Within hours of assuming office, India’s new RBI Governor, Dr. Raghuram Rajan, has signaled a clear intent at pursuing financial sector
reform. Wasting no time, he used his inaugural address to announce a host of measures aimed at increasing competition, operational freedom and allocative efficiency of banks as well as measures to increase financial market depth and consumer choice.
In addition, he announced measures aimed at mobilizing more banking capital flows though – given that these will be necessarily swapped
with the RBI – will not have a direct impact on the spot exchange rate.
While these announcements will not fundamentally alter near-term growth-inflation dynamics, they are structural in nature and have the
clear potential to boost growth in the medium-term, if they are taken to their logical conslusion. This phenomenon, in conjunction with the reformist signal these announcements send on Day 1, have understandably excited markets. At the time of going to press,
the Rupee was 1.5% stronger and equities had rallied 2.5% -- driven mainly by the banking sector.
In addition, Parliament has swung into action over the last 72 hours. Both houses of Parliament have approved the Land Acquisition Bill
(though it goes back for approval to the Lok Sabha (lower house) after the Rajya Sabha (upper house) introduced some amendments) and the Lok Sabha late last night finally approved the long-standing Pension Reform Bill. While industry has voiced concerns on
the cost of acquisition under the new land bill and pension bill still awaits clearance from the Rajya Sabha, there is at least a palpable sense that the legislative gridlock has finally been broken.
Banking reforms get a push
In his inaugural address, the Governor highlighted the central bank has several tools to generate growth by accelerating financial development
and inclusion. Towards that end, he announced that:
The granting of new banks licensing will be expedited and the RBI expects to announce the new licenses sometime during, or shortly after,
January 2014. The process would entail an external committee, chaired by former RBI Governor Dr. Bimal Jalan, that would screen applicants and make recommendations to the top brass of the RBI who, in turn, would propose the final slate to the Committee of
the RBI Central Board.
Differentiated and on-tap licensing could subsequently be pursued for the banking sector. The Governor referred to pursuing a recent
public discussion-paper issued by the RBI that proposes, among many other reforms, allowing specialized banks to operate in India through differentiated licenses; allow new banks to enter on a continuous basis; and setting up an efficient deposit insurance
and resolution mechanism to support the tiered banking system.
Operational freedom for banks will be enhanced with domestic commercial banks no longer needing RBI approval to start new branches, subject
to fulfilling some inclusion criterion.
The non-performing assets (NPA) situation needs to be addressed, towards which steps to accelerate the working of Debt Recovery Tribunals
and Asset Reconstruction Companies will soon be announced. Furthermore, the RBI plans to create a centralized database of large borrowers so that banks can share and use that information
Medium-term measures to increase allocative efficiency of capital will be pursued by targeting an eventual reduction in banks’ SLR requirements
and rationalizing their priority sending requirements
Pushing towards deeper financial markets
In addition to the banking measures, the Governor spoke about the importance of deepening financial markets --- the leit motif of his
2008 Report on Financial Sector Reforms – so that risk that should ordinarily be absorbed by arms-length financial markets do not, be default, gravitate towards the banking sector. To create this needed depth, in turn, he spoke about the importance of not
banning position taking – in a marked departure to the approach the central bank has pursued over the last two years. Towards this end, he announced that:
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The extent to which exporters will be permitted to rebook cancelled forward exchange contracts will be increased from 25% to 50%
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Imports – who were heretofore not allowed this facility – will be able to do so to the extent of 25%
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Cash-settled 10 year interest rate future contracts will be introduced
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Interest rate futures on overnight interest rates will be considered
Attracting more banking capital inflows
Given the stress that India’s currency and BoP has come under over the last few months, all eyes were on the measures the new governor
would/could announce on attracting more capital inflows. The Governor announced two specific measures:
First, that the RBI will offer a special concessional window for banks to swap fresh FCNR(B) dollar deposits for a minimum tenor of three
years at a fixed rate of 3.5% per annum. Essentially, this would significantly reduce the local-currency cost of these deposits and thereby incentivizes banks to mobilize new deposits and aggressively lever it up.
With the scheme open till November 30th, it is undoubtedly the case that fresh FCNR (B) deposits could simply be funds that
were previously in NRE (rupee) deposits and, upon redemption, move to a dollar deposit. In a sense, this would not constitute a new inflow from the perspective of the system as a whole. However, to the extent that banks will be aggressively levering these
inflows up (which would constitute new flows), the bulk of the inflows will not be a result of the cannabilization of existing NRI flows.
Second, banks’ current overseas borrowing limit of 50 percent of the unimpaired Tier 1 capital will be raised to 100% and borrowings
mobilized under this provision can be swapped with the RBI at a concessional rate of 100 bps below the market-prevailing swap rate.
Markets expecting $10-14 billion, but remember…
Markets are expecting about $5-7 billion capital inflows under each of these initiatives. Together, therefore, these initiatives could
potentially attract $10-14 billion of inflows. However, it’s important to bear in mind that:
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because they will necessarily be swapped with the RBI (to be attractive), they are not expected to have a direct impact on the spot exchange rate
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essentially they are tapping the same pool of global liquidity that has traditionally been available for India. Consequence, higher flows under theses avenues could potentially result
in correspondingly lower flows under other initiatives (e.q. quasi sovereign bonds issuances that are expected)
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could result in a burst of rupee liquidity over the next 4-6 weeks in the interbank market which could potentially complicate interest rate management at the short end. But more clarity
is expected on that front in the September 20th review.
While this would not affect the total reserves of the central bank (spot reserves will rise but so will forward liabilities) to the extent
that “usable” reserves go up – and these flows partially offset the impact on reserves from the oil-swap window – it might induce the central bank to implement the oil window more consistently and/or intervene more aggressively in the FX market and so, indirectly,
could prop up the currency. But that remains to be seen.
Easing frictions for households
The Governor concluded his comments by hinting that ultimately all of these financial market reforms were meant to increase the welfare
of households. Consequently to protect them from the vagaries of high retail inflation and ease other frictions they faced, he announced several specific initiatives, including:
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The issuing of Inflation Indexed Savings certificates linked to the new CPI by end-November 2013
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Implementing a national giro-based Indian Bill Payment System such that households will be able to use bank accounts to pay bills electronically
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Facilitate the setting up “white” POS devices and mini ATMs by non-bank entities to cover the country to improve financial access in the rural economy
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Setting up a technical committee to facilitate the introduction of mobile payment systems to help improving payment efficiency.
The legislative process finally gains some traction
In all the focus on the transition at the central bank, what has gotten lost in the shuffle is that – after months of inactions– there
is finally some legislative traction in Parliament. Earlier this week both houses approved the Food Security Act. This came as no surprise as it was always going to be politically very hard for any party to be seen opposing a populist piece of legislation
in an election year.
However, one legislative success led to another. Both houses of Parliament have approved the Land Acqusisition Bill -- though it now
goes back for re-approval to the Lok Sabha after the Rajya Sabha introduced some amendments. The bill, which will replace over a century-old law, stipulates mandatory consent of at least 70 per cent for acquiring land for
Public Private Partnership
(PPP) projects and 80 per cent for acquiring land for private companies. It proposes compensation upto four times the market value in rural areas and two times the market value in urban areas. While industry still voices concerns that the Bill would significantly
increase the costs of acquisition , it has, at least, injected certainty into the land acquisition process.
In some more legislative traction, the Lok Sabha passed the
Pension Fund Regulatory and Development Authority
(PFRDA) Bill which paves the way for foreign investment in the sector. The Bill allows 26% foreign investment in the
Pension
sector, with additional increases in the foreign limit linked to the Insurance Bill. Furthermore, it gives statutory backing to the interim pension authority that had been functioning on executive authority for over a decade. Finally, it provides legal backing
to the pensions regulator to create a social security architecture that channels savings of households into the financial sector. The Bill is expected to pass the Rajya Sabha soon.
All eyes now move to the RBI’s mid-quarter review on September 20th where markets will glean the new Governor’s views on monetary
policy and how to deal with the stagflationary shock that the sharp exchange rate depreciation has imparted to the macro economy. What transpires at the review -- and how markets react -- are likely to have a more important bearing on near-term macro dynamics.
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