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Financial Reforms - Past and Present (Dr. Raghuram Rajan Governor - January 29 2016 - at NCAER New Delhi)

News and Press Release - Dated:- 30-1-2016 - I thank Shekhar Shah for inviting me to deliver the C.D. Deshmukh lecture at NCAER. Sir Chintaman Dwarakanath Deshmukh, an ICS officer, was truly a giant of modern India. In 1943, he was the first Indian, as well as the youngest in its history to date, to be appointed the Governor of the Reserve Bank of India. He subsequently served as the Finance Minister in the Union Cabinet. It was during this time that he also became a founding member of the Gover .....

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shan in recognition of his services. Sir C.D. Deshmukh died in 1982. C.D. Deshmukh was an institution builder. I am currently the caretaker of one he led, the Reserve Bank of India. Let me assure him that the Reserve Bank is in fine fettle. In a country where time has weighed heavily on the quality of institutions, the integrity, capability, and motivation of my colleagues allows the Reserve Bank to continue to stand tall. The world today, however, is much less comforting. Industrial countries a .....

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ng in reducing inequality. It grew at 7.6 percent in 2010, and had discovered huge oil reserves which the then President Lula likened to winning a lottery ticket . Yet the country shrank by 3.8% last year, and its debt got downgraded to junk. Growth will be no better this year. What went wrong? Paradoxical as it may seem, Brazil tried to grow too fast. The 7.6 percent growth came on the back of substantial stimulus after the global financial crisis. In an attempt to keep growth high, the New Yor .....

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rilling, instead became embroiled in a corruption scandal. Even as government pensions burned an ever larger hole, budget deficits expanded, and the political consensus to narrow them has become elusive. Inflation touched double digits in the 4th quarter of 2015. While the Brazilian authorities are working hard to rectify the situation, let us not ignore the lessons their experience suggests. It is possible to grow too fast with substantial stimulus, as we did in 2010 and 2011, only to pay the p .....

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s experience suggests, the enormous costs of becoming an unstable country far outweigh any small growth benefits that can be obtained through aggressive policies. We should be very careful about jeopardizing our single most important strength during this period of global turmoil, macroeconomic stability. There is a public discussion of whether India should postpone, yet again, the fiscal consolidation path it has embarked on. Clearly, the Government will balance various compulsions in taking its .....

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ith UDAY, the scheme to revive state power distribution companies, coming into operation in the next fiscal, it is unlikely that states will be shrinking their deficits, which puts pressure on the centre to adjust more. Some say that fiscal expansion is necessary to generate the growth needed to put our debt to GDP ratio back on a sustainable path. This is a novel argument. Ordinarily one would think that a government should borrow less, that is, run lower fiscal deficits, in order to reduce its .....

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oes not really care whether we stay on the consolidation path or not. But the bond markets, where we have to finance over ₹ 10 lakh crore of deficits plus UDAY state bonds, do care. Deviating from the fiscal consolidation path could push up government bond yields, both because of the greater volume of bonds to be financed and because of the potential loss of government credibility on future consolidation. It was James Carville who said I used to think if there was reincarnation, I wanted t .....

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n achievement given two successive droughts that would have, in the past, pushed inflation into double digits. Despite this success, we hear voices suggesting weakening the fight against inflation. Let me reiterate that macroeconomic stability relies immensely on policy credibility, which is the public belief that policy will depart from the charted course only under extreme necessity, and not because of convenience. If every time there is any minor difficulty, we change the goal posts, we signa .....

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I am reminded today of the period 1997-2002 when India labored and reformed with only moderate growth, only to see a decade of high growth after that. Before I turn to the main body of this talk, a word on interest rates. Industrialists grumble about high rates while retirees complain about the low rates they get today on deposits. Both overstate their case, though as I have said repeatedly, the way to resolve their differences is to bring CPI inflation steadily down. Let me explain, starting wi .....

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wants to buy dosas and at the beginning of the period, they cost ₹ 50 per dosa. Let us say he has savings of ₹ 1,00,000. He could buy 2,000 dosas with the money today, but he wants more by investing. At 10% interest, he gets ₹ 10,000 after one year plus his principal. With dosas having gone up by 10% to ₹ 55, he can buy 182 dosas approximately with the ₹ 10,000 interest. At 8% interest, he gets ₹ 8,000. With dosas having gone up by 5.5%, each dosa costs ₹ .....

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8 dosas. He is about 2.5% better off in the low inflation period in terms of dosas. This is a long winded way of saying that inflation is the silent killer because it eats into pensioners principal, even while they are deluded by high nominal interest rates into thinking they are getting an adequate return. Indeed, with 10% return and 10% inflation, the deposit is not giving you any real return net of inflation, which is why you can buy only 2,000 dosas after a year of investing, the same as you .....

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ition, he said his revenues had not grown at all, with his volume growth barely offsetting the price decline for his product. While commiserating with him, I said lower input costs must be a boon, because commodity prices have fallen even more sharply than output prices. He grudgingly agreed they had helped. When asked about his profits, he eventually admitted they were at an all-time high. But nevertheless, he said, we need safeguard duties because foreigners are dumping below cost! Put differe .....

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sing tariffs at a time when costs are falling everywhere - aside from the inflationary impact, for every happy domestic businessman whose prices are raised by the imposition of tariffs on imports, we have an unhappy domestic businessman whose costs are raised by the very same tariffs, as well as unhappy consumers. Cleaning Up the Banks One very important contributor to macroeconomic stability is healthy banks. Banks in India have a number of stressed loans on their balance sheet. In some cases, .....

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his utmost to put it back on track. But to do all this deep surgery, the bank has to classify the asset as a Non Performing Asset (NPA), a label banks are eager to avoid. Alternatively, instead of deep surgery, the banks could apply band aids, they could extend and pretend , lending the promoter the money he needs to make loan payments. The project s debt obligations grow, the promoter loses further interest, and the project goes into further losses. A number of good banks in our system have ta .....

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has indicated he will support the public sector banks with capital infusions as needed. Our estimate is that the support that has been indicated will suffice, especially when coupled with other capital sources that are usually available to banks. Our various scenarios also show private sector banks will not want for regulatory capital as a result of this exercise. Finally, the RBI is also working on identifying currently non-recognizable capital that is already on bank balance sheets, such as un .....

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ess manageable. Let me now turn to the structural reforms that we intend to implement in the financial sector, which will build on the platform of macroeconomic stability to generate growth. We will increase efficiency through greater entry and competition. We need more participation in our financial markets to increase their size, depth, and liquidity. Participation is best enhanced not through subventions and subsidies but by creating supporting frameworks that improve transparency, contract e .....

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onomy. After over a decade of no new entry, we have seen two new private banks enter last year, and a number of payment banks and small finance banks will enter this year. We will put licensing for universal banks on tap soon. Incumbents have expressed fears about unfair competition. Competition is only unfair if it is not on the same playing field. In fact, new entrants have no privileges that incumbents do not already enjoy. We hope, though, that the new entrants will find innovative ways of g .....

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because some of these new entrants will go after their customers. This is no bad thing because, hitherto, those customers have had limited choice. Public sector banks will need to automate more so as to reduce transactions costs, cut administrative overheads and improve response times, even while improving their risk assessment and monitoring systems so that they can use the wealth of information they have gathered over the years to make sound lending decisions. Almost surely, this transformati .....

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Board Bureau, which will select board members, will come into operation soon. We have to pay board members of PSBs a market compensation if we are to attract decent talent - otherwise we risk attracting an unwieldy mix of the truly patriotic and the truly unscrupulous, with the latter intending to profit by their board position. When thousands of crores can be diverted by a bad board decision, should we not ensure we have adequate integrity and talent on bank boards? More decisions need to be d .....

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blic sector banks have identical strategies and are competing for the same pie, we have to allow the boards more freedom to differentiate their banks. Finally, as bank health recovers, the issue of PSB mergers can be addressed. Almost surely, some banks will have to merge to optimize their use of resources. But talking of bank mergers, which take a lot of management attention, especially when each bank management is preoccupied with dealing with stressed assets, is probably premature. At the sam .....

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ensity to get into trouble. But we also should not stand in the way of innovation. There is a Chinese saying: Cross the river by feeling the stones . The RBI has tried to follow that path of experimentation and incremental liberalization. So, for example, as increasingly innovative new services want their customers to have the ability to make payments quickly, we have allowed small value card payments without two-factor authentication. As we and financial institutions gain experience, and as new .....

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d out will allow anyone to make a payment to anyone else with a bank account simply via a mobile and a unique email-like address. The Trade Receivables Exchanges will be a boon to small businesses. Essentially, any business that has a receivable against a large firm can sell it as a bill on the exchange, after the large firm acknowledges it has been supplied the goods. Not only will the small firm get paid quickly, buyers will discount the bill at the rate associated with the large firm, and thu .....

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rchant can be the basis for making him a loan and recovering payment. I am especially excited by the possibilities afforded the carpet seller from Srinagar, who can display her wares across the globe, with the marketplace arranging marketing, logistics, and finance for her. Financial Inclusion The Prime Minister s Jan Dhan Yojana has created accounts for much of the excluded population. Government has taken the next step of attaching a variety of financial services such as accident and life insu .....

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al inclusion, we risk lending to people who have little ability to manage money and overburdening them. By drawing them into the formal system through savings and payments first, then insurance, we get them accustomed to managing money before tempting them with credit. This is the successful method we have followed with Self Help groups, and is what we should do more widely. Importantly, we need a variety of firms and NGOs to help small businesses with management advice so that they can flourish .....

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sier access to credit necessitates harsher consequences of default, including the loss of collateral. Aadhaar has given individual borrowers the possibility of using their future access to credit as collateral. I do hope the Supreme Court clears up the cloud over its use quickly. But there are also situations where borrowers have physical collateral they can use to lower their cost of credit and improve access. We really need to reexamine mandates that banks should lend without collateral to cer .....

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redit information bureaus, collateral registries, and debt recovery tribunals. Perhaps the most important source of collateral value is land. We need better digital mapping and clean records of land ownership across the country so that land can be used more effectively as collateral. Andhra Pradesh s pattas for tenant farmers is also an innovation that will help tenants get access to credit. Consumer Protection and Literacy Finally, newcomers and outsiders need protection against unfair practice .....

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ng as well as the proper functioning of bank infrastructure such as branches and ATMs, will be expanded. We are also working with state law enforcement authorities through State Level Coordination Committees to try and nab fly-by-night operators before they do real damage. As access to finance improves, we need customers to protect themselves. Higher education is not sufficient protection. Many of you must have received an email from me saying that the RBI had concluded a pact with the IMF or th .....

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