Raghuram Rajan’s announcement that he won’t seek a new term as governor of the Reserve Bank of India leaves a key policy challenge to his successor -- the successful completion of a clean-up of more than $100 billion of stressed assets on the books of Indian banks.

Rajan’s campaign to force the country’s banks to recognize the true state of their bad loans culminated in a six-month asset-quality review that led to banks reporting a surge in bad-debt disclosures and higher losses earlier this year. But the March 2017 deadline set by Rajan for the completion of the clean-up will come after he leaves office in early September.

The asset-quality review is “still a work in progress” and will need to be completed by Rajan’s successor, said Saswata Guha, director for financial institutions at Fitch Ratings in Mumbai. “There were some very important initiatives taken under Rajan’s tenure and it’s important that those actually see fruition.”

The review is “the most important” banking sector reform undertaken by Rajan, Guha said. With bad loans at a 15-year high, the project is a crucial step toward reviving credit growth and bolstering India’s $2 trillion economy.

Weekend Letter

“The intent of the review was very noble and was essentially to protect the system from slipping further into the asset-quality abyss,” Guha said.

Rajan jolted the country on the weekend with a letter to RBI staff saying he will step down when his term ends in early September and return to academia. The rupee fell on Monday to a four-week low, before recouping some of its losses, while stocks, including those of banks, rose as optimism that Britain may remain in the European Union offset Rajan’s announcement.

Since taking office in 2013, the former International Monetary Fund chief economist helped strengthen and stabilize the rupee, and propel the nation’s foreign-exchange reserves to an all-time high. Those moves, along with the implementation of an inflation-targeting regime, built India’s credibility with investors and helped it overtake a slowing China as the world’s fastest-growing major economy.

Beyond the asset-quality review, the RBI under Rajan also developed reforms to facilitate loan recovery from failing corporate debtors, and a framework to boost mobile payments.

Corporate Loans

In the letter announcing his decision to step down, Rajan said the bank clean-up isn’t finished, though measures taken so far had “brought more credibility to bank balance sheets.”

Indian lenders -- particularly the state-run banks -- have been saddled with troubled corporate loan books as companies struggle to repay debt amid a slump in commodity prices and slowing industrial output. Stressed assets rose to 11.3 percent of total Indian bank loans as of Sept. 30, RBI data show.

A key plank of the asset-quality review was to force banks to declare the true state of their problem loans, and end the practice of hiding bad debts by restructuring them, or pouring good money after bad to keep debtors alive.

“You can put lipstick on a pig, but it doesn’t become a princess,” Rajan told bankers soon after he took over as RBI governor in 2013. “So dressing up a loan and showing it as restructured, and not provisioning for it when it stops paying, is an issue. Anything which postpones a problem rather than recognizing it is to be avoided.”

Meanwhile, Prime Minister Narendra Modi’s administration has moved to reassure foreign investors after Rajan’s announcement, suggesting that the RBI’s own capital could be used to bolster state-owned banks as they grapple with nonperforming loans, according to a document obtained by Bloomberg on Monday.

The government also pledged to quickly fill the role Rajan will vacate, with five candidates in the running to become the RBI’s new governor, according to a state official who asked not to be identified, citing rules for speaking with the media.

“Whoever comes, that governor should carry on the legacy,” said Gaurang Shah, vice president at Geojit BNP Paribas Financial Services Ltd. Still, “a vacuum will be there. The experience, the knowledge, leadership and the can-do spirit will be missing.”

Source:
courtesy of BLOOMBERG

by Darren Boey

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