New RBI governor Rajan may face short honeymoon
Hindustan Times 10th September 2013
Analysts say it is a mistake to believe the suave star economist, whose first day on the job last week one financial daily likened to the "central banking equivalent of a blockbuster movie opening," is a miracle man who can rescue India's ailing economy.
"There was tremendous elation among market participants over Rajan's appointment," Ajay Bodke, strategy head at Mumbai investment house Prabhudas Lilladher, told AFP
"But we need to temper that exuberance and look dispassionately at the economic fundamentals and that picture is not good," he said.
The former International Monetary Fund chief economist has been plunged into a maelstrom of a record current account deficit , a hefty fiscal deficit, stubborn inflation, a weak currency and a sharp economic slowdown.
Analysts say Rajan, famed for forecasting the 2008 global financial meltdown, can provide symptomatic relief by using various mechanisms to lure overseas funds to cover the high current account deficit.
But the government holds the most important levers for reviving economic growth, cutting public subsidies and the twin deficits and restoring foreign investor confidence, analysts say.
"The government needs to take decisive measures to signal to international markets that India is taking the path of fiscal rectitude and shunning the path of populist prolificacy," Bodke said.
With elections due by next May and the government struggling in the polls, it may be hard for the ruling left-leaning Congress party to take any tough decisions, analysts say.
For instance, India urgently needs to cut diesel subsidies to lower its massive fuel import bill which is ballooning its current account deficit -- but foreign minister Salman Khurshid conceded Friday such a move "has political implications".
The economy has gone dramatically downhill since the the last decade when growth regularly topped 8% and 9% while the UPA government has become mired in corruption scandals that sent foreign investors fleeing.
The economic slowdown risks a shortfall in the government's tax revenue projections, exacerbating the fragility of India's finances.
India's economy grew 4.4% in the quarter ended June, the weakest pace since 2009 when the world was reeling from the international financial crisis.
Now the country is being called the "sick man of Asia" and is facing the threat of becoming the first of the BRICS nations of Brazil, Russia, India, China and South Africa to lose its investment credit status.
Still, Rajan, 50, has hit the ground running.
In his first speech Wednesday, he outlined plans to draw more funds from abroad to support the rupee and free up financial markets and the banking sector.
The rupee has lost nearly a fifth of its value against the dollar since the start of the year.
Rajan radiated an energy that contrasted with the normal crawling pace of policymaking in a performance which was both "bold and brilliant", wrote Raghuvir Srinivasan, business editor of The Hindu newspaper.
So far, the so-called "Rajan-effect" is holding.
The BSE benchmark Sensex surged more than 1,000 points in the last three trading sessions while the rupee staged a strong rally to reach 65.24 to the dollar, up from a record low of 68.85 hit last month.
But banking giant Barclays noted India still faces risks from more global financial market uncertainty as an expected paring of US stimulus triggers outflows from emerging markets as well, as the threat of higher oil prices amid turmoil in the Middle East.
Rajan has a "mountain to climb", The Hindu noted.
Analysts say he is in a policymaking box as India confronts its worst financial crisis since 1991 when it was forced to pawn gold in exchange for an IMF bailout.
Despite clamour from business for lower borrowing costs, analysts say he cannot loosen monetary policy to spur the economy for fear of propelling high inflation higher and weakening the rupee further.
In fact, Rajan's comments suggest he is likely to be "more hawkish", said CLSA economist Rajeev Malik said.
The former top finance ministry advisor and professor at the prestigious University of Chicago's Booth School of Business has sought to temper expectations of what he can do, saying he has "no magic wand".
"Any entrant to the central bank governorship probably starts at the height of their popularity. Some of the actions I take will not be popular," he declared in his inaugural speech.
"The governorship of the central bank is not meant to win one votes or Facebook 'likes'.
Rajan effect on banks: 'Cautious' rating to banking sector-Indian Express
The short-medium-and long-term plans. The short-term steps announced by the RBI (lower swap cost on FCNR and foreign currency borrowings) aim to address currency issues with negligible benefit to banks. The secondary effect of the recent move by the RBI on the bond market, if any, would be the key event to watch for. However, the medium-term (branch/bank licensing) and long-term plans (structural reforms) could have a positive impact, whenever they are implemented.
Short-term measures have negligible impact from an earnings perspective: The RBI has allowed two measures to boost dollar flows—(i) FCNR (foreign currency non-resident account) deposits can be swapped with the RBI at 3.5%, which would enable banks to raise dollar deposits at attractive rates (Libor + 400 bps + 3.5%) for lending in the domestic currency; (ii) banks can raise foreign currency borrowings up to 100% of tier-1 against 50% currently and swap with the RBI at a rate of 100 bps less than the ongoing swap rate. These two measures would have limited impact on banks' earnings as (i) the landed cost of these deposits would be almost similar to term deposits and (ii) the ability to raise borrowings, at least, has been impacted in the current environment.
FCNR deposits have languished at $15 bn in recent years and CDS (credit default swap) spreads of large banks increased by about 200 bps in recent months, making it challenging to raise these funds. We note that large PSU banks like State Bank of India, Bank of Baroda, Bank of India and ICICI Bank would be direct beneficiaries as they have a large international presence.
Medium-term measures positive especially on branch licences: The two key medium-term measures—(i) RBI indicated that new bank licences would be announced by January 2014 and that it would constitute a panel headed by former RBI governor Bimal Jalan to assist in the screening process; (ii) "well-run banks" would have the flexibility to open branches of their choice, a key positive in our view, as India remains an urban-centric market. Delays in the approval process and time-bound implementation, frequent issues raised by banks, have been addressed. However, banks would still need to fulfill certain inclusion criteria in under-served areas as a proportion of their expansion in urban areas.
Long-term measures are many, but there are no defined time lines for implementation:
SLR and priority sector.
The RBI will look to reduce the SLR (statutory liquidity ratio) for banks over the long term but in a calibrated manner, noting the role played by banks currently as well as the current state of government finances. The long-term objective would be to shift the ownership of these instruments to long-term asset players like pension funds and insurance companies. A panel, headed by Nachiket Mor will relook at banks' priority sector lending requirements. While the financial inclusion objective would continue, the panel would suggest requisite changes, if any. The RBI's final guidelines on PSL (priority sector lending) saw very limited acceptance of recommendations in the draft guidelines issued in February 2012.
Licensing policy. (i) The RBI would look at the possibility of continuous licensing for new banks after due consultation with various stakeholders. (ii) Also, differentiated licensing (small banks/local banks/wholesale banks) or converting large urban co-operative banks into commercial banks would be explored. (iii) Foreign-owned banks would be allowed to convert to wholly owned subsidiaries after addressing a few regulatory bottlenecks. This would allow these banks to operate like any other domestic bank.
Other key long-term measures
Loan impairment. Reduction in bottlenecks in the efficient functioning of Debt Recovery Tribunals and Asset Reconstruction Companies. Creation of infrastructure to share large common exposure across banks. Aadhaar would be used to build individual histories of clients. To address cash-flow requirements of SME borrowers, the RBI would look at establishing an Electronic Bill Factoring Exchange, which would allow borrowers to discount their bills quickly and fairly.
Payments. Introduction of a new bill payment system that facilitates easier payment of day-to-day bills for consumers. Introduce new mobile-payment systems, especially through SMS. Facilitate setting up of "White Label" ATMs. Introduction of inflation-indexed savings certificates to hedge savers against negative real interest rates.
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