Two Years Of Shaktikanta Das, Three More To Come

Shaktikanta Das replaced Urjit Patel on Dec. 12, 2018, as the 25th governor of the Reserve Bank of India. That announcement and the transition was swift, but it came after six to nine months of bickering between the RBI and the government. The two years since have been adventurous and remarkable in every aspect.

2019 was adventurous from the traditional RBI standards, 2020 has required the heavy hand of the RBI to stabilise the financial system.

Governor Das would be hoping and praying for some normalcy in central banking operations in his remaining three years. I say three because I do not see any reason why his tenure will not be extended beyond 2021, by two years. It is his to refuse.

Das enjoys the confidence of his political bosses. While at the Finance Ministry, he was the public face of demonetisation – the Modi government’s disastrous financial experiment. At the RBI, he has done much more for the economy, markets, and for the government than expected. The RBI’s actions accounted for about half of the government’s Rs 20 lakh crore Atmanirbhar Bharat package. The relationship is symbiotic.

Indelible Mark On Credit And Monetary Policy

Das began on the front foot. Led by him, the Monetary Policy Committee cut the repo rate in five successive meetings starting February 2019 from 6.5% to 5.15%. In October 2019, the MPC committed to ‘remain accommodative as long as necessary’. I had likened that comment to the famous Mario Draghi commitment to do ‘whatever it takes’ to save the Euro. Das had managed to sway the MPC from a tight inflation mandate to commit to supporting growth.

In December 2019, with the 10-year bond yield refusing to budge below 6.5%, Das began a U.S. Fed-like ‘Operation Twist’. The U.S. Fed, having reached zero bound introduced Twist in 2012 to get longer tenor bond yields lower. The RBI had scope to cut rates but began Twist to support the government-borrowing programme.

Expanded Tool-Kit: Monetary, Regulatory, And Moral Suasion

Das reminded the markets to never discount a central bank. If a central bank can’t cut rates, it can add liquidity and get rates down. If the yield curve is steep and it cannot conduct open market operations, it can conduct Twist operations. Monetary transmission remains weak, it can launch long-term repo operations. Money not reaching stressed sectors, the central bank tweaks it to targeted-LTROs. A central bank, willing to be bold, has monetary arsenals to subdue and manage markets.

As interest rates reached their limit, Das moved to regulatory dispensations to drive through the monetary transmission. Since March 2020, bankers keenly await Statement II of the monetary policy document on regulatory and market development policies. From using LTROs, targeted liquidity facilities, change in risk weights, tweaking of HTM limits, repo linked lending rates, the RBI has tried several ways to try and improve credit delivery and market functioning. We are back to the days of monetary and credit policy.

Das also used ‘open mouth operations’, a less used tool in today’s times. He urged bond traders to be competitive but not combative and help the RBI in managing the government bond auctions smoothly.

Das Earns His Stripes

Early on in Das’ term, former RBI Governor YV Reddy picked up what may prove to be an underlying theme of the 25th governor’s tenure. Reddy pointed to a June 2019 speech from Das which said “the fact remains that though the focus of monetary policy is mainly on inflation and growth, the underlying theme has always been financial stability.” His focus on financial stability is not unlike Reddy’s.

“The signal from RBI Governor Shaktikanta Das is that the balance will tilt in favour of the inter-dependence of policies and implicit coordination with the government and the full service nature of the RBI,” Reddy wrote in Business Standard.

“Financial Stability And Orderly Evolution Of The Yield Curve Is A Public Good”

I have never heard a central banker say something like this. I think this is an over-extension of its role as a debt manager for the government.

Das has linked one aspect of financial stability to market rates. By that, he is suggesting that the RBI will intervene to correct the yield curve. Central bankers, over the last 10 years, have lorded over the bond market. To a point, where the markets do not function without the support and presence of the central bank.

Indian bond traders too look up to the RBI. They expect RBI to manage the liquidity so that short-term rates are anchored. They want RBI to ‘Twist’ to support the longer end of the market. Every time, bond yield rise by 5-10 bps, they expect RBI to announce OMOs. The corporate bond investors await RBIs OMOs in state development loans to manage and align their yield curve.

In short, there is a ‘Das Put’ in the markets. A belief that Das will support the markets.

This was needed post-Covid-19. However, the RBI has to wean the markets away from this default assumption. The trajectory of bond yields and thus the returns from fixed income in the coming year will depend on how well the RBI manages this transition.

Das has a few other immediate challenges to overcome and some broader expectations to meet:

• Managing The Impossible Trinity:

In a global liquidity glut, as risk aversion subsides, capital flows will seek higher risk/higher return destinations. India has already seen those flows in its equity market. India’s bond market limits have substantially increased. The RBI needs a plan to manage these (potential) large inflows. It cannot manage forex, inflation, and allow free capital flows at the same time. For now, they have prioritized managing the FX rate. They may have to shift the priority to managing inflation.

• Normalisation Of Monetary Policy:

Since Das took over, the RBI has bought Rs 5 lakh crore of government bonds and over Rs 8 lakh crore of US dollars. This is a significant intervention and accommodation, resulting in a large spike in money supply and base liquidity. Is the central bank liquidity action bypassing the remit and mandate of the MPC?

Also, how long do rates remain low and liquidity in excess depends on what RBI deems as normal. Is 6% inflation normal against its target of 4%? Is 7% growth normal, as against 5-6%? These are crucial decisions that will determine normalisation. These decisions will be crucial as it impinges on financial stability.

• Independence In Actions:

There is a reason why many talk about central bank independence. We just have to look at Turkey to see what happens when investors lose faith in the central bank because of government overreach. We are not in that situation but it is important to assert and display independence from time to time. Investors have to believe that the central bank is independent enough to take tough actions.

YV Reddy, for instance, in that same op-ed asserted, “The next step will presumably in favor of negotiation for greater autonomy for the RBI within the ambit of the government’s policies, in preference to asserting independence.” As Raghuram Rajan put it once “..having de-facto independence is more important than de-jure independence”.

I believe regulatory independence matters more to the central bank than monetary independence. India has a monetary policy committee to decide on interest rates. A compromised RBI would allow the government to hold sway on most other aspects. For instance, is ‘Atma-Nirbharta’ guiding the RBIs FX management? Are government-mandated loan facilities bypassing the regulator? Will RBI be able to stave off corporates from entering banking?

Many see Das as a government yes-man. We are yet to see him being critical of any government action. RBI’s and his independence will be put to test as it normalises monetary and regulatory dispensations.

Das will be known for having taken bold actions. Actions never attempted at the RBI before. What he will be remembered as, however, will depend on his actions in the coming years.

Arvind Chari is Head - Fixed Income & Alternatives at Quantum Advisors. Views expressed are personal. Disclaimer.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.