The central bank will have to revive credit growth, drain liquidity and keep inflation on hold: that’s just the beginning of his tasks.
RBI Governor Shaktikanta Das | Photo: Bloomberg
Shaktikanta Das started his innings at the Reserve Bank of India in 2018 with a crisis in hand. A debate was raging over the central bank’s autonomy and its capital framework. His predecessor Urjit Patel resigned abruptly–allegedly due to differences with the government –and his successor had to fill in quickly. Since then, Das has tackled many crises: the liquidity crunch at non-banking finance companies, a slowing economy and the coronavirus pandemic.
He managed the pandemic’s impact well, reacting promptly by cutting interest rates sharply and taking many other steps, central bank watchers say.
Now that the economy is returning to normal, a different challenge faces the former civil servant. Here are six priorities of Das, 64, has as he starts his second term after the government extended on Friday gave him another three years in office. He will be the first governor in seven decades to have such a long tenure at the Reserve Bank (RBI) when he completes his second term.
Reviving credit growth
Bank credit growth–one of the key indicators of economic activity–remains muted. According to central bank data, loans of commercial banks grew by 0.6% in the financial year so far; year-on-year growth is 6.5%.
“Revival of the credit market could be one of his priorities,” said Sachin Chatuverdi, Director General at the Research and Information System for Developing Countries (RIS), and a member of the RBI’s central board.
“Because there is huge liquidity in the market, all the banks are sitting on cash. How do we take that forward? That could be one priority of the governor,” Chaturvedi told Business Standard. Insulating the Indian economy from global spillovers would be another priority, he said. Improving banking in the semi-urban and rural areas could be another task.
Draining excess liquidity
There has been a huge liquidity overhang in the banking system for more than a year now. The daily net liquidity absorption under the liquidity adjustment facility (LAF) averaged Rs 7.8 trillion in the second fortnight of September to October (up to Oct 13), as compared to Rs 8.9 trillion in the first fortnight of September.
A similar liquidity situation also emerged after the demonetisation exercise of 2016. The withdrawal of liquidity resulted in a massive liquidity crunch for the non-banking finance companies. As a result, the central bank is extremely careful this time on withdrawing the excess liquidity.
“Bringing down the liquidity to normal levels is a big challenge,” said Abheek Barua, chief economist, HDFC Bank. “You can very easily infuse money in the system but getting out is a very tough task without causing serious disruptions in the market,” Barua said.
Returning to 4% inflation targeting
The pandemic had forced the central bank to target inflation within the band of 2-6%. The inflation-targeting framework mandates the central bank to target 4% inflation with a variation of 2% on both sides. Since boosting growth was priority, the central bank accepted a wider tolerance zone than it would have during normal times.
Now going back to policy making during normal times will be a priority for the central bank. Market participants said while the liquidity normalization process has started, the move to normalizing the monetary policy from an ultra-loose stance, may start as early in the December policy with an increase in the reverse repo rate. The reverse repo rate was reduced more than the repo rate since the onset of the pandemic, which resulted in the widening of the corridor to 65 bps, from 25 bps. (100 bps = 1 percentage points).
“We continue to expect the RBI to pursue a relatively dovish stance while it focuses on growth amid a more flexible inflation-targeting regime that has evolved under Governor Das. This was a shift from the approach of the MPC under former Governor Urjit Patel, which was characterized by a commitment to stick to the midpoint of the 2-6% target range,” economists at Barclays said, referring to the monetary policy committee.
“Overall, we continue to expect the reverse repo rate to be raised at the December policy meeting, the last of Governor Das’s first term, but the repo rate is likely to be raised only by Q2 22, when we believe the RBI will view India’s economic recovery as durable,” Barclays said.
HDFC Bank’s Barua also says that the growth challenge is still there. “We are still considerably below the pre-pandemic trend growth path. So we cannot go all out for inflation management, especially when inflation is supply driven.”
In the face of heavy inflows, managing the exchange rate to keep Indian exports competitive is another area of priority from the central bank. In the foreign exchange market, the Indian rupee appreciated against the US dollar in September 2021 by 0.8 per cent (m-o-m) on the back of robust FPI inflows. This was reflected in the movement of the rupee in terms of the 40-currency real effective exchange rate (REER) index, which appreciated by 0.7 per cent over its level a month ago. While there was downward pressure on the rupee during mid-October, but again the rupee has started gaining ground.
“If India is indeed such an attractive market place, with all the IPOs that are coming in, then we can see a situation like 2004 when the rupee appreciated very sharply. How to manage that? I think that is a very big challenge for the governor,” Barua said.
Resolution of PMC Bank
The central bank has to manage troubled lender Punjab & Maharashtra Cooperative Bank’s (PMC) merger with Unity Small Finance Bank, which is a joint venture of Centrum Financial and Bharat Pe. It has experience in that task by rescuing YES Bank and Lakshmi Vilas Bank.
The merger of the two entities is probably in the final stages, which will happen as soon as the scheme of amalgamation is notified by the government. Ensuring a smooth transition of PMC depositors who are facing hardship for more than two years, to Unity is likely to be one of the immediate priorities of Das.
Bank license to corporates
An internal working group of the RBI has proposed granting bank license to the corporate sector. While the central bank is yet to take a call on the issue, India Inc believes the government allowing private banks to undertake its business (which was only allowed for public sector banks) is an indication of things to come. Sooner than later, Das has to take a view on this issue.