Urjit Patel, governor of the Reserve Bank of India (RBI), attends a news conference in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)  

Urjit Patel Calls For ‘Good Policy Housekeeping’; Cautions Against Guarantees And Subventions

Citing transitions underway in two of the world’s largest economies – the U.S. and China – Reserve Bank of India governor Urjit Patel on Wednesday said that India needed to ensure “good policy housekeeping” to ensure stable macroeconomic conditions.

An environment of macroeconomic stability has been built over the last few years and must not be frittered away, the governor said. He was speaking at a function to commemorate the establishment of GIFT or Gujarat International Finance Tec-City, an International Financial Services Centre (IFSC).

For us, in India, good policy housekeeping should be the cornerstone. It is easy and quick to fritter away gains regarding macroeconomic stability. But hard and slow to regain them.
Urjit Patel, Governor, RBI

The creation of a monetary policy framework backed by legislation, Patel said, is an important step. Monetary policy is now determined by the Monetary Policy Committee, as opposed to the earlier practice of the RBI governor deciding on the policy course.

The RBI is now tasked with a notified target for retail inflation of 4 percent (+/- 2 percent).

Low and stable inflation is an essential prerequisite for having a meaningful interest rate structure or regime whereby decisions by savers and investors help to achieve maximal allocative efficiency in an economy whose investment rate has to increase for better growth outcomes.
Urjit Patel, Governor, RBI

Along with keeping a tab on inflation, the RBI continues to press for smoother transmission of monetary policy, said Patel.

Banks have been criticised in the past for not effectively transmitting rate cuts by the central bank, despite the shift from the base rate calculation of lending rates to the marginal cost of funds based lending rate. The sharp improvement in liquidity after the central government’s demonetisation exercise has led several banks to cut their lending rates earlier this month, thus completing the transmission of rates that began falling in January of 2015.

Caution On Interest Subventions

While not directly commenting on recent schemes announced by the government, Patel cautioned against policies of interest subvention and credit guarantees.

..while some government guarantees and limited subventions can help, steep interest rate subventions and large credit guarantees also impede optimal allocation of financial resources and increases moral hazard. The mandates for these have to be narrow, and thus perforce be deployed judiciously, within a regulatory framework, which RBI has suggested.
Urjit Patel, Governor, RBI

Patel added that credit guarantees increase the government’s contingent liabilities, and add to risk premia for its own borrowing. “Guarantees per se at the end of the day have limited utility in solving important sector issues.”

On December 31, the Prime Minister announced that home loans up to Rs 9 lakh would receive an interest subvention of 4 percent while those up to Rs 12 lakh will be eligible for a 3 percent reduction in applicable interest rates.

In addition, the government also announced that credit guarantees offered to small and medium enterprises would be extended up to Rs 2 crore from the earlier limit of Rs 1 crore.

Pitch For Fiscal Consolidation

Patel also noted that prudent fiscal management is key for macroeconomic stability. The government, which is due to present its budget on February 1, is required to maintain a fiscal deficit of 3 percent of GDP for fiscal 2018. There is, however, an expectation that a new committee looking into the fiscal consolidation framework would allow the government to work within a fiscal deficit band, giving it some room to increase spending.

Patel highlighted that despite the improvement in the fiscal position since 2013, India’s general deficit remains among the highest.

Since 2013, the central government has successfully embarked on a fiscal consolidation path. Even then, our general government deficit (that is borrowing by the centre and states combined) is, according to IMF data, amongst the highest in the group of G-20 countries. In conjunction, the level of our general government debt as a ratio to GDP is cited by some as coming in the way of a credit rating upgrade.
Urjit Patel, Governor, RBI

A sharp increase in government borrowing cannot be a short cut to long-lasting higher growth, Patel said while adding that the better alternative would be to institute structural reforms and reorient government expenditure towards public infrastructure.

Push For Bank Capital

Patel also stressed on the importance of recapitalising India’s public sector banks.

The government has allocated Rs 70,000 crore for capital injections into state banks over a four year period. As part of a four-year capital infusion plan, the government had committed to infuse Rs 25,000 crore each in 2015-16 and 2016-17 and Rs 10,000 crore each in 2017-18 and 2018-19. This, however, is seen as inadequate by most external agencies. A surge in bad loans, after the RBI conducted an asset quality review in 2015, has only added to the capital requirements of Indian banks.

A well-capitalised domestic banking system enhances the comfort of the various stakeholders to conduct business in the offshore IFSC as well. It is therefore critical that efforts towards developing an attractive offshore financial centre should also include measures for adequate provision of capital to the domestic banking system. 
Urjit Patel, Governor, RBI

Patel has called for the setting up of a unified regulator for the IFSC. This, he said, would help in better regulation and supervision of the financial entities in the GIFT City.

“While individual regulators can supervise the entities initially when the size of the business is small, a unified regulator would be necessary to pay undivided attention to the IFSC. Work on the design of such a framework should begin soon so as to be able to implement this in time,” said Patel.

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