RBI Gov Shaktikanta Das’ first 3 yrs were action-packed; what to expect from the next 3 yrs

The Reserve Bank of India (RBI), under the bureaucrat-turned-Governor Shaktikanta Das, saw an action-packed three years with the central bank aggressively supporting growth, bringing stability to the financial system after the IL&FS debacle, creating a record-level foreign exchange reserve and managing pandemic-related challenges. Seventy-four-year-old Das has now got an extension of another three year in office.

What to expect from Das in the next three years and what are the challenges?

Anchoring inflation expectations

Das has the biggest task of anchoring inflation expectations as the targeted level of a consumer price index (CPI) or retail inflation is at 4 per cent set by the government for the six-member monetary policy committee (MPC), which fixes the policy interest rates. At a time when the energy prices are creating havoc in the market, the RBI actually lowered its inflation forecast from 5.7 per cent to 5.3 per cent in 2021-22. In the first pandemic year, the CPI was around 6 per cent, which is close to the upper band of RBI's targeted level. Globally, inflation has been rising with some of the countries hiking interest rates to contain the inflationary pressure. It would be interesting to see how Das navigates the central bank when there are strong headwinds.

Withdrawal of surplus liquidity from the market

The RBI under Das had been on an accommodative stance much before the pandemic struck. When Governor Das took charge nearly three years ago, the liquidity in the market was in neutral mode. Post the IL&FS. debacle, the market was asking for more liquidity. Das had opened the liquidity floodgates to support the financial system and also support the economy, which was in a slowdown mode. But excess liquidity has the potential to fuel inflation. The current daily surplus liquidity in the system is close to Rs 10 lakh crore. The RBI's stance under Das is to remain ‘accommodative’ for “as long as necessary” to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy. But  a view is building in the market that RBI should normalise monetary policy or get back to a neutral stance as Covid-19 is no longer a big risk.

The government is already on overspending mode post the pandemic with a fiscal deficit of 9.3 per cent of the GDP in 2020-21 and a targeted level of 6.8 per cent in 2021-22. The 5-year fiscal consolidation path has a road map to achieve a 4.5 per cent fiscal deficit by 2025-26. Governor Das has to balance the two as too much of liquidity in the market could create an inflation danger, which will eat away the growth. A low and stable inflation always contributes to long-term high sustainable growth in the economy.

Allowing large NBFCs and corporate into the banking

There are two RBI commissioned reports that have recommended converting large NBFCs into banks as they pose a systemic risk for the financial system. Another report made a case for allowing large industrial houses into banking.  The debacle of IL&FS and Dewan Housing and Finance Ltd (DHFL) have shown that large NBFCs have emerged as a big risk to the stability of the financial system. NBFCs have strong linkages with banks, mutual fund and insurance industry as they borrow funds from these institutions. Last week, the RBI announced a four-layer based regulatory framework for NBFCs based on their size, activity, and perceived riskiness. Bigger the size and risk of the assets, the higher would be the oversight and regulatory requirement. But there are also inherent risks in having a large NBFC in the system because of the limitations on the liabilities (or funding side).

Under Das, the RBI is open to allowing NBFCs and even foreign banks to acquire private banks in the country. A consortium of Centrum (NBFC) and BharatPe (fintech) -- for the first time -- was allowed to acquire the failed PMC Bank during his tenure. Similarly, the RBI had allowed foreign bank DBS to acquire Lakshmi Vilas Bank. This kind of matchmaking between a foreign bank and a private sector bank took place for the first time. The next three years of Das would be interesting as further consolidation will take place in the banking industry with the public sectors banks are also up for privatisation and a complete sale.

The foreign exchange policy

The RBI under Das has created a huge pool of foreign exchange reserves of $635 billion. The current policy of buying dollars and releasing equivalent rupee resources has many implications for the RBI's balance sheet as well as for the country's financial health. There is a debate amongst economists on the adequacy of foreign exchange reserves as there is a cost attached to it. Many are suggesting that the country has adequate forex reserves if one analyses it based on the import cover, which is 16-17 months of imports. In terms of short-term to long-term external debt, the country has sufficient reserves to take care of any sudden outflows of such loans. Will Das continue with a dollar buying spree?

The next three years are going to be interesting as the US tapering (withdrawal of liquidity) could lead to an outflow of dollars from the emerging markets. It could impact the value of the domestic currency against the US dollar. But if the tapering is slow and gradual, the policy of continuing with dollar buying would have implications for the RBI's balance sheet as these reserves yield very low returns (less than 2.6 per cent per cent per annum)  and the central bank ends up paying higher money to banks under reverse repo (3.35 per cent) when it absorbs liquidity from the market.

Launch of RBI's digital currency

The RBI is against any kind of private digital currency or cryptocurrencies launched by private exchanges in India or issued by global platforms or exchanges. The function of issuance of currency is under the domain of the RBI as it is the monetary authority with a specific mandate. Even as the discussions and the technology is evolving for such currencies globally, the RBI under Das is already working towards launching a central bank digital currency (CBDC). In fact, the RBI is working on doing some pilots to understand the currency operations at the ground. In the next three years, Das will certainly lay the foundation for RBI-issued digital currency.

Helping government raise debt at a lower cost

The RBI Governor has always maintained that managing the 10-year G-Sec yield curve is for public good. The RBI's support to keep the yields at below 6 per cent was seen as a support to the government's borrowing programme. It actually helped the government to raise money at a lower cost. Post pandemic, the government had to resort to huge borrowings from the market as budget revenues crashed and the expenditure towards welfare measures and also for capital expenditure jumped big time. Governor Das had also taken measures like allowing retail investors to buy government securities in order to broad base the investors. The next three years would be challenging for Das as the yields or the interest rates are on the rise because of higher inflationary expectations.

Reforms in the cooperative banks

There have been big changes in the cooperative banking space in the last three years with the government giving more powers to the RBI in regulating the banks. The RBI has been encouraging consolidation in the urban cooperative banking space. In the next three years, Das has to encourage cooperative banks to professionalise the management and board, set up risk management framework, adopt technology, encourage M&As and initiate stress testing to monitor the weak banks.

Also read: Cabinet reappoints Shaktikanta Das as RBI governor for 3 years