Trial by fire

Dr Subbarao completes a generally successful first year

Duvvuri Subbarao, who completes his first year as Reserve Bank governor today, took office under very adverse circumstances. The global recession was under way, reinforced by the fact that central banks around the world had hiked their policy rates to combat the inflationary surge of early 2008. That surge was abating by the time Dr Subbarao took office, but the lagged effects of interest rate increases were yet to be felt. Within a week of his assuming office, Lehman Brothers went bankrupt, which triggered violent upheavals in the global financial system. For countries like India, this was the prelude to massive outflows of capital as global investors flew to "safe" havens. The RBI had to deal simultaneously with the combined impact of a worsening recession and an acute liquidity crunch. Looking back over the year, how did it do?

Overall, it has done quite well, although it took some time for RBI to get started and there were some missteps in the initial months when the regular policy reviews saw surprising inaction, followed quickly by policy measures as if to make up. From October 11, a steady series of measures was undertaken to infuse liquidity into the system (through reductions in the cash reserve ratio) and reduce the cost of funds (through cuts in the repo rate). In early December, there was a significant display of co-ordination between the finance ministry and RBI, with the simultaneous announcement of a fiscal stimulus package and banking measures that would, among other things, provide support to a rapidly degenerating construction sector.

Then, the second week of March saw an abrupt turnaround in global equity markets; this caused a sharp reversal in capital flows and also helped ease domestic liquidity conditions. With the exception of exports, signs of stabilisation in the real economy (including significantly the real estate sector) became visible. The challenge now shifted to dealing with the pressure on interest rates that the huge increase in government borrowing requirements was exerting. Concerns about excessive accommodation by the RBI were expressed in the run-up to the July policy announcement. To his credit, Dr Subbarao shifted to a neutral stance in keeping with the general global pattern. Going forward, balancing the need to manage inflationary expectations with keeping interest rates soft enough to revive private spending is the next challenge he will have to face. The trial is not over by any means, but Dr. Subbarao seems to have come to grips with the rapidly changing landscape.

One weakness of his first year has been an inadequate use of occasion. Even while the crisis was at its deepest, he did not announce any changes in the quarterly statements of October 2008 and January 2009, leading many people to infer that the RBI was under-estimating the severity of the problem. His actions between announcements, though, clearly suggested otherwise. From an organisational perspective, his views on greater transparency and internal debate around policy issues reflect his intent to modernise the 75-year-old institution that he heads. As he completes his first year in office, there is growing assurance that he was indeed an appropriate choice.