When Raghuram Rajan took Dosa economics to Columbia University

Let me explain.
Let me explain.
Image: Reuters/Paco Chuquiure
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On April 18, a group of students at New York’s Columbia University gathered at the campus to hear Reserve Bank of India (RBI) governor Raghuram Rajan deliver the inaugural Kotak Family Distinguished Lecture on “India in the global economy.”

Before becoming central bank governor in 2013, Rajan, 53, was the chief economist at the International Monetary Fund from 2003 to 2007, the youngest to occupy the position. He is widely credited with predicting the global economic slowdown in 2008, the worst financial collapse since the Great Depression of the 1930s. As RBI governor, he leads the policies of one of the world’s fastest-growing large economies.

After the speech, Rajan answered students’ questions about India’s foreign exchange reserves, how the country’s monetary policy gets transmitted to commercial banks, and the alarming levels of non-performing assets (NPAs) in Asia’s third largest economy. His signature ”dosa economics” was part of the conversation. He also discussed the effect the monsoon could have on interest rates. Monsoon rains are critical for India, where around two-thirds of the population depends on farm income and over 40% of the cropped area does not have any form of irrigation other than rainwater.

Here are the edited excerpts of the Q&A:

India has very healthy foreign exchange reserves today. Do you expect this strong position to continue in the near future? What happens if oil prices rise back to over $100 a barrel?

We haven’t targeted a particular level of forex reserve build up.

There is a school of thought that says let the currency move and don’t try to control it. That’s something we appreciate, but in an emerging market, with institutions that are not as strong as industrial countries, you find there are collateral effects of both the money coming in as well as money going out. So we intervene when there’s a substantial flood of capital coming in and we don’t want the currency to move only as a result of capital flows. Similarly, when it goes up, especially in times of panic, we let it go up but perhaps not as fast and we hold it down.

When the oil prices start rising again—which at some point they must—we have to see how the government’s playbook plays up. Certainly the country’s current account deficit will be affected, but I presume that even if that goes up to 2% from where we are now, that can be sustained for some time.

You have shown some annoyance with the fact that monetary policy is not being transmitted effectively. What kind of rules are being worked on to ensure transmission?

We cut interest rates, but we didn’t see the banks translate that into lending rates. The banks said, “Well, we did it before and you can’t expect us to do it every time.”

It’s not like in the developed countries where you  just cut interest rates and everything else happens for you. We have to work on multiple fronts to make sure that any policy action actually works.

We have systematically gone about each impediment in the way of policy transmission. One impediment was the small savings rate, where post offices were offering deposit accounts that pay really high-interest rates. So even though the policy rate was being cut, you could deposit your money somewhere in the economy where it would get high interest rates. So we were talking to the government to tie up those rates to market interest rates. But that’s an important political decision because no matter what your customers get on the lending side, they also want to get good returns on the savings side.

I have a lot of pensioners writing to me about why they used to get 9.5% returns and now they get 7%. I ask them to look at how inflation rate is much lower now, which means you are actually making money now. I called that dosa economics and that went viral at some point.

So in general things are moving in the right direction but you need to keep thinking, what are the roadblocks and keep changing.

If the monsoon is normal, will your hands be strengthened more to cut interest rates?

We are watching the development of inflation and we are also looking for signs of good monsoon. As evidence builds up one way or the other, it will give us more information. We are still in accommodative mode but precisely how much and when, we will have to see.

How much of a concern are NPAs for the Indian banking system right now?

I think what’s happening on the NPA front is a cleanup. Now, this becomes loaded with a lot of morality. I think one should take out the morality from the NPA cleanup. The NPA cleanup is simply about whether the loan is performing or non-performing. It may have become non-performing simply because you had terrible luck or because it was somebody else’s fault—somebody cancelled your licences, somebody didn’t give you approvals on time, your partner didn’t perform.

There could be all sorts of reasons why companies get into a trouble. If they get into trouble, the loan becomes a non-performing asset. Declaring it non-performing has two effects—firstly, it’s an accounting thing, which helps people trust the accounts of the bank and they know how much is non-performing and how much is performing; secondly, it gives anybody the chance to come together and put an asset back on track. We want these assets to get back on track very much.

What are the preventive measures being taken to ensure that banks don’t give loans to the wrong people in the first place?

That requires a transformation of the banks. The government has said very clearly that it will not interfere in the process of granting loans. Next stage is to improve the administrative structures and the management of banks. The job of the chairman has been separated from the CEO’s and we have looked for wider pools to find CEOs. The boards have been revamped and more professionals have been inducted and some of the old directors are being moved. So there is a hope that this process will transform the governance and function of banks.

Banks are pushing lending to startups where a lot of risk is involved. Would this increase NPAs?

The universe that lends to startups is different than old-style companies. Banks typically are lending to old-style companies and startups are getting funded by venture capital and private equity. As enterprises get more mature, they go out and take bank loans. But there is a functioning enterprise at the time, as opposed to two people in a garage.

What’s the current state of India’s debt market?

What we lack is a strong corporate debt market. We need to strengthen the capabilities to do large projects. Many projects start with a lot of bank debts but when they cross a certain milestone you have got to offload it to the corporate debt market.

I think the missing piece there is the bankruptcy code. The corporate debt holder today is asking what if the company gets into trouble? How will I get my money back? So in order to solve those issues, we need a proper bankruptcy system, which will allow lower rated credits to get access to the market.