Central bank rerun

It is now official that Duvvuri Subbarao will be governor of the Reserve Bank of India for two more years. Subbarao has already steered the RBI through some of the most difficult times,and in view of the greater uncertainty and challenges that may face financial markets in the coming days,an extension is a good decision. Subbarao became RBI governor just at the beginning of the global financial crisis and therefore faced immense challenges right from the beginning he handled them well and put together a speedy and appropriate policy response. The earlier,relatively more conservative,regime might have perhaps had a greater resistance to the kind of quick and bold steps that Subbarao was able to make.

Once again the RBI will face many difficult challenges. The global economy is going to be a difficult one to handle. Emerging economies cannot escape the problems that the US and Europe will throw up. Global and domestic currency and bond markets could easily see turmoil in the coming two years. The RBI governor will need to be alert and nimble in his responses to what may come. One of Subbaraos biggest contributions to monetary policy in India has been to move away from a de facto peg to the US dollar. Despite pressure on exports,large capital inflows and high volatility of exchange rates,the RBI did not intervene significantly in currency markets and pile up dollars. The lessons Subbarao must have learnt as finance secretary before he became RBI governor would have included the difficulties of sterilised intervention. This lesson clearly proved to be valuable and his decision to stay away from large-scale intervention in currency markets gave RBI monetary policy independence. On the other hand,as RBI governor,Subbaraos biggest failing has been in controlling inflation. Indeed,inflationary expectations have worsened under his governorship very sharply. He has raised interest rates sharply in an attempt to control inflation,but thanks to badly drafted speeches harking back to RBIs old themes and language,he has not sent out the right messages. He has not convinced households and markets that his commitment to inflation control stands above all else that the RBI is required to do.

In the next two years,apart from negotiating through the expected global uncertainty,Subbaraos biggest challenge will be to reorient the multi-instrument,multi-objective,non-accountable,non-transparent RBI into a central bank that promises and delivers price stability. He has now been given another chance to change the RBI and help it fit the needs of a rapidly growing India.