Does RBI need a political governor?

Raghuram Rajan, India’s banking czar, will be history by September 2016. He enjoys unprecedented popularity and near cult status as Reserve bank governor. While some of this has to do with his youthful looks and fresh demeanour — very unusual in a profession peopled by dour old men, much of his appeal is related to the confidence and skill he brings to the job, which he plunged into in weeks rather than months, that is the usual learning curve. Industry — usually taciturn about rooting for bureaucrats, came out openly in support of his conservative strategy to keep the rupee stable, build foreign reserves, check inflation and keep the interest rates at levels that give real returns to the large mass of middle-class savers.

International capital flows are as much about fundamentals as about the rutba — the credibility and charisma — of the Central bank. Dr Rajan is the first RBI governor who came to the job with considerable experience in international finance (in the IMF) and even more significantly, a long spell in American academia, working in the same area. To the billionaires who make the markets move, Dr Rajan is a familiar face, with a track record of original thinking and practical foresight. He is best known for disagreeing with mainstream economists and foretelling the 2008 financial meltdown.

In India, his legacy is the exquisite symphony, he wrote, of caution mixed with big-bang reforms. On interest rates, he was consistently cautious. His mantra was that flooding the economy with cheap money is not a quick-fix for growth. Instead, it can spark off high inflation, as in Brazil. To the common man, this resonates well with the millennium’s conundrum of jobless, inequitable, high growth. Given these flaws in today’s post-industrial, service-oriented growth, Dr Rajan preferred to focus on keeping inflation low, preserving the real incomes of the disadvantaged who don’t have the luxury of inflation-indexed incomes.

His historic big reform was to publicly finger banks that had lent inefficiently, destroyed capital and most likely enhanced corruption — given the magnitude of bad loans accumulated by them since 2011. He shone a bright light on the bad loans overburden rather than keeping them hidden under furtive refinance Ponzi schemes. He was likened by “incrementalist reformers” to a bull in a china shop — pulling down both fraudsters and unlucky entrepreneurs alike.

Admittedly, big-bang reforms shake up the cozy status quo and inflicts pain. But if followed through with decisive surgery, as Dr Rajan recommended, it can create wealth rather than slowly bleed the financial system till it collapses, as happened in 2008. Will there ever be another Rajan as RBI governor? India is a conflicted society — at once eulogising “white knights” like Dr Rajan, and yet shrinking away from creating ripples in the village pond.  It takes a lifetime of work in India to play the system harmoniously. Dr Rajan came before India was ready for him. So while we may not be able to digest a Rajan today, there is unlikely to be a shortage of “suitable” talent. But the real pity is — why have we tried to “fix” a system that is not broken. Why not let the good work continue?

The irony is that by letting Dr Rajan go in September this year, the government will actually be cementing his “rock star” legacy. The second half of 2016 is blighted by uncertainty and will be hell for the new governor. First, is the near-term questionmark over Brexit on June 23. If the “Leavers” win, Europe is surely in for turbulent times. But this may not actually happen, as the British are far too practical.

Second, even without a Brexit, the economic outlook is gloomy. Protectionism is growing and geopolitical instability is getting worse. These are rich grounds for a flight of capital to safety and away from emerging markets like India. A tightening by the US Federal Reserve in the second half of this year can convert the capital flight into an outward-bound tsunami, severely denting our foreign exchange reserves. The only good news is that oil prices are likely to remain low. The low lead time for the mothballed 500-odd oil fracking rigs in the United States to return to work ensures that any uptick in price beyond $50 will deliver a supply response. Saudi Arabia, with nominal production costs, a deficit budget and current account and a proposed public listing for its oil company, is unlikely to rein in production or oil revenue. But low oil prices also depress incomes in oil-producing countries, which is bad for Indian exports and disastrous for inward remittances — that are largely dependent on the Gulf countries remaining lucrative employment sinks for Indian expatriates.

Low growth potential in the coming years, combined with the domestic compulsions of the largest state election in Uttar Pradesh in 2017 and a national election in 2019, are likely to strain the fiscal discipline which the finance minister has imposed since 2014. We need a governor who has the political acumen to align with the government’s compulsions of quickly improving the well-being of voters and also the economic guile to minimise the resultant damage caused by politics to the economy. This can only be someone who has his finger on the pulse of Bharat; the experience of having walked this tightrope earlier and the good fortune of being lucky.

His main job would be to strike practical deals — with big defaulters to ensure that capital starts getting rolled over; with banks so that interest rate cuts are passed on to consumers; with the government so that Dr Rajan’s efficiency-enhancing steps of cutting red tape and discretion in licensing of financial intermediaries are carried forward and banking discipline maintained. The macro-economic ball is likely to be played mostly by the government. What it should guard against most are self-goals.