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The Reserve Bank Governor’s rich legacy

— PHOTO: K. PICHUMANI

IN AND OUT: The new Reserve Bank of India Governor, D. Subbarao (left), with his predecessor Y. V. Reddy.

The credit and monetary policy for 2008-09 had spelt out a hierarchy of policy objectives: price stability and anchoring inflation expectations; ensuring orderly financial markets and maintaining conditions conducive to growth. RBI Governor Y. V. Reddy had then explained that a prioritisation of the traditional monetary objectives was relevant but only for the short-term: the priorities would naturally change depending on the circumstances, he had said.

In what proved to be Dr. Reddy’s last annual policy statement _ there was a quarterly review in July _, reining in inflation dominated all other policy objectives. Indeed several months earlier, the central bank had come out strongly in favour of containing inflation even if that meant slower economic growth.

There is always a trade off between growth and price stability anywhere while implementing monetary policies. However, whereas until last year the

RBI as well as many other central banks could do a ‘deft balancing’ of the often conflicting pressures, this year has been vastly different. Around the world, central banks have been forced to hike interest rates to curb demand side pressures.

In India too, the RBI has been tightening the monetary screw thereby pushing up interest rates. Various administrative and supply side measures taken by the government to increase the availability of essential commodities were not sufficient.

Last Friday, when Dr. Reddy handed over the baton to D. Subbarao, inflation at 12.34 per cent was more than twice the target range of 5 - 5.5 per cent. Economic growth has been slowing down. The Prime Minister’s Economic Advisory Council had scaled down its forecast for the year tojust 7.7 per cent. The official estimate for the first quarter (April-June ) was 7.9 per cent.

It will be totally unjustified to attribute the slowdown amidst persistent inflation to the tough monetary policies alone. Inflation this time has been a global phenomenon. Both developed and developing countries are relying on their central banks to curb inflation. In India, the loose fiscal policy involving subsidies, loan waiver and so on is equally responsible for the high inflation.

Yet it is the RBI’s interest rate policy that seems to have been at the centre of a controversy between the central bank and the Finance Minister. Although recent interest rate hikes were publicly endorsed by Finance Minister Chidambaram there have been many occasions in the past when he tried talking down the rates even if the monetary signals from the RBI called for higher interest rates. It is to the credit of Dr. Reddy that he succeeded in preserving central bank autonomy in the face of tremendous pressures. After all, lower interest rates resonate well with highly vocal sections of commerce and industry too. Public sector banks are forever listening to their political masters rather than to the central bank while formulating their individual interest rate policies.

That brings into focus the RBI’s role in furthering financial sector reform. There has been no dearth of recommendations. Two recent reports covering the entire gamut of reform including one by a committee headed by former IMF chief economist Raghuram Rajan are available. However, the RBI’s approach to reform and other contentious matters has been calibrated.

On several occasions and on several contentious matters, RBI governors, whether Dr. Reddy or his predecessor, had chosen a calibrated approach. In the Indian context, ‘big bang’ measures such as complete exit of the government from ownership of PSBs are simply not possible. However, what is important to note is that there have been substantial achievements in areas such as maintaining financial stability and regulation of non-banking finance companies (NBFCs).

Consider the following:

(1) Banks and financial institutions in the developed world are reeling under the onslaught of the sub-prime and credit market crises. If Indian institutions are largely spared, it is primarily due to the intrinsic strengths of policies. A conservative, cautious approach to opening up the financial sector to foreign capital has stood the country in good stead.

(2) There is no home-grown sub-prime crisis either. As far back as 2004, the RBI had warned banks against some reckless lending by way of home and retail loans. Such exhortations, very unpopular at the time, have been proved right.

(3) More specific examples include the measured moves toward capital account convertibility. While the current account has been liberalised, the capital account still has restraints whose number is however coming down. The important point is that very few countries have full convertibility. Besides, with ongoing relaxations, very few miss full convertibility of the rupee.

(4) All Indian banks have raised the capital necessary to meet the Basel II requirements. This is a tremendous achievement considering the plight of major banks from the West.

(5) NBFCs, especially the loosely regulated residuary non-banking finance companies, are being brought under regulation. This has been an extremely sensitive issue considering the political clout some of them have.

(6) Consumers have been getting a better deal. The banking ombudsman machinery has been strengthened; credit card users are to get a better deal.

(7) There has been progress in areas such as inclusive banking and financial education. These are areas that are only now receiving their due attention even in the West.

Finally, it is important to stress the point that during the first four years of Dr. Reddy’s tenure there was spectacular growth accompanied by low inflation. It is only in the last year that inflation has surged and growth is moderating.

Dr. Reddy’s legacy goes far beyond some of the impressive achievements listed above.

He has been a communicator par excellence — not merely to the markets. He has the gift of simplifying even arcane monetary policy statements.

One hopes that his departure from the RBI gives him more time and opportunity to practise his vaunted communication skills.

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