Urjit Patel’s Third Year: Fighting Ghosts Of The Past And The Future

Urjit Patel completes two years as the 24th governor of the Reserve Bank of India this week. From navigating the noisy aftermath of demonetisation to reading the riot act to India’s banking sector, Patel’s governorship hasn’t had a dull moment.

The third year of his tenure is likely to be equally eventful.

On the agenda – ensuring the country’s hard-earned macroeconomic stability isn’t frittered away in an election year and persisting with a thorough clean-up of the banking sector.

Fighting The Ghosts Of Banking Past

Taking the clean-up of Indian banking to a logical conclusion is undoubtedly Patel’s biggest task.

The process of bad loan recognition was started under Patel’s predecessor Raghuram Rajan. But over the last two years, the clean-up has gone beyond just bad loans.

Let me explain.

Earlier this year, the RBI announced a new stressed asset framework. Attention has been focused on the immediate impact of that circular, but its true impact lies in its potential to change unhealthy credit habits, which have become endemic over the past few years.

A one-day default was not REALLY considered a default. And it was okay for a borrower to delay payments, as long it they came in before the 90-day overdue point, which leads to an account being classified as non-performing. Not good enough, says the RBI. A default is a default. And banks and borrowers must treat it as such.

This no-nonsense attitude adopted by the RBI has extended to other aspects of banking.

Take for instance, the prompt corrective action framework. There are 11 government owned banks under this framework. Two have been asked to virtually stop lending. By doing so, the RBI is sending out a message that weak banks should either shape-up or ship-out. Patel, in recent speeches, has also argued for greater powers of public sector banks to ensure the sector remains healthy.

The clean-up has extended to private banks.

Last year, banks were told to disclose the difference between their assessment of bad loans and the regulator’s. As a result, almost all top private lenders have had some explaining to do.

Earlier this year, the RBI asked the board of Axis Bank to reconsider the appointment of Shikha Sharma for another term. Sharma chose to step down instead. More recently, Yes Bank informed stock exchanges that that Rana Kapoor will continue to be the bank’s CEO until further notice, suggesting that the regulator has not yet made up its mind on whether Kapoor should get another term at the helm of the bank.

The message – regulatory approval is no longer a rubber-stamp.

A new framework for bank auditors has been put in place. And don’t be surprised if the regulator’s attention turns to bank boards next.

Should Patel succeed in this attempt, the clean up of the banking sector could become his lasting legacy.

Risks Looming In The Shadows

Patel won’t have the luxury of focusing on the banking sector alone. As the head of a ‘full service’ central bank, he will also have to work hard to ensure that macroeconomic risks don’t build up.

To be sure, the burden of inflation control—core to economic stability—now rests with the Monetary Policy Committee rather than with the governor’s office. The burden of ensuring that fiscal prudence is not abandoned lies with New Delhi. And the RBI can do little to address a widening current account deficit.

The immediate focus is the Indian currency. The rupee is trading at record lows but there is no panic in the markets. Many, including government officials, feel that a weaker currency is beneficial. But it doesn’t take much for a healthy correction to turn unhealthy. The RBI would need to remain adequately prepared with possible options to support the rupee, should it be needed.

The bond markets have calmed down in the past few months after a period of intense volatility. It is quite possible that volatility will return in the second half of the year. Not everyone is confident that the government will be able to meet its fiscal deficit this year, liquidity will tighten and borrowings will be high.

Putting The Demonetisation Demon To Rest

Finally, as Patel enters his third year, the demonetisation story appears to be behind him. The RBI’s latest annual report shows that 99.3 percent of the currency demonetised came back to the system. The remaining Rs 10,720 crore has been shifted to the ‘miscellaneous’ category in the the ‘other liabilities and provisions’ segment. There is no large transfer to the government.

The cash-to-GDP ratio was at 10.9 percent as of March, 2018 and remains the highest across emerging and developed market economies, said the RBI’s annual report. It is, however, marginally lower than the 12.1 percent before demonetisation.

However, it works out to around 88 percent of its underlying 3-year trend had there been no demonetisation, said the RBI.

The proportion of high value notes is at 80 percent compared to 86 percent earlier.

With the release of the final data on currency returned, the RBI, in many ways, has closed the demonetisation chapter at its end. It is now mostly up to the government to explain why it did what it did and what it achieved.

For Patel, this allows a return to the two big tasks on hand – cleaning up Indian banking and steering the Indian economy through a potentially treacherous year.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.