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5 problems the new RBI governor may have to tackle
Raghuram Rajan, the governor of Reserve Bank of India, made an announcement last week that he would not opt for a second term as the Reserve Bank of India (RBI) governor. So, come September, we would see a new governor take over the reins of India’s monetary policy.
Here are five challenges the new governor may face at the helm:
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Rise in inflation
India has had a lifelong battle with inflation, the rise in prices of goods and services over time. Inflation eats into the value of money, making life difficult for people. The RBI, naturally, has focused on controlling this inflation. It has succeeded in the near past—retail inflation fell from double digits to 5%-levels. However, it spiked to a 19-month high of 5.76% in May this year. A delayed monsoon, as well as increase in international crude oil prices, could push inflation higher in the recent past.
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Banking system cleanup
India’s banks face a huge problem because of bad loans. The Rajan-led RBI led a cleanup of the banks’ balance sheets through various reforms like giving banks greater powers and flexibility. However, this is not a one-time solution. The high amount of Non-Performing Assets (NPAs) is a systemic issue, especially in the case of state-run banks that see a high degree of political interventions. This means the new RBI governor has to continue the strict efforts to help reduce the stress on India’s banks.
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Liquidity crunch
The Indian banks have also repeatedly faced another problem in the past few quarters – liquidity crunch. This is when banks do not have enough cash resources for short-term operations. As a result, banks often end up borrowing more money overnight from the RBI and other banks. This puts great stress on profitability as well as interest rates. The RBI has to continue its efforts in easing this liquidity crunch without compromising on its inflation-targeted monetary policy. Dealing with this can help ensure banks pass on rate cuts to customers. Otherwise, monetary policy changes may not be effective.
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Monetary Policy Committee
In the recent Budget, the government announced the setting up of a Monetary Policy Committee, consisting of six members. Three of these will be from the RBI, including the RBI governor and deputy governor. This is a shift from the current system, where the RBI has sole control over the country’s monetary policy. The new RBI governor would have to ensure a smooth transition to the new system.
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Rupee stability
Today, India is more exposed to external global threats than earlier when it was a sheltered economy. This has a direct impact on the Rupee exchange rate. One of the RBI’s responsibilities is to ensure the Rupee does not see great volatility. This though may be more challenging in the coming future, especially when the US Federal Reserve announces an increase in the US interest rates. Secondly, a more pressing concern is the redemption of the three-year Foreign Currency Non-Resident (FCNR) Bank Deposits that the RBI had initiated to combat the Rupee’s steep depreciation in 2013.
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$20 billion
FCNR deposits worth $20 billion are up for redemption between September and November 2016. This could lead to outflows to the tune of about $20 billion, Raghuram Rajan said recently. This means banks will have to buy dollars, putting pressure on the rupee. However, the RBI has amassed forex reserves worth $360 billion. It can intervene in the currency markets to stabilize the rupee if required. This can help ease the pressure off the rupee.
