Outgoing Reserve Bank governor Raghuram Rajan’s last credit policy announcement Tuesday was rather tame compared to the scorching pace of reforms he undertook to reform the banking system to bring in efficiency, clean up banks’ balance sheets and recognise non-performing assets rather then brushing them under the carpet. He has made banks competitive, bringing in universal banking, payments banks and “on tap” licensing where once banks struggled to even open a branch, as one banker noted. A revolutionary change was introducing lending based on the marginal cost of funds, to ensure banks pass on the benefit of lower costs to borrowers by cutting loan rates.
This made housing loans cheaper. So while policy rates were kept unchanged as food prices were still high, Dr Rajan promised a lot of action before his term ends on September 4. He did well to chide banks for passing on rate cuts “modestly”, but held out hope that once corporate demand picks up and banks clean up their balance sheets, they would seek corporate business. The good news: the economy is on an upturn and growth momentum will get a boost from the good monsoon, that could raise agricultural growth and see rural demand rising. To underline this Dr Rajan kept the GDP growth rate at 7.6 per cent for 2016-17.
Interestingly, this may be the last time an RBI governor alone will decide policy rates. The six-member Monetary Policy Council that is being formed will decide the rate collectively. With three RBI representatives and three from the government, it is likely the latter would push for cutting rates. The MPC is a major institutional reform to modernise India’s monetary policy framework. It is likely this committee may cut rates as the monsoon progresses across the country, bringing down food prices in future, that will in turn give space for rates to be further reduced. The upside risk to inflation still lurks in the background, as full implementation of the 7th Pay Commission recommendations on allowances, specially on house rent, could affect the consumer price index.
The long-awaited GST is unlikely to increase inflation, though as Dr Rajan pointed out, when it was implemented in Malaysia there was some price rise initially. But it’s still too early to predict if it will send prices up as its rate is yet to be decided. Another major step taken by Dr Rajan was in consumer protection. There were complaints of harassment in the implementation of the KYC rules, which have since been simplified and there are RBI websites to help consumers. Dr Rajan’s successor will indeed have a challenging task to maintain the same pace of reform.
