RBI’s autonomy as regulator at risk

As Raghuram Rajan prepares to move out of the office of the RBI Governor, the implications of his exit and the manner in which he has been booted out raise important issues that go well beyond the RBI and will reinforce fears that the establishment will brook no voice that does not sing its tune. While the government decides and the media speculates on who will take over, this is also a good time to contemplate how the RBI will be managed hereon and what direction the monetary policy of the country will take going forward.

The message the episode leaves for a range of professional leaders and advisors across institutions is not that they must perform their duty to the best of their ability and in the light of objective information but that they must read the signals coming from above and act as told.

There can be no doubt that the government is not obliged to renew the tenure of the Governor and it has allowed him to serve out the agreed term.  Yet, there is little doubt that the exit has been unpleasant, made more so by the wild cat and personal attacks on Rajan when he could not respond directly while holding high office. This has left a bad taste with many in the RBI and all those who have regard for the manner in which Rajan has led the central bank.

The message the episode leaves for a range of professional leaders and advisors across institutions is not that they must perform their duty to the best of their ability and in the light of objective information but that they must read the signals coming from above and act as told. This cannot be a comforting thought; it hurts the system, blanks out good advice and pushes ‘yes men’ over professionals.  It leaves us poorer, weaker and less ready to meet the challenges of our time.

That apart, there are some specific issues at the RBI that travel well beyond the institution itself.

Before he leaves, Rajan will have the opportunity to put his seal on one last monetary policy statement on August 9, less than a month before he remits office at the end of his three year tenure on September 4. This will also be the last time any Governor will have the last word on the direction of the monetary policy. All policies from thereon will be guided by a committee, which brings down the power of the Governor and his internal team of RBI advisors but also opens up a host of issues, particularly under a government that can get overbearing.

The committee system works well in the US, where the policy is guided by a 12-member Federal Open Market Committee, the FOMC, and the Bank of England, which runs with a nine member committee. In India, the committee system was suggested by the RBI and pushed by the Governor.

In principle, a committee is better than an individual, howsoever accomplished, because it brings to the table views and perspectives from outside the RBI, which can be technically sound but disconnected from what ails the common man, particularly when it comes to issues like price rise, unresponsive banks and bad loans. In the case of the RBI under Rajan though, it is a case of the RBI coming out more aggressively on worries about price rise and the government apparently looking not too pleased about it!

In these circumstances, the worry would remain that a committee system will be used to push a line that may not be in sync with the current reading on the health of the economy as seen by an independent and professionally run RBI.

In that sense, the transition is a huge change that should best have been navigated by a Governor who has been in the saddle, understood the RBI and has had time to take a considered longer-term view of the economy.

A new Governor with a new system to guide monetary policy under an establishment that is known to push a particular line, which is to lower rates and enable quicker growth, makes for a combination that cannot inspire confidence at a time when we have important internal as well as global challenges facing us.

The farewell statement from Rajan to his staff leaves little doubt that he was “open to seeing…through” the transition to the committee system and the other unfinished task of the bank clean up initiated under Asset Quality Review. This leaves little doubt that he has had little choice but to exit at this time.

What is worse, the challenge to the Governor’s position has come on an issue that should worry all those concerned with a directional view that promotes and even demands short term growth boosters in the form of interest rate reductions at a time inflation has barely come under check and continues to remain a worry.

Will the Narendra Modi government be keen on showcasing a growth story at the cost of price stability that matters the most to the weakest or does it prefer a different pace, one that balances growth with price stability and is advocated by the RBI going slow on rate cuts?

It bears repeating that there are serious concerns to this approach and no one better articulated them than the late and highly respected economist Savak Tarapore, who held the office of the Deputy Governor of the RBI.

“You can't slay the dragon of inflation without hurting growth,” Mr. Tarapore had once said, quoting economist CA Yandle. And elsewhere, he wrote as clearly as only he could by warning that the biggest threat to the high growth story is the inflation spiral. He said, “Given the large number of the poor in our country, a 6-7% sustained growth with a 3-4% inflation would be preferable to a 9% growth with a 9-10% inflation.”

This should be the dharma of the RBI, words that ought to be framed and hung in the office of every Governor.  That could possibly be one important act that Rajan could do before he demits office, leaving behind a strong message to any new Governor that the RBI is mandated to work for non-inflationary growth and that inflation, if unchecked, will inevitably and eventually kill growth.

The question therefore is not one of economic policy or the persona of the governor and whether he stays or goes but one of the political direction under the BJP. Will the Narendra Modi government be keen on showcasing a growth story at the cost of price stability that matters the most to the weakest or does it prefer a different pace, one that balances growth with price stability and is advocated by the RBI going slow on rate cuts?

To the extent that the non-renewal of Rajan’s tenure indicates the former, it brings bad news not only for the poor of India but paradoxically also for growth because that too will tumble when the priorities of those in power are so skewed.

(Jagdish Rattanani is Editor, SPJIMR. Ranjit Pattnaik is Pofessor, SPJIMR. Views are personal)