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Subbarao’s effectiveness has been compromised by a government that often appears to think of RBI as a vacuum cleaner |
Reserve Bank of India Governor D Subbarao will complete his three-year term in early September. It remains to be seen if he will get an extension, but it is best to avoid the useless speculative zeal that some columnists and the local media have succumbed to. However, it is instructive to assess his hits and misses. He is the third consecutive RBI Governor who had to navigate the Indian economy through significant global financial and economic turbulence. Earlier, Bimal Jalan (1997-2003) had to deal with the fallout of the Asian financial crisis of 1997, and Y V Reddy (2003-08) had to check the build-up of the global liquidity-driven boom-bust cycle. The complexities were different in each case as the Indian economy continued to increase its integration with the rest of the world. However, each governor distinguished himself in dealing with the emerging challenges, and in limiting the subsequent economic, social and political costs, though Dr Subbarao probably had the worst cards dealt to him. It was a baptism of fire for Dr Subbarao. After all, he took over from Dr Reddy in early September 2008 and the Lehman bust occurred soon afterwards, pushing the world into uncharted dangerous waters. No one knew exactly how events and markets’ reaction would unfold. There was heightened uncertainty and most of the conventional policy-making tools seemed limited in their effectiveness. Policy makers cannot conduct experiments in such crises, and while everyone wants to be protected, the beast transforms itself suddenly and repeatedly, thus forcing policy makers to be quick on their feet but with no guarantee of success. Dr Subbarao deserves full marks for the aggressive policy response that cushioned the downside to growth following the global financial crisis, for the measures that prevented significant economic crippling, and for engineering a quick economic turnaround. The RBI announced several monetary and non-monetary measures, conventional and unconventional, to deal with the global financial crisis. More importantly, it reportedly resisted the calls for even bigger reduction in rates, and fought against a formal monetisation of the fiscal deficit, the latter being a hard-won battle by the RBI. Central banks are risk managers, not gamblers, and the RBI’s calculated approach paid off. People expect central banks to always have the right answers but it is often forgotten that central banks are run by people and, in the absence of perfect foresight, actions and solutions may not always be clear. This is particularly true when a new crisis erupts as financial innovation outsmarts financial regulation to change the nature of the next crisis. High inflation is where the RBI under Dr Subbarao will get brickbats, some of them undeserved, in my opinion. It goes without saying that the essential dharma of a central bank is to at least keep inflation in check. But India’s inflationary pressures are a complex mix of demand- and supply-side factors, cover food and non-food categories, and are structural and cyclical in nature, with global commodity prices also being a key driver. A lax fiscal policy undermined the effectiveness of monetary tightening, and poor RBI was left to clean up the mess while making sense of the embarrassingly inadequate and poor-quality economic data published by the government. The lasting solution for India’s inflation challenge lies with the government’s supply response and faster reforms, not just in higher interest rates. Dr Subbarao continued with the reform agenda of developing the local financial markets and sticking with the gradual liberalisation of the capital account. But his term should be best remembered for the path-breaking hands-off approach towards the rupee, partly owing to the compulsions of a tight monetary policy. The hike in the savings deposit rate was another important decision during his term, so was the move to a single policy rate (finally!). He brought about some important changes in monetary policy communication, including the release of the minutes of the meetings of the technical committee on monetary policy. These matter less for the common person but play a crucial role in the transmission across the financial world, which in turn affects the real economy. The policy statement was shortened and policy reviews were moved to a six-week cycle, the latter being an important reform. However, the live telecast of monetary policy was an unnecessary overkill. A recent editorial in this paper unconvincingly argued about moving back to a quarterly frequency for policy reviews. Bad advice sometimes crops up in the most unexpected areas, as was the case with this suggestion. The need and importance of the six-week cycle arise because India is more integrated with the rest of the world, which is, in any case, in a topsy-turvy mode. There are quickly shifting global cross-currents and the high-frequency data allow for quicker reaction than waiting for once-a-quarter move. More importantly, high frequency of meetings does not mean that the RBI has to act at each meeting, but such a schedule anchors markets to expect any possible move as per the schedule rather than the old “anything, anytime” approach that added to policy uncertainty. Dr Subbarao, with his surprisingly disarming personality for a central banker, often explained things in a non-technical manner, and was refreshingly secure to avoid pretending to know more than he did. He often came across as a consensus builder but was not a pushover as initially feared. He spoke his mind on issues such as the Financial Stability Development Council and the setting up of the debt management office (DMO). Ironically, as finance secretary, Dr Subbarao had endorsed the DMO, but as RBI Governor, he has been right to advise not to rush into it. The DMO should eventually happen, but the government first needs to show fiscal responsibility by convincing investors that it can properly add and subtract on its fiscal accounts. In the final tally, the positives under Dr Subbarao’s tenure more than outweigh the negatives. High inflation is perhaps the biggest stigma but that outcome would have been there no matter who was leading the war. This is because the government’s irresponsible fiscal approach and the embarrassing inability to move on reform initiatives undermined the effectiveness of monetary tightening. Indeed, Dr Subbarao’s constructive record as RBI Governor does not warrant a place in history as the first of the four consecutive Governors to be denied less than five years in office. He surely deserves better, and has earned it.
The author is senior economist at CLSA, Singapore. The views expressed are personal
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