Government, RBI to devise monetary framework for central bank, says Raghuram Rajan

The government and the Reserve Bank of India will this year negotiate to formulate a monetary framework for the central bank that lays more emphasis on inflation, the bank's Governor Raghuram Rajan has said. "This year the government and the RBI will negotiate together to formulate a monetary framework for the RBI...The idea is to move towards an objective which has much more emphasis on inflation," Rajan said in a speech in Chicago on Friday. He said the focus for the RBI has been on controlling inflation and on creating a sound monetary framework. The RBI Act of 1934 does not say anything about the framework that the RBI operates under, he added.

"Since 1934 we have not figured out a framework for the RBI. (It is) time we do it. The government and the RBI will do that," he said. Rajan reiterated that RBI is aiming to bring down the headline number to 8% by end of this year and to 6% by the end of next year. "After that the framework will start kicking in and the government will determine what level it wants inflation at, through some kind of act," he said.

 Rajan also noted that India is finally seeing growth improve, with the country's GDP growing to 5.7% in the last quarter up from about 4.6% a year ago. He, however, cautioned that while this growth is "reassuring" there still tremendous room for further improvement. "I do not want to jump up and down about this number. It is reassuring but we need more of it. My hope is that this year we do a (GDP growth) of 5.5%, may be a little better" and target a growth figure in the 6s next year and around 7% by 2016. The fiscal deficit too had blown out from 2.5% to 6.5% and the government worked "very hard" to bring it down. He said the fiscal deficit is projected to come down to 4.1 per cent this year and by 0.5 per cent every year after 2014.

He, however, said that everything is not "hunky dory" and there is still lots that need to be done. "After you cut the deficit the second step is fix the quality of the fiscal deficit," he said. 

Rajan also spoke about the measures being taken by the central bank to deal with borrowers who default on repaying their loans. "We have also told borrowers if they hold out too long and if there is malfeasance, we will label them willful defaulters which means they cannot get credit from the system again for any other project. That is a pretty serious threat in India. This is a regulatory threat," he said, adding that once a borrower is labelled willful defaulter the person is a "high risk" and the central bank would even impose huge capital requirements on banks if they lent to such a defaulter.

RBI has also coined another term called "non-cooperative defaulter." "If you don't pay you are called non-cooperative which again raises your capital requirements if you get a loan from anywhere, effectively again using the threat of stopping the lending to any other project this person may be involved with years down the line if they don't cooperate now," he said.

Noting that one of the biggest concerns in an emerging market is dealing with distress, Rajan unfortunately in India the bankruptcy system is archaic and when somebody defaults it is hard getting the money back. "We have to work on improving distress and we have been working on making sure the banks get their money back, using every instrument we have essentially creating a bankruptcy system outside the bankruptcy system," that relies on regulations as the way to enforce so as to get a little more bite in dealing with the non-performing assets.

Without naming anyone, Rajan said "some one" was declared a willful defaulter last week. "But we need to do more and we need to effectively create that bankruptcy system itself. These are stop gap arrangements for the broader  objective of creating a functioning bankruptcy system which is speedy," he said.