1957 was an eventful year in Reserve Bank of India’s history. Sir Benegal Rama Rau was the fourth Reserve Bank governor, and till date remains the longest serving head of the institution from 1949 to 1957.
A member of the Indian civil service like his predecessor Sir Chintaman Deshmukh, Sir Rama Rau was known for his mild manners but he was a determined central bank governor, and oversaw the first round of banking sector consolidation post-independence. He also has the unfortunate distinction of being the first RBI governor to resign under unpleasant circumstances.
On his actions to raise interest rates, the finance ministry under TT Krishnamachari belligerently asked Rama Rau to reconsider his stance. Having issued an order, it is chronicled that TTK (as Krishnamachari was known as) and Rama Rau had a public altercation in the finance ministry, post which Rama Rau tendered his resignation, lest he be fired publicly from the job. For what it is worth, the cabinet under Jawaharlal Nehru sided with TTK and conveniently threw the institution of RBI along with its governor under the proverbial bus.
From there on, for a considerable period of time, finance secretaries or chairman of State Bank of India were handpicked to run the central bank for several decades and it took longer for the institution to recover from that balmy January morning in 1957.
Conflict over the operational control of monetary policy and interest rates between various stakeholders is not new in India. It is also not a problem unique to India. Since the Reserve Bank of India was set up in 1935, it has successfully dealt with operational challenges from State Bank of India over controlling India’s monetary system in the early years. Later on, the RBI successfully navigated economic liberalization to barter for considerable independence on setting monetary policy from the Ministry of Finance. Not having to monetize fiscal deficits was a major step in that direction. However, being independent does not imply lack of interdependence. Indeed, with the overarching shadow of fiscal policy on India’s inflation and external sustainability, RBI can hardly hope to control inflation or inflation expectations without critical support from and coordination with the Ministry of Finance.
With that as a backdrop, it is worth contemplating over the recent histrionics that India and India watchers have been subjected to over the renewal of Governor Raghuram Rajan’s term, which expires later this year. This author in the past has actively backed Governor Rajan’s actions, and is probably what you would call in twitter language his ‘bhakt’. But the most dismaying aspect of this public and increasingly ugly tussle between Rajan’s backers and his detractors is their lack of faith and concern in the institution of RBI and over the top predictions on the coming apocalypse if Governor Rajan was to exit the central bank.
The biggest irony for the author is that this scare mongering of a meaningful and long lasting economic blowback ignores the biggest reforms Governor Rajan himself has pursued in the Reserve Bank during his term, that is of institution building.
Let us take the constitution of an independent Monetary Policy Committee (MPC) as a prime example. By vouching for an MPC with independent members to be set up, both the central bank and the government are pursuing a more democratic and modern monetary policy setup. At the same time, adopting a flexible inflation targeting regime makes India’s monetary policy more rule based, and to an extent zeroes in on India’s fundamental problem, that is inflation.
For the policy watchers calling for billions of outflows if the incumbent leaves, one can safely say that these institutional reforms are unlikely to be reversed, atleast in the very near term. For international investors who are used to high inflation and persistent currency depreciation in India, governor Rajan spoke and acted on the right issues. However, his departure may only be a necessary, but not a sufficient condition for these investors to lose faith in India’s economic potential. As long as institutional focus on keeping inflation in check and rupee under control remains, India will continue to be a major destination for foreign investment.
Leadership at the RBI is important. Post liberalization, India has had a great run with RBI governors. They have successfully navigated the economy through multiple periods of crisis, and deepened India’s financial system significantly, providing a bedrock for the country to grow on. However, from a long term perspective, rather than worrying about outflows on a personnel appointment, preserving the autonomy and credibility of the institution is the key challenge in front of both the incumbent governor and the government. This can only be achieved by bringing in the best practices and hiring the best people to work at the central bank.
In fact, the more distressful aspect of the entire speculation for this author is around the list of possible successors being mooted, and the lack of institutional respect accorded to the RBI itself by proposing these names. In a sense, by appointing Raghuram Rajan, former finance Minister P Chidambaram shifted the goalpost, and some viable candidates by an earlier metric fall significantly short in matching up to the incumbent.
However, even if governor Rajan’s term is extended, it is likely to be not more 2-3 years, upon which he will most likely move back to academia, as he has long stated. As such, for the government and hopefully for Governor Rajan in his second term, the more pressing question to address and ponder over in next two to three years is how does one build upon the institutional credibility of the central bank and India’s financial system in a manner, that it does not remain beholden to an individual.