Two pluses, one minus and an unknown

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A change of guard is taking place at the Reserve Bank of India (RBI) and it is a good time to look at recent history and seek some lessons. India is fortunate in having more than one distinguished RBI governor steady the economic ship during periods of global turmoil. While recalling that, it is also necessary to ask what the future holds.

Bimal Jalan's tenure as RBI governor is mainly remembered for the way India was able to avoid the ripple effects of the Asian financial crisis. This was made possible partially by the country's earlier conservative approach to financially opening up to the rest of the world. Mr Jalan's personal style of out-of-the-box thinking and not doing what the market expected at particular junctures also helped. Always known for the light touch he brought to policy making, Mr Jalan was far from being a prisoner of any kind of orthodoxy.

Y V Reddy, the next governor, was a career civil servant who brought with him some unforgettable lessons learnt during his days at the Union finance ministry when the country faced the most serious balance of payments crisis since Independence. His tenure was marked by the resolve with which he resisted the pressure from the Union finance ministry to take the country down the road towards full capital account convertibility. As the global financial crisis broke out in 2008 and the contagion engulfed Europe, there was near-universal relief that Mr Reddy had not broken down the battlements. For this, of course, he did not earn the gratitude of the finance ministry. In fact, the foundations of animus between the two were laid and got worse over time.    

Unfortunately, D Subbarao's stewardship of the RBI will not be remembered in the same positive way as that of his two predecessors. He leaves even as the country faces severe external pressure, which is manifest in the rupee's decline. Some depreciation in the wake of an inflationary bout is considered a good corrective, but the pressure on the rupee seems unrelenting. Mr Subbarao's policies did not create the inflationary pressures that are pulling the rupee down (the credit for that goes to the government's fiscal policies), whereas Alan Greenspan's policies led to the global financial crisis.

In a way Mr Subbarao was plain unlucky. But that is not all. The RBI under him responded according to conventional monetarist principles when maybe a Jalan or a Reddy would have thought more unconventionally. In the face of inflation, it tightened money and raised interest rates - which put a damper on business confidence and played a role (along with the global slowdown) in decelerating India's growth rate. There was an inability to see that the culprit was food inflation, which was brought on by more buying power in the hands of poor people. They don't borrow from a bank to buy more food; but businessmen do to invest in expanding capacity.

When the rupee came under pressure, the RBI stopped monetary easing and halted the downward journey of interest rates. This adversely affected business sentiment. These moves haven't had the desired results so far. It is unlikely that higher interest rates and tighter liquidity will ease the pressure on the rupee. What will help is a weaker appetite for gold, as inflation goes down and higher fuel prices are dampening demand for energy.

Raghuram Rajan's appointment as RBI governor has been widely welcomed. Two aspects of his record need to be remembered. He made history by foreseeing the global financial crisis. What is not so widely remembered is that, in his report on financial sector reforms, he advocated greater capital account convertibility (along with much else) - advice that seems unsound with hindsight. Further, recently, he seemed open to the idea of India floating sovereign bonds abroad to shore up reserves, an option that was ruled out subsequently. While India has issued such bonds earlier during tight balance of payments situations, current conditions do not appear to require such a measure.

Overall, his thinking seems to be in the Fund-Bank mould - when what has saved India in the past is going against received wisdom. The Indian economy and the social forces driving it are far too complex for solutions of any particular kind to work. Besides, there's no point in having a brilliant RBI governor if politicians do not listen to him. You need a person who is able to add persuasion to advice behind the scenes. In this, an insider who knows how the system works has a greater chance of success.

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