Advising RBI Governor Dr Raghuram Rajan

August 1, 2016

Advising RBI Governor Dr Raghuram Rajan

This refers to the “Open Letter to the Governor” (Economic Times, August 1) from Mythili Bhusnurmath. Though time is not yet ripe to debate the kind of advice Dr Rajan may give to his successor, or to himself, in the unlikely event of being forced to continue beyond September 4, 2016, media having failed to force GOI to name next RBI Governor much before the so called ‘Rexit’, there is a need to invent new topics for discussion.

The fear that Dr Rajan will embarrass his successor by giving unsolicited advice, through media, is far-fetched. Last three years he has not taken his problems within the Reserve bank of India or with GOI to the media. There is no denying that there may be instances of GOI spokespersons, Finance Minister or politicians raising controversial issues while speaking to media and Dr Rajan clarifying RBI’s position while talking on such subjects.

Having said that, the ‘open letter’ undoubtedly is interesting reading.

M G WARRIER, Mumbai

RBI Governor Dr Raghuram Rajan*

M G WARRIER

Dr Rajan, as is evident from his academic and professional record, is a fast learner and capable of finding solutions to the toughest of economic and monetary problems. His challenges lie in (a) how fast he will be able to ‘unlearn’ the IMF lessons which were moduled with prosperity of the developed world in view and (b) how quickly he will get convinced about the historic dual responsibility of RBI to ensure distributive justice while supporting economic growth and reframe his arguments to convince North Block that after all RBI has been on the right path and what the central bank lacked was the support from GOI.

It has to be said to the credit of GOI that, even if it was  in self-interest, generally, compared to other statutory bodies and PSUs, Reserve Bank of India has been getting a fair deal in selection and timely appointment of its head. This time, the process has been more transparent and all have accepted that among the candidates considered, the most meritorious has been selected.
This should give considerable confidence to Dr Raghuram Rajan who takes over charge from Dr D Subbarao in the first week of September 2013. The only negative in the whole affair is, as on several occasions in the past, once again GOI has opted for a short-term appointment. This time it should have been for a five-year term in the first instance itself. We are not privy to the information as to whether the decision to appoint Rajan for 3 years was because of a casual ‘cut & paste’ from previous appointment orders or because GOI thought, if friction between RBI and GOI persists, changing RBI Governor more often is a soft option. As someone in the media already observed, the flip side is, if things do not go well, Dr Rajan could choose an assignment anywhere, a choice, many in top positions in India do not have.
Ideally, RBI Governor should have an average tenure of 5 to 10 years. If such a norm was followed, Dr Rajan would have been perhaps the 15^th Governor of RBI. Now he is 23^rd! All Governors who have stayed in office beyond 4 years have contributed to the strength of the central bank.

Dr Rajan, as is evident from his academic and professional record, is a fast learner and capable of finding solutions to the toughest of economic and monetary problems. His challenges lie in (a) how fast he will be able to ‘unlearn’ the IMF lessons which followed a syllabus with prosperity of the developed world in view and (b) how quickly he will get convinced about the historic dual responsibility of RBI to ensure distributive justice and supporting economic growth. He will have to reframe his arguments to convince North Block that after all RBI has been on the right path and what the central bank lacked was the support from GOI. If he succeeds in this and take out RBI from the apron strings of finance ministry, RBI will remember him as its savior.

Given the state of our economy and the relationship issues between Finance Ministry and RBI that have surfaced  in the recent past the new RBI Governor’s job profile will need much more than the normal requirements such as understanding economics, monetary and financial issues, familiarity with the way the system works in India in the international context. He should have the interest of the majority of the country’s population which lives below the internationally accepted poverty line (per day expenditure of $2) and should not being a good listener and, should not hesitate to give the government his advice even if it is disturbing to the government struggling to keep together an incoherent coalition.

The new Governor will continue to be confronted with observations like “RBI has traditionally fought for status quo. India is at a juncture when more of the same policy won't help” which mock at the reality and do  not do justice to RBI’s history. India’s central bank has all along done justice to its mandated role and more often beyond that. The criticism emanates from comparisons with central banks of developed countries which have their role limited to certain aspects of monetary management. RBI since at least the dawn of independence, has taken on itself the responsibilities relating to institution building and credit deployment for various purposes depending on priorities of the governments of the day, in addition to the central bank’s core functions. The present focus on financial inclusion and taming inflation which are incidentally in tune with the vision expressed by the Governor-Designate Dr Rajan is consistent with the tradition maintained by RBI.

 Once he gets a feel of the constraints with which RBI has been having a tight rope walk in harmonizing the monetary policy in the recent past with the unbridled fiscal policy guided by pulls and pushes of a coalition government at the Centre, Rajan is unlikely to toe the GOI line on fiscal deficit  and Current account deficit particularly that of the Finance Minister .  As a corollary, Finance Minister Chidambaram may not find an RBI Governor who will support his pet project FSLRC ( Financial Sector Legislative Reforms Commission ) which has produced a report aimed at making RBI a ‘department’  of the Finance Ministry. Chidambaram who put his Secretary Dr D Subbarao as the Governor of RBI hoping to have a submissive Governor found a different person in Subbarao soon after he started functioning from Mint Road. In that context, perhaps, Chidambaram is going to be ‘second time’ unlucky. I would like to quote from a mail I received soon after appointment of Rajan was announced:

“Raghuram Rajan is well known for his independent views and he was one of the economists who had predicted the Global Financial Crisis . During the farewell function for Alain Greenspan in  2005 , Rajan delivered a controversial paper  with the title “ Has Financial Development Made the World Riskier?". Rajan  predicted the  Global Financial Crisis.  He  argued that financial sector managers were encouraged to take risks ( called tail risks )  that generate severe adverse consequences with small probability but, in return, offer generous compensation the rest of the time. He further argues that the most important concern is whether banks will be able to provide liquidity to financial markets  This is exactly what happened . The US treasury Secretary Lawrence Summers ( known for  his arrogance) was on the dais  and he accused  Rajan as a “ luddite “ ( a 19^thcentury expression for being a violent protester ) . Rajan was proved right . ….Rajan has also clear positions on austerity measures and he is at loggerheads the liberal Princeton economist Paul Krugman ( Nobel prize winner).”  

 FSLRC  report inter alia makes the following recommendations:

·  The actual functioning of the regulator should lie in three areas — regulation-making, executive functions and administrative law functions.

·  Any policy should be made not just by the RBI Governor but by a council comprising Governor and Deputy Governor from RBI and five more external members appointed by the Government.

·  The Government, in consultation with the Governor, should give the Central Bank quantifiable, measurable objectives; the RBI will need to state reasons why it has failed to achieve the objectives and what remedial action it will take to achieve the objectives.

·  The government and not the RBI should make rules with respect to capital inflows. This recommendation is irrespective of whether the inflows are FDI, FII, Forex loans or NRI deposits.

·  The RBI will also be the banking regulator but it won’t have any control over non-bank finance companies (NBFCs).

·  The Reserve Bank of India should be responsible only for overseeing the banking industry and for monetary policy, while the management of the government’s debt and of foreign remittances (thus far under the exclusive domain of the RBI) should be directly under the supervision of the government.

·  With regard to capital control, the Finance Ministry should make rules for inbound capital flows, while the onus of making rules for outbound capital flows should rest with the RBI.

As observed in the earlier part of this article, Rajan is a fast learner. One hopes, during his OSD(Officer on Special Duty) days in RBI from the second week of August, 2013, he had occasion to glance the following books:

1.       History of the Reserve Bank of India Vol I

2.      All India Rural Credit Survey

3.      Review of the Indian Monetary System (Sukhmoy Chakrabarty)

4.      Report of the Committee on Financial Sector Reforms (Narasimham Committee)

These will give Dr Rajan a feel of the role played by RBI since its inception in the evolution of the financial system to meet the country-specific needs. A reading of these books will also tell one why the cut and paste FSLRC report is not finding favour inside RBI.

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*Article published in The Global ANALYST, September 2013. A slightly edited version appears @pages 60-64 of my 2014 book “Banking, Reforms & Corruption: Development Issues in 21^st Century India”