The legacy of Raghuram Rajan

Mon, Jan 25 2016. 

http://www.livemint.com/Opinion/p2SZMu6ay7HYOj13v3BxjN/The-legacy-of-Raghuram-Rajan.html

The RBI governor has reiterated his commitment to restore the central value to Indian business: trust. In time, when we look back on his term at the helm, this will be his enduring legacy

On the sidelines of the just concluded meeting of the World Economic Forum in Davos, Reserve Bank of India (RBI) governor Raghuram Rajan reiterated his commitment to restore the central value to Indian business: trust. In time, when we look back on his term at the helm, this will be his enduring legacy—something for which we will be grateful.

In a Walk the Talk session with Shekhar Gupta, the evergreen newsman, Rajan built his case around three astute and insightful observations on the wrongs of some segments of corporate India or what is less generously referred to as the cost of crony capitalism.

—If you flaunt your birthday bashes even while owing the system a lot of money, it does seem to suggest to the public that you don’t care. I think that is the wrong message to send. If you are in trouble, you should be cutting down your expenses.

—The system has been geared to favouring those who have the ability to work the courts. The policy that you (large businessmen) follow is that during good times, you take the upside; but in bad times, you go to banks and ask how much of a haircut (loan write-offs) are you going to take?

—It is not about being against big businesses or successful businessmen or businesswomen and neither is it a Robin Hood issue.

Rajan then went on to emphasize the objective of what he has pursued in his tenure since he took over as RBI governor in 2013. “This is an issue about the wrongdoers among the community who (have) raised the cost of borrowing for everybody,” he said.

Typically, most of these statements, also made in the past, have been taken up in the context of a clean-up of all that is bad in the system. Appealing while it may be sound, it is a case of missing the wood for the trees.

Rajan’s focus is not the bad guys. Instead, it is what they are doing to the system. By pulling political connections and gaming the overburdened judicial system, the fat cats are defaulting on loans but not paying the price for it. (Think of what would happen to you if you missed your equated monthly instalments or EMIs on either a house or a car loan.) In other words, commercial banks are stuck with bad loans—in several cases, they have to engage in a write-off—and the risks.

What this does is to push up the risk premium for all borrowers. That’s exactly why there is such a huge gap in the commercial lending rate and the policy rate of the RBI. This, in short, is the price of crony capitalism. It is not just banks that are impacted; the resulting high interest rate regime precludes investments, erodes the competitive ability of Indian business and leaves a big hole in our wallets through payouts on EMIs.

It is fascinating that Rajan had the clarity to see this from the very moment he took charge at the RBI. In his interviewto Mint immediately after he took over, he said, “What happens is that we bail out promoters who have siphoned out the money or who have too little equity but retain full equity holding, so that when the project is back on stream, they get all the upside and the downside is borne by banks.”

The point he made then, as he observed in Davos, was that the pain of restructuring has to be borne fairly: Those who have equity upside should either put in substantial amount of new equity or share in the upside without making the bank write down more.

Responding to a follow-up question in the Mint interview, he said, “We have situations where groups are sitting on plenty of money, but that money is not feeding into projects that are in difficulty. Restructuring is a legitimate activity. You make mistakes. We want the real assets to be working. But in doing that, it is also a fairness issue. And the public will get totally very angry if they see the fairness issue is not being met.”

What Rajan has done is to unambiguously spell out the need to bridge the trust deficit between banks and corporate India—a few bad eggs have sullied it for everyone. As RBI governor, there is only so much he can do. The onus is now on politicians to ensure that errant corporates are reined in for the global good.

The big test will be as to how quickly the bankruptcy code, which has been introduced in Parliament, will be turned into a law. Just as the passage of the single goods and services tax will establish an audit trail for business transactions, the bankruptcy code will ensure speedier closure of companies that go belly up (which is a very natural phenomenon) to minimize the economic pain all around. Expect vested interests to make every effort to stall this legislation; it would be a travesty if they succeeded in denying the next generation.

The idea of Start-up India seeks to foster entrepreneurs in the country—where, at one time, business was considered evil—and Rajan’s legacy will ensure a level playing field. The future of India is on the line.

Anil Padmanabhan is deputy managing editor of Mint and writes every week on the intersection of politics and economics.