Former RBI Governor C. Rangarajan stresses need to preserve competition to achieve banking efficiency

In an interview with CNBC TV18 on Wednesday, Rangarajan highlighted the pivotal role of competition in driving efficiency within the banking system and stressed the importance of maintaining a competitive environment among banks, noting that significant steps were taken during his tenure to introduce such a competitive framework, including the entry of new private sector banks.

Rangarajan further stressed the importance of the board of directors for the effective management of banks. He noted that the selection and appointment of board members is vital as the board is ultimately responsible for the functioning of the bank.

He recommended ensuring a robust system for selecting board members and holding the board collectively accountable for the bank’s performance.

Below is a verbatim transcript of the interview:

Q: You have been through much of this process for 77 years, 37 of them as a policymaker. What would you say is the greatest achievement of the Indian economy?

A: Today, India is considered to be the fifth largest economy in the world. Of course, we are a big country and we have a huge population. That gives us a big economy. However, I think that compared to what it was two decades ago, reaching the level of the first economy is an achievement in itself, although there are other major problems.

Secondly, I would say that we have achieved self-sufficiency in food grains. This is a very important step forward considering how difficult the food situation was in India in the 1950s and 1960s.

Thirdly, I would like to say that in the case of the service industry, particularly in the IT sector, we have achieved very good results and are considered by other countries to be one of the largest exporters of these services. Therefore, I should also mention that we have a reasonably solid industrial base, capable of producing a variety of capital goods, intermediate goods and consumer goods.

I also want to mention that India’s fertility rate has come down to around two per cent, so in another two decades, perhaps the population will stabilise. Although we should have taken steps much earlier, it is a fact that we are now at a level or a stage where we can say that within two decades, the population will stabilise.

Q: Well, going back to 1991, what do you think was the most difficult and the greatest achievement at that time?

A: Well, the point is that there were two things. One was to manage the crisis because we had to get out of it, that is, in 1990 and then in 1991 measures were taken to stabilise the economy. Then we thought that after stabilising it we had to reform the economy, because it is not just a matter of solving the problem, the balance of payments problem. We have to build an economy that does not face this kind of crisis from time to time, and that is why we started to introduce reforms. That started almost in 1991 and accelerated in the following years, and then it was followed by various governments.

The most important thing is that we did not stop at solving problems, but moved on to reforms, and if I could put it in a nutshell, we made a break in three important aspects. First, we dismantled the complex system of permits, licenses and controls that dominated the system. Second, we redefined the role of the State and, third, we abandoned the policy of import substitution at any price and decided to embrace international trade.

Q: Let me talk about the way we handled the public sector banks, because that was directly under the Reserve Bank. Under your leadership and of course under Dr Manmohan Singh and the others, you all got the first state-owned bank listed and over the decade, other public sector banks also got listed. But since then, we have not made any major changes in the governance of public sector banks. What would you recommend? Some time ago, your deputy at that time, Dr Reddy, had said that they should be brought under the Companies Act. What advice would you give to the current regime?

A: I think the most important point is that several steps have been taken to introduce and initiate a competitive system in the banking system. Ultimately, it is competition that will ultimately lead to efficiency in the system. That attempt was achieved by allowing new private banks to enter the banking sector in my time. As a result of that, I think we are in a situation where almost 30% of the banking system is now in the hands of the private sector. We really have to ensure that this competitive system is maintained and that public sector banks, in order to survive and grow, must be very competitive.

But you were asking about governance and so on. I think the most important thing is the way in which the board members are appointed and selected. Ultimately, the management of a bank rests with the board of directors and so the most important thing I would really recommend is to ensure a proper system of selection of people for the board of directors and to make the board as a whole responsible for the functioning of the banking system. I think that is a critical variable in making the banking system more efficient.

Q: You also wrote in The Hindu about how we should pursue our new goal of a “Viksit Bharat” – a developed India – by 2047. What would you say should be the first two or three major policy changes we need to implement?

A: First of all, I think that to be a developed country, our per capita income has to go from the current level of something like $2,500 to $13,000, and that requires, according to various calculations, under some assumptions about the price level, inflation and the exchange rate, growth of between 6% and 7%, but perhaps closer to 7%.

This requires the gross rate of fixed capital formation, or the investment rate, say, to be about 35% if we assume an incremental capital-output ratio of 5 years to 1. I think the incremental capital-output ratio in the recent period has been about 5.

So the first thing we really need to do is to make sure that the investment rate in the country remains at 35% of GDP, and that is critical if we really want to become a developed country. We are close to achieving that, I think we are now at 33.3% of GDP, so it is not something that is out of reach.

But there is a point in this: the recent rise in the investment rate has been due to the rise in capital expenditure by the Indian government. That is not the answer. I think the real answer lies in the pick-up in private investment, because the rise in capital expenditure by the central government has also been accompanied by a high fiscal deficit.

If you look at the fiscal deficit of the Indian government over the last four years, it is well above 3% of GDP, which was considered adequate. So, we have to create a suitable climate for private investment to pick up. That is one of the important things we have to do.

Secondly, development strategy is an issue that the government should consider. I would say that development strategy should be multidimensional. The East Asian tigers adopted a single objective, such as export-led growth. But such export-led growth is no longer possible. Firstly, developed countries are not growing as fast. Secondly, there has been a change in the attitude of developed countries regarding free trade.

So, while exports are important, external demand is also important. In a sense, exports are a critical test of the efficiency of the economy. So, we cannot ignore them. But it is not the export-led strategy that will really take us to a higher level and I would say that we really need to have a multidimensional approach to development strategy.

The third point I would like to mention is that the biggest challenge that India will have to face is employment and jobs. The fact is that employment growth is not as fast as income growth. It is true that growth without jobs is bad, but jobs without growth are not sustainable.

Let us not say that vacancies in the Indian government or in the state governments need to be filled. That is not the way to do it. I think the real problem is going to be that the new technologies that are on the horizon are going to make the problem even more complicated. Developed countries in Europe are now talking about a four-day work week instead of a five-day work week. So that is the direction in which things are moving. What I would say is that the income elasticity of employment is going down.

To watch the full interview, please watch the attached video.