures to ease interest rates if he thought that would stoke inflation, there is rising conjecture over his continuing as governor after his term expires in September.

Moreover, senior political figures in the ruling party like Subramanian Swamy have launched a public attack on the way Rajan has managed the monetary pressures, kicking up a debate on the governor’s performance so far. What gets lost in the cacophony of public tirades, unfortunately, is an objective assessment of Rajan’s contributions during his term so far. 

Although in the general public eye, his stance of fighting an unflinching battle against inflation take precedence over every other measures the RBI undertook under his leadership, his efforts to set the banking system right may easily be one of the most remarkable, and far-reaching. The latest move was to tell banks to classify loans that will potentially turn bad, and make provisioning for those, according to their degree of stress, in the banks’ books.

This creates short term pressure – for instance, profits of ICICI Bank, India’s largest private sector lender, took a 76 per cent knock in the March quarter of fiscal 2016, after it set aside an additional contingency reserve of Rs 3,600 crore to account for an increase in bad loans. The country’s largest lender State Bank of India (SBI) saw its profits fall eight per cent after provisions for the March quarter rose 41 per cent. Deepak Parekh, HDFC chairman, had remarked that "too much anaesthesia will turn the patient comatose", referring to the stern clean-up measures.

But Rajan feels this pain will pass, as it is the aftermath of a "deep surgery" he has carried out to restore banks, especially state-owned, back to health, without resorting to what would be otherwise "band-aid" measures. Recent media reports have said that state-owned banks wrote off Rs 1.14 lakh crore in the past three years, after their lending to risk-ridden sectors such as iron and steel, power, mining, rigs and cement sectors turned bad.

That malaise is what Rajan is targeting to address. The other major measure he undertook was the granting of 23 banking licences to new players - two given universal banking licenses in April 2014, 11 issued payments banks licenses in August last year, and 10 for small finance banks in September last year. Eight of the ten banks given small bank licenses were microfinance companies, in a move that would expand financial services activities in rural and semi-urban areas.

“Small finance banks will offer basic banking services, accepting deposits and lending to unserved and under-served sections including small business units, small and marginal farmers, micro and small industries, and entities in the unorganised sector,” the RBI said. India has an unbanked population of 233 million in 2015, according to PwC India, so this is an important step towards financial inclusion. The handing over of licences to firms such as the department of posts, Fino Paytech, Tech Mahindra and National Securities Depository to run payment banks, will boost cashless payment services in the country as never before.

Similarly, Bandhan Bank, that received a universal banking license along with IDFC, has already been working among thousands of women in rural areas in the country’s eastern region, meeting their small financial requirements, and the license will help bolster its work in that space. In the foreign banking space, Rajan eased curbs by encouraging large foreign banks to become local subsidiaries. The innovation that is expected to result from this move will drive better quality customer service for banks, media reports say. 

When Rajan, named by Time magazine earlier this year as one of the 100 most influential people in the world, took office in 2013, the country’s economy was in a precarious state, characterised by high inflation, sub-5 per cent GDP growth, a weak currency and investors fleeing on policy delays and corruption charges.

Rajan, born in Bhopal into a Tamil family, went about his task with alacrity, wielding a battle against inflation that has left him with more foes than friends. Through tight monetary measures, Rajan succeeded in containing inflation, aided by falling global prices of oil. Inflation, which was over 10 per cent around the time Rajan took over, has now been reined in at sub-six per cent levels.

The rupee, meanwhile, which had sunk to a historic low of 68.83 against the dollar in August 2013 rose to 61 in November 2014. However, it has been falling much of the period thereafter, to touch 68 in January this year due to a weak global economy, low crude prices and large sell off by foreign institutional investors. In April, the RBI cut interest rates by 50 basis points, from 7.25 per cent to 6.75 per cent, once Rajan felt that inflation was under control.

The economy, meanwhile, is in better shape, as the government would have us believe, posting over 7 per cent growth and being a global outlier, although the new way in which growth is computed has been contested by some. The fiscal deficit, meanwhile, was reined in as targeted, thanks to the low crude oil prices and low public expenditure.  

If that is the case, then the RBI governor deserves kudos for running a tight ship and now giving way to populism. Agreed, the initial years of the UPA-2 regime were marked by exponential growth in the economy, but what’s not to be forgotten is that the period also led to the largest creation of bad loans, with reckless investments cleared for projects that often ended up as non-starters.

Even chief economic advisor Arvind Subramanian, one of Rajan’s sharpest critics, has remained quiet for months about Rajan’s policies, after his early tirade against the governor. If fiscal prudence is the way forward, Rajan is on the right path, feel many, and will be judged as someone who held forth steady in choppy global waters.