What Urjit Patel can do to beat (or at least match) Raghuram Rajan’s performance at the RBI

As Raghuram Rajan exited the Reserve Bank of India headquarters on Sunday, his deputy took his place as the governor of the central bank. Urjit Patel has been around in the RBI under Rajan’s watch long enough to know how to do his job well. However, he will have to do more than just take forward what Rajan had set in motion.

When Rajan took over as RBI governor in 2013, the economy was in a shambles and he managed to rectify a fair bit of it to set India back on the growth trajectory. However, as he himself admitted, a lot of work remains unfinished, particularly with regard to fixing industrial growth – and this is where Patel faces his first challenge.

Industry creaking along

Patel’s hands are largely going to be tied when it comes to targeting inflation through interest rates. Detractors of Rajan often cited his unwillingness to lower interest rates as grounds for criticism, but Patel will be unlikely to reverse this in the short term. In August, India set an inflation target of 4%, with a tolerance for a 2% fall or rise. With inflation rates currently hovering around 5.7%, Patel will find it difficult to argue for an increase in rates.

However, where he has ample scope to make a difference is in kick-starting industrial growth.

Foreign Direct Investment in manufacturing has fallen beyond its 2011 levels. FDI inflows fell to $8.4 billion last year, while it stood at $9.3 billion in 2011-12.

Moreover, Indian exports fell for 18 straight months, before making a slight recovery in June, when the figure rose by 1.2% on year-on-year estimates. Last year too, exports fell 15.6%, but India’s Minister of Commerce and Industry Nirmala Sitharaman recently insisted that the fall has been arrested and there will now be steady growth.

Moreover, the government’s flagship Make In India programme to boost manufacturing in the country does not seem to have increased the contribution of manufacturing to the Gross Domestic Product, or the FDI in manufacturing, as demonstrated here. The RBI data also claims that manufacturing has been more or less flat for the last decade.

Low investments

The index of industrial production, which measures economic activity in the industry, has been going through wild ups and downs over the last year. For instance, it stood at 2.2% in June compared to the peak of 9.9% it achieved in October 2015.

The RBI Annual Report released on August 29 flagged some of these concerns while pointing out that industry hasn’t done so well in the early few months of this year and there’s no turnaround in sight – at least in the short term.

“Industrial activity has been in contraction mode in the early months of 2016-17, pulled down by manufacturing,” the report said. “Looking ahead, no strong drivers are discernible at this juncture that could engineer a turnaround.”

The report added that export demands remain anaemic.

Moreover, the breakup of index of industrial production numbers in the RBI’s report suggested that manufacturing shrunk by 0.7% between April and June as compared to last year, while capital goods declined a massive 18% in the same period.

Even Rajan, in his statement on the report, had said that low investment remains a concern.

“The key weakness is in investment, with private corporate investment subdued because of low capacity utilisation, and public investment slow in rolling out in some sectors,” Rajan said.

Task cut out

While Rajan in his foreword to the annual report indicated that an increase in demand as a result of the increase in public money with the Seventh Pay Commission could boost investments, a lot more needs to be done and Patel has his task cut out.

The clean-up of non-performing assets from banks is still not complete and as the banks increase their provisions for writing off the unrecoverable loans – the bulk of which are given to large corporate borrowers – the credit offtake to industry is bound to reduce.

A report released by credit rating agency India Ratings in June said that India Inc is swimming in bad debt, or unrecoverable loans, as a majority of the large borrowing companies do not have enough resources to repay or refinance their loans. Patel’s first task will be to ensure that credit availability to small and medium enterprises does not reduce because banks are wary of lending to industries now.

In July, Rajan said that smaller enterprises face the biggest cash crunch due to lower access to credit and their clients often demand a long moratorium on making payments. He had said that RBI will soon introduce three systems that will discount trade receivables, or unreceived bills, to improve this situation. Patel will have to make sure these systems are in place on time and work as desired.

There are also other major banking and corporate reforms underway that Patel will be expected to contribute to and supervise, including the bankruptcy law. The law will impose a time limit on settling bankruptcy cases – 270 days at most, as opposed to the current average of four years a case – and is expected to develop the bond market in India, which experts claim is untapped.

To ease the credit crunch, the government is trying to tap into RBI’s funds – which it uses for foreign exchange management and other key functions to keep the economy stable – to recapitalise public sector banks that have been bogged down by non-performing assets.

However, a 2003 paper authored by Patel gives us a clue of how he feels about this, and where he might take that conversation.

“It needs to be recognised that the only sustainable method of ensuring capital adequacy in the long run is through improvement in earnings profile, not government recapitalisation or even mobilisation of private capital from the market,” he wrote in the paper, according to Firstpost.