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.
Receive Daily Updates
Recent Posts
Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.