Centring the bank

The new RBI governor, D. Subbarao, faces many difficult challenges. In the short term, inflation looms large. With the rupee continuing to depreciate, it is difficult to bring inflation under control. The governor should move away from the traditional approach of raising interest rates. Using reserves and easing capital controls to strengthen the rupee could help in controlling prices without hurting growth. In the longer run, Subbarao8217;s biggest challenge is to support the financial sector and monetary policy reforms. India is integrating with the world economy at a fast pace. RBI must provide an environment and a regulatory framework that encourage and facilitate India8217;s globalisation.

The first challenge is to dismantle the licence permit raj in Indian finance. In the early 8217;90s India implemented reforms in trade and industry and got rid of the licence permit raj that characterised socialist India. Today such reforms need to be done in the financial sector. In recent months there has been a lively debate on these issues led by the Percy Mistry and Raghuram Rajan reports on the financial sector. The governor has the responsibility of taking the recommendations related to RBI forward. The setting up of a new regulatory architecture that caters to the needs of modern finance will require sacrificing turf and adopting policies that are good for the economy, rather than the narrow objectives of the institution.

An equally important challenge is the reform of RBI itself. A number of central bankers around the world have relieved themselves of their other responsibilities like public debt management, banking regulation and exchange rate policy and become wholly focused on inflation. This would involve handling not only conservative, closed economy worldviews, but also the RBI union and staff in this transformation to a smaller, modern central bank focused on inflation. The task of setting up an inflation-targeting central bank requires an intellectual armour that RBI does not possess today. It will not be enough to move away from the focus on the currency as recommended by Mistry and Rajan. It needs the creation of a new framework for monetary policy compatible with the needs of modern India.