Raghuram Rajan: The five Pillars of Reserve Bank of India's financial
sector policies
Speech by Dr Raghuram Rajan, Governor of the Reserve Bank of India, at Bancon 2013,
Mumbai, 15 November 2013.
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Good evening. I thank the organisers for inviting me. These are challenging times for the
Indian economy, but I have dwelt on those near-term challenges elsewhere. Let me turn
instead to the opportunities we have to make India a far better place than it is today,
focussing in particular on finance.
Much of the world is ageing, facing the demographic tax of having to pay for an increasingly
elderly population with a shrinking work force. Much of the world has run out of easy paths to
growth. Having built infrastructure everywhere and exploited natural resources to their fullest,
many countries are left with building bridges to nowhere to stimulate growth. Much of the
world is also well-educated, well-fed, and well-connected through roads,
telecommunications, and finance. India is unlike the rest of the world. Our population is
young, our infrastructure inadequate, and too many Indians are poorly educated, poorly fed,
and poorly connected. But this is precisely why our low-hanging opportunities for betterment
are plentiful in the coming years. All we need to do is to pluck them.
So if it is so easy, why are we not there already? This is an important question, but I don't
want to go into the political economy of underdevelopment today. Suffice it to say that India
is battling the internal interests that held it back in the past. While victory is not assured, we
have made sufficient progress that we can look ahead to what we need to do in the next few
years to put ourselves firmly back on the path of strong and sustainable growth.
Some would say we need to focus on manufacturing. Others point to the industries we do not
have, such as electronics or computer chips, and say that is what we need. Echoes of
industrial planning seem to be heard once again in the corridors of power. I am worried
because we seem to be reverting to a dialogue of protection and subsidies that we left
behind long ago. Our industrial sector is no longer an infant that needs to be molly-coddled.
While we should not enter into free-trade agreements that give foreign manufacturers an
undue advantage, that is no reason for us to now respond by giving domestic manufacturers
protection. We must remember that one domestic producer's advantage from protectionist
profits is paid for by the consumer, or shows up as another domestic producer's cost
disadvantage.
Instead of targetting specific industries for governmental attention, which risks bringing back
all the baggage of the Licence Permit Raj that we have left behind, let us focus on improving
the conditions for growth for all. Our measure of success should be the jobs that are created,
not by giving government subsidies or protections to labour-intensive industries or sectors
but by developing a facilitating, though competitive, environment that will result in the
emergence of the best solutions.
This requires a disciplined focus on four issues:
1. We need to improve the quality of our infrastructure, especially the logistical support
and power that industry and services need. Grand plans are on the anvil, such as,
the Delhi-Mumbai Industrial Corridor. We need to complete such projects on time,
and within budget. The success of the New Delhi Metro suggests that timeliness and
cost control are not foreign to the Indian psyche.
2. Our youth need education and training for the jobs that will be created. Some of this
will be higher degrees, not just computer science but also design or civil
engineering. Some of it will be appropriate vocational education that teaches them
to be good plumbers and electricians rather than unemployable low-skilled
engineers. Teaching our citizens can be a stepping stone to teaching the world.
India can be at the forefront of providing mass technology-enabled education laced
with appropriate human inputs to the world.
3. We need better business regulation. This does not always mean less regulation but
it means regulation that is appropriate to the objective and that is enforced. I am told
that factories in one state are still required to have a snake trap on the factory floor
by law, a law that has not been changed since the days factories were surrounded
by jungles. The lack of change may be sheer inertia, but it may be more sinister
rent-seeking. All too often, we have too much regulation on the books and too little
regulation in practice, with the worst of the regulated finding unscrupulous ways
around the regulation while the honest are stymied.
We have strong labour laws in theory that are meant to protect employees, but in
practice we have a very flexible system with no incentive for firms to invest in their
workers or hold on to them, and no loyalty towards the firms from workers. This
needs to change if we are to have more skilled manufacturing jobs.
4. And finally, we need a better financial system, which will finance the needed
infrastructure and the expansion of every producer ranging from the kirana shop
owner to the industrialist even as it allows households to save safely with positive
real returns, insure themselves against health emergencies or old age costs, and
borrow at low cost to finance consumption. Importantly, the financial system should
not require constant subsidies to bail it out.
Five pillars of RBI's developmental measures
In the rest of this talk, I want to focus on what we at the Reserve Bank are doing to improve
the financial system. We plan to build the Reserve Bank's developmental measures over the
next few quarters on five pillars. These are:
1. Clarifying and strengthening the monetary policy framework.
2. Strengthening banking structure through new entry, branch expansion, encouraging
new varieties of banks, and moving foreign banks into better regulated
organisational forms.
3. Broadening and deepening financial markets and increasing their liquidity and
resilience so that they can help allocate and absorb the risks entailed in financing
India's growth.
4. Expanding access to finance to small and medium enterprises, the unorganised
sector, the poor, and remote and underserved areas of the country through
technology, new business practices, and new organisational structures; that is, we
need financial inclusion.
5. Improving the system's ability to deal with corporate distress and financial institution
distress by strengthening real and financial restructuring as well as debt recovery.
Let me elaborate on each of these measures a little.
First, we are among the large countries with the highest consumer price inflation in the world,
even though growth is weaker than we would like it to be. Much of the inflation is
concentrated in food and services. Our households are turning to gold because they find
financial investments unattractive. At the same time, many industrial corporations are
complaining about high interest rates because they cannot pass through their higher costs
into higher prices for their products.
We can spend a long time debating the sources of this inflation. But ultimately, inflation
comes from demand exceeding supply, and it can be curtailed only by bringing both in
balance. We need to reduce demand somewhat without having serious adverse effects on
investment and supply. This is a balancing act, which requires the Reserve Bank to act firmly
so that the economy is disinflating, even while allowing the weak economy more time than
one would normally allow for it to reach a comfortable level of inflation. The weak state of the
economy, as well as the good Kharif and Rabi harvest, will generate disinflationary forces
that will help, and we await data to see how these forces are playing out. No single data point
or number will determine our next move.
I think the market understands what we are trying to do. But we do need a more carefully
spelled out monetary policy framework than we have currently. Action on the framework will
follow the submission of the Dr. Urjit Patel Committee report, which is expected to submit its
report by end December 2013.
Second, we have already announced measures to free bank branching, and to incentivise
foreign banks to incorporate domestically. Going forward, we have to give our public sector
banks, which are a national asset, the means to improve their competitiveness. Many of
them have made enormous strides in the last decade - for instance, the extent to which they
have digitised their operations is extremely praiseworthy - but because competition in the
banking sector is likely to increase in the next few years, they cannot rest on their laurels. In
the coming months, we will discuss with stakeholders in public sector banks about what
needs to be done to further improve their stability, efficiency and productivity.
Third, we need to enlist markets in the aid of banking. Liquid markets will help banks offload
risks they should not bear, such as interest rate or exchange risk. They will also allow banks
to sell assets that they have no comparative advantage in holding, such as long term loans to
completed infrastructure projects, which are better held by infrastructure funds, pension
funds, and insurance companies. Liquid markets will help promoters raise equity which is
sorely needed in the Indian economy to absorb the risks that banks otherwise end up
absorbing. Rather than seeing markets as being inimical to the development of the banking
sector, we have to see them as complementary - of course, this requires you bankers to
build on your risk management capabilities so that you can use markets effectively.
In the coming weeks, we will roll out more recommendations of the Gandhi Committee report
to improve the liquidity and depth of the G-Sec market. We will then turn to money markets
and corporate debt markets. We will introduce new variants of interest rate futures and
products like inflation indexed certificates, and work to improve liquidity in derivative markets.
Fourth, we have to reach everyone, however remote or small, with financial services.
Financial inclusion does not just mean credit for productive purposes, it means credit for
healthcare emergencies or to pay lumpy school or college fees. It means a safe means of
remunerated savings, and an easy way to make payments and remittances. It means
insurance and pensions. It means financial literacy and consumer protection.
We have made great strides in inclusion, but we are still some distance from our goal. We
have adopted a branch based strategy for inclusion, but it is not enough. Too many poor
people in so-called "over-banked" urban areas still do not have access to banking services.
We have many experiments under way to use technology, mobile phones, new products
such as mobile wallets, and new entities as business correspondents to link people up to the
formal financial system. Much as with cell phones where we created a frugal Indian model,
we need a frugal, trustworthy, and effective Indian model for financial inclusion. The
Dr. Nachiket Mor Committee is helping us think through possible models, and I am hopeful
that when we outline measures based on its recommendations, our fine banks, NBFCs, IT
companies and mobile players will rise to the occasion. At a more detailed level, we have set
up committees like the Sambamurthy Committee to advise us on how to expand mobile
banking in India through encrypted SMS based funds transfer in any type of handset.
I should emphasise the need for banks like the ones represented in this room to move
beyond simply opening bank accounts to ensuring that poor customers are confident and
comfortable enough to use them. Innovation in reaching out to the underserved customer,
rather than simply posting higher numbers in branches or bank accounts opened, has to be
part of our efforts.
And last but not least, with have to deal better with distress; The natural, and worst, way for a
bank management with limited tenure to deal with distress is to "extend and pretend" to
evergreen the loan, hope it recovers by miracle, or that one's successor has to deal with it.
The natural incentive for a promoter to deal with distress is to hold on to equity and control
despite having no real equity left, and to stand in the way of all efforts to resolve the
underlying project while hoping for an 'Act of God' to bail him out. Not all bankers and
promoters succumb to these natural incentives but too many do.
We have to ensure that the system recognises financial distress early, takes steps to resolve
it, and ensures fair recovery for lenders and investors. We could wish for a more effective
judicial process or a better bankruptcy system, but while we await that, we have to improve
the functioning of what we have. In the next few weeks, we will announce measures to
incentivise early recognition, better resolution, and fair recovery of distressed loans. We will
focus on putting real assets back to work in their best use. Here again, you bankers have a
critical role to play by fighting the natural incentives that are built in to the system. You have
to help those with genuine difficulty while being firm with those who are trying to milk the
system. The RBI will help you with every means at our disposal.
Let me conclude. We are going through a period of great cynicism about what India can do.
That cynicism does not just permeate the foreign press and their audiences, but also infects
our domestic debate. Every policy is greeted with suspicion and scrutinised for evidence of
malfeasance. With no upside to making decisions, it is no wonder that decision making has
slowed. The solution, however, cannot come through inaction but through action, action that
is, and is seen to be, purposeful, unbiased, and effective. No doubt mistakes will be made,
but if the weight of clean actions builds up, the miasma of suspicion that pervades our
society today will ebb. The Reserve Bank of India intends to play its part in making this
happen.