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RBI's Rajan Says Indian Economy Fundamentally Sound With Bright Future

RaghuramRajan RBI 090413

The new governor of the Reserve Bank of India Raghuram Rajan said on Wednesday that the country's economy remained fundamentally sound despite challenges, in a bid to assure markets, investors and households amid the sharp rupee depreciation and stock market volatility.

"These are not easy times, and the economy faces challenges," Rajan said in a statement after taking charge as the 23rd governor of the Indian central bank.

"At the same time, India is a fundamentally sound economy with a bright future."

Rajan will make his first monetary policy statement on September 20.

Regarding policy communication, the former IMF chief economist stressed that transparency and predictability regarding central bank actions are important during times of financial volatility and domestic political uncertainty due to elections next year.

"The Reserve Bank of India should be a beacon of stability as to its objectives," he said. "That is not to say we will never surprise markets with actions."

"A central bank should never say "Never"!," Rajan said. The public should have a clear framework as to where we are going, and understand how our policy actions fit into that framework, he noted.

The Chicago University finance professor, who previously served as the chief economic advisor to the Indian government, said the primary role of the central bank was to ensure monetary stability, that is, to sustain confidence in the value of the country's money.

"Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures," Rajan said.

Inclusive growth and development as well as financial stability are the two other important mandates for the RBI, the central banker said. The country needs 'faster, broad based, inclusive growth leading to a rapid fall in poverty', he added. He also announced that the RBI will shortly notify banks that they need not approach the central bank for permission to open a branch.

Further, Rajan said the central bank will issue new bank licenses only based on the highest standards of transparency and diligence. He also revealed that an external committee, chaired by former RBI chief Bimal Jalan, will screen bank license applications and make recommendations. New bank licenses may be announced around January 2014, he said.

Rajan hopes to explore more avenues for banking reforms and regulations aimed at freeing entry and allowing more frequent licensing process. Moreover, the central bank is close to concluding the process of allowing qualifying foreign banks to move to a wholly owned subsidiary structure, where they will enjoy near national treatment, he said.

The RBI chief also stressed on the need to reduce the requirement for banks to invest in government securities in a calibrated way and hopes that the scope for such reduction to increase as and when government finances improve and as the penetration of other financial institutions such as pension funds and insurance companies rises.

"Together with the government and regulators such as SEBI, we will steadily but surely liberalize our markets, as well as restrictions on investment and position taking," Rajan said.

Consequently, Rajan announced that the RBI will allow importers to re-book 25 percent of canceled forward exchange contracts and the limit available to exporters was raised to 50 percent. The central bank will launch cash settled 10-year interest rate future contracts and explore the introduction of interest rate futures on overnight interest rates, he said.

While acknowledging that it might be a strange time to talk about rupee internationalization, Rajan pointed out the need to think beyond the next few months. "As our trade expands, we will push for more settlement in rupees," he said.

The Indian rupee has depreciated sharply over the past few weeks, hitting record low 68.85 against the dollar late August.

The central bank will offer a special concessional window to banks for swapping dollar deposits from non-resident Indians. The facility will be available for dollar funds mobilized for a minimum tenor of three years and over, at a fixed rate of 3.5 percent per annum.

Further, the RBI also raised the the current overseas borrowing limit of 50 percent of the unimpaired Tier I capital for banks to 100 percent. Such overseas borrowings can be swapped at a concessional rate of 100 basis points below the ongoing swap rate prevailing in the market, the bank said.

Both swap schemes will be open up to November 30, Rajan said.

The central bank chief said he will continue with steps to strengthen the financial infrastructure in the country. Referring to the rising non-performing assets of banks, he said, "The bad loan problem is not alarming yet, but it will only fester and grow if left unaddressed."

He also announced specific measures for households that includes the issue of Inflation Indexed Savings Certificates linked to the CPI New Index to retail investors by end-November 2013. The RBI also plans to implement a centralized bill payment system to allow households to make payments such as school fees and utility bills through electronic transfers.

"We want to make payments anywhere anytime a reality," Rajan said. Further, the central bank will allow non-bank entities to set up point-of-sale devices and mini ATMs throughout the country to improve access to financial services in rural and remote areas. The bank also plans trial cash payments using pre-paid cards issued by non-bank entities and promote financial transactions via mobile phones.

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